[Federal Register Volume 85, Number 148 (Friday, July 31, 2020)]
[Rules and Regulations]
[Pages 46422-46530]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-15525]
[[Page 46421]]
Vol. 85
Friday,
No. 148
July 31, 2020
Part IV
Department of the Treasury
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Office of the Comptroller of the Currency
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Federal Reserve System
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Federal Deposit Insurance Corporation
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Commodity Futures Trading Commission
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Securities and Exchange Commission
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12 CFR Parts 44, 248 and 351
17 CFR Parts 75 and 255
Prohibitions and Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds and Private Equity
Funds; Final Rule
Federal Register / Vol. 85, No. 148 / Friday, July 31, 2020 / Rules
and Regulations
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DEPARTMENT OF TREASURY
Office of the Comptroller of the Currency
12 CFR Part 44
[Docket No. OCC-2020-0002]
RIN 1557-AE67
FEDERAL RESERVE SYSTEM
12 CFR Part 248
[Docket No. R-1694]
RIN 7100-AF70
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 351
RIN 3064-AF17
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 75
RIN 3038-AE93
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 255
[Release No. BHCA-9; File No. S7-02-20]
RIN 3235-AM70
Prohibitions and Restrictions on Proprietary Trading and Certain
Interests in, and Relationships With, Hedge Funds and Private Equity
Funds
AGENCY: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); Securities and Exchange
Commission (SEC); and Commodity Futures Trading Commission (CFTC).
ACTION: Final rule.
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SUMMARY: The OCC, Board, FDIC, SEC, and CFTC (together, the agencies)
are adopting amendments to the regulations implementing section 13 of
the Bank Holding Company Act (BHC Act). Section 13 contains certain
restrictions on the ability of a banking entity or nonbank financial
company supervised by the Board to engage in proprietary trading and
have certain interests in, or relationships with, a hedge fund or
private equity fund (covered funds). These final amendments are
intended to improve and streamline the regulations implementing section
13 of the BHC Act by modifying and clarifying requirements related to
the covered fund provisions of the rules.
DATES: Effective date: The final rule is effective October 1, 2020.
FOR FURTHER INFORMATION CONTACT:
OCC: Roman Goldstein, Risk Specialist, Treasury and Market Risk
Policy, (202) 649-6360; Tabitha Edgens, Counsel; Mark O'Horo, Senior
Attorney, Chief Counsel's Office, (202) 649-5490; for persons who are
deaf or hearing impaired, TTY, (202) 649-5597, Office of the
Comptroller of the Currency, 400 7th Street SW, Washington, DC 20219.
Board: Flora Ahn, Special Counsel, (202) 452-2317, Gregory
Frischmann, Senior Counsel, (202) 452-2803, Kirin Walsh, Attorney,
(202) 452-3058, or Sarah Podrygula, Attorney, (202) 912-4658, Legal
Division, Elizabeth MacDonald, Manager, (202) 475-6316, Cecily Boggs,
Senior Financial Institution Policy Analyst, (202) 530-6209, Brendan
Rowan, Senior Financial Institution Policy Analyst, (202) 475-6685,
Christopher Powell, Senior Financial Institution Policy Analyst, (202)
452-3442, Nathaniel Grant, Lead Financial Institution Policy Analyst,
(202) 452-3105, David McArthur, Senior Economist, (202) 452-2985,
Division of Supervision and Regulation; Board of Governors of the
Federal Reserve System, 20th and C Streets NW, Washington, DC 20551.
FDIC: Bobby R. Bean, Associate Director, [email protected], Andrew D.
Carayiannis, Senior Policy Analyst, [email protected], or Brian
Cox, Senior Policy Analyst, [email protected], Capital Markets Branch,
(202) 898-6888; Michael B. Phillips, Counsel, [email protected],
Benjamin J. Klein, Counsel, [email protected], or Annmarie H. Boyd,
Counsel, [email protected], Legal Division, Federal Deposit Insurance
Corporation, 550 17th Street NW, Washington, DC 20429.
CFTC: Cantrell Dumas, Special Counsel, (202) 418-5043,
[email protected], Division of Swap Dealer and Intermediary Oversight;
Mark Fajfar, Assistant General Counsel, (202) 418-6636,
[email protected], Office of the General Counsel; Stephen Kane, Research
Economist, (202) 418-5911, [email protected], Office of the Chief
Economist; Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SEC: Juliet M. Han, Senior Counsel, William Miller, Senior Counsel,
Benjamin A. Tecmire, Senior Counsel, or Jennifer Songer, Branch Chief
at (202) 551-6787 or [email protected], Investment Adviser Regulation
Office, Division of Investment Management, and Katherine Hsu, Office
Chief, or Benjamin Meeks, Special Counsel at (202) 551-3850, Office of
Structured Finance, Division of Corporation Finance, U.S. Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Notice of Proposed Rulemaking
III. Overview of the Final Rule
IV. Summary of the Final Rule
A. Qualifying Foreign Excluded Funds
B. Modifications to Existing Covered Fund Exclusions
1. Foreign Public Funds
2. Loan Securitizations
3. Public Welfare and Small Business Funds
C. Additional Covered Fund Exclusions
1. Credit Funds
2. Venture Capital Funds
3. Family Wealth Management Vehicles
4. Customer Facilitation Vehicles
D. Limitations on Relationships With a Covered Fund
E. Ownership Interest
F. Parallel Investments
G. Technical Amendments
V. Administrative Law Matters
A. Use of Plain Language
B. Paperwork Reduction Act
C. Regulatory Flexibility Act Analysis
D. Riegle Community Development and Regulatory Improvement Act
E. OCC Unfunded Mandates Reform Act
F. SEC Economic Analysis
G. Congressional Review Act
I. Background
Section 13 of the BHC Act,\1\ also known as the Volcker Rule,
generally prohibits any banking entity from engaging in proprietary
trading or from acquiring or retaining an ownership interest in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund (covered fund).\2\ The statute expressly exempts
from these prohibitions various activities, including, among other
things:
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\1\ 12 U.S.C. 1851.
\2\ Id.
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Underwriting and market making-related activities;
Risk-mitigating hedging activities;
Activities on behalf of customers;
Activities for the general account of insurance companies;
and
Trading and covered fund activities and investments by
non-U.S. banking entities solely outside the United States.\3\
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\3\ 12 U.S.C. 1851(d)(1).
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In addition, section 13 of the BHC Act contains an exemption that
permits banking entities to organize and offer, including sponsor,
covered funds, subject to certain restrictions, including
[[Page 46423]]
that banking entities do not rescue investors in those funds from loss,
and are not themselves exposed to significant losses due to investments
in or other relationships with these funds.\4\
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\4\ 12 U.S.C. 1851(d)(1)(G). Other restrictions and requirements
include: (1) The banking entity provides bona fide trust, fiduciary,
or investment advisory services; (2) the fund is organized and
offered only to customers in connection with the provision of such
services; (3) the banking entity does not have an ownership interest
in the fund, except for a de minimis investment; (4) the banking
entity complies with certain marketing restrictions related to the
fund; (5) no director or employee of the banking entity has an
ownership interest in the fund, with certain exceptions; and (6) the
banking entity discloses to investors that it does not guarantee the
performance of the fund. Id.
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Authority under section 13 of the BHC Act for developing and
adopting regulations to implement the prohibitions, restrictions, and
exemptions of section 13 is shared among the Board, the FDIC, the OCC,
the SEC, and the CFTC (individually, an agency, and collectively, the
agencies).\5\ The agencies originally issued a final rule implementing
section 13 in December 2013 (the 2013 rule), and those provisions
became effective on April 1, 2014.\6\
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\5\ 12 U.S.C. 1851(b)(2).
\6\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds; Final Rule, 79 FR 5535 (Jan. 31, 2014).
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The agencies published a notice of proposed rulemaking in July 2018
(the 2018 proposal) that proposed several amendments to the 2013
rule.\7\ These proposed revisions sought to provide greater clarity and
certainty about what activities are prohibited under the 2013 rule--in
particular, under the prohibition on proprietary trading--and to better
tailor the compliance requirements based on the risk of a banking
entity's trading activities. The agencies issued a final rule
implementing amendments to the 2013 rule in November 2019 (the 2019
amendments), and those provisions became effective in January 2020.\8\
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\7\ Proposed Revisions to Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships
With, Hedge Funds and Private Equity Funds, 83 FR 33432 (July 17,
2018).
\8\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, 84 FR 61974 (Nov. 14, 2019). The regulations
implementing section 13 of the BHC Act, as amended through June 1,
2020, are referred throughout as the ``implementing regulations.''
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As part of the 2018 proposal, the agencies proposed targeted
changes to the provisions of the 2013 rule relating to acquiring or
retaining an ownership interest in, sponsoring, or having certain
relationships with a fund and sought comments on other aspects of the
covered fund provisions beyond those changes for which specific rule
text was proposed.\9\ The 2019 amendments finalized those changes to
the covered fund provisions for which specific rule text was proposed
in the 2018 proposal.\10\ The agencies indicated they would issue a
separate proposal addressing and requesting comment on the covered fund
provisions of the rule and other fund-related issues, and, in February
2020, the agencies issued a separate notice of proposed rulemaking that
specifically addressed those areas (the 2020 proposal).\11\
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\9\ 83 FR 33471-87.
\10\ In response to the 2018 proposal, the agencies received
numerous comments related to covered fund issues for which no
specific rule text was proposed. However, in the preamble to the
2019 amendments, the agencies generally deferred public
consideration of such comments to a future proposed rulemaking. 84
FR 62016.
\11\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, 85 FR 12120 (Feb. 28, 2020).
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II. Notice of Proposed Rulemaking
In the 2020 proposal, the agencies proposed revisions to a number
of the provisions regarding covered fund investments and activities as
well as to other provisions of the implementing regulations related to
the treatment of funds. The proposed changes, which were based on
comments received in response to the agencies' questions in the 2018
proposal and the agencies' experience with the implementing
regulations, were intended to reduce the extraterritorial impact of the
implementing regulations, improve and streamline the covered fund
provisions, and provide clarity to banking entities regarding the
provision of financial services and the conduct of permissible
activities in a manner that is consistent with the requirements of
section 13 of the BHC Act.
To better limit the extraterritorial impact of the implementing
regulations, the 2020 proposal would have exempted the activities of
certain funds that are organized outside of the United States and
offered to foreign investors (qualifying foreign excluded funds) from
the restrictions of the implementing regulations. Under the 2013 rule,
in certain circumstances, some foreign funds that are not ``covered
funds'' may be subject to the implementing regulations as ``banking
entities,'' if they are controlled by a foreign banking entity, and
thus could be subject to more onerous compliance obligations than are
imposed on similarly-situated U.S. covered funds, even though the
foreign funds have limited nexus to the United States. Accordingly, the
2020 proposal would have codified an existing policy statement by the
Federal banking agencies (the OCC, Board, and FDIC) that addresses the
potential issues related to a foreign banking entity controlling
qualifying foreign excluded funds.
The 2020 proposal also would have made modifications to several
existing exclusions from the covered fund provisions to provide clarity
and simplify compliance with the requirements of the implementing
regulations. First, the 2020 proposal would have revised certain
restrictions in the foreign public funds exclusion to more closely
align the provision with the exclusion for similarly-situated U.S.
registered investment companies. Second, the 2020 proposal would have
permitted loan securitizations excluded from the definition of covered
fund to hold a small amount of non-loan assets, consistent with past
industry practice, and would have codified existing staff-level
guidance regarding this exclusion. In addition, the 2020 proposal would
have revised the exclusion for small business investment companies to
account for the life cycle of those companies and requested comment on
whether to clarify the scope of the exclusion for public welfare and
other investments to include rural business investment companies and
qualified opportunity funds. Finally, the 2020 proposal would have
addressed concerns about certain components of the preamble to the 2013
rule related to calculating a banking entity's ownership interests in
covered funds.
The agencies also included in the 2020 proposal several new
exclusions from the covered fund definition in order to more directly
align the regulation with the purpose of the statute. For example, the
agencies recognized that the implementing regulations have inhibited
banking entities' ability to extend credit by restricting their
relationships with credit funds, and the 2020 proposal would have
created a new exclusion for such funds. Under the 2020 proposal,
banking entities would have been able to invest in and have certain
relationships with credit funds that extend the type of credit that a
banking entity may provide directly, subject to certain safeguards.
Relatedly, the 2020 proposal would have established an exclusion from
the definition of covered fund for venture capital funds. This
provision was intended to facilitate banking entities' abilities to
engage in this important type of development and investment activity,
which may facilitate capital formation and provide important financing
for small
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businesses, particularly in areas where such financing may not be
readily available. In addition, the agencies believed that excluding
such activities would be consistent with the purpose of the statute, as
it would exclude fund activities that do not present the risks that
section 13 of the BHC Act was intended to address.
The 2020 proposal also would have allowed a banking entity to
provide certain traditional financial services to its customers via a
fund structure, subject to certain safeguards and limitations. First,
the 2020 proposal would have excluded from the definition of covered
fund an entity created and used to facilitate customer exposures to a
transaction, investment strategy, or other service. Second, the 2020
proposal would have excluded from the covered fund definition wealth
management vehicles that manage the investment portfolio of a family
and certain other closely related persons. Both of these provisions
were intended to allow a banking entity to provide such services in the
manner best suited to its customers.
In addition, the 2020 proposal would have permitted a banking
entity to engage in a limited set of covered transactions with a
covered fund that the banking entity sponsors or advises or with which
the banking entity has certain other relationships. The implementing
regulations generally prohibit all covered transactions between a
covered fund and its banking entity sponsor or investment adviser. The
agencies, in the 2020 proposal, recognized that the existing
restrictions have prevented banking entities from providing certain
traditional banking services to covered funds, such as standard
payment, clearing, and settlement services.
Lastly, the 2020 proposal would have clarified certain aspects of
the definition of ownership interest. Currently, due to the broad
definition of ownership interest, some loans by banking entities to
covered funds could be deemed ownership interests. The 2020 proposal
included a safe harbor for bona fide senior loans or senior debt
instruments to make clear that an ``ownership interest'' in a fund
would not include such credit interests in the fund. In addition, the
2020 proposal would have clarified the types of creditor rights that
may attach to an interest without necessarily causing such an interest
to fall within the scope of the definition of ownership interest.
Finally, the 2020 proposal would have simplified compliance efforts by
tailoring the calculation of a banking entity's compliance with the
implementing regulations' aggregate fund limit and covered fund
deduction and provided clarity to banking entities regarding their
permissible investments made alongside covered funds.\12\
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\12\ Separately, the agencies proposed various technical edits
to the implementing regulations. See infra Section IV.G (Technical
Amendments).
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The agencies invited comment on all aspects of the 2020 proposal,
including specific proposed revisions and questions posed by the
agencies. The agencies received approximately 40 unique comments from
banking entities and industry groups, public interest groups, and other
organizations and individuals. In addition, the agencies received six
letters related to the subject matter considered in the 2020 proposal
prior to the formal comment period. The agencies are now finalizing the
2020 proposal, with certain changes based on public comments, as
described in detail below.\13\
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\13\ Comments are generally discussed in the relevant sections,
infra. The agencies also received several miscellaneous comments.
One commenter suggested revising Sec. __.21 (Termination of
activities or investments; penalties for violations) of the
implementing regulations to provide for mandatory prison time for
violations of the implementing regulations. Anonymous. The agencies
believe that this comment is beyond the scope of the current
rulemaking. Another commenter encouraged the agencies to exempt from
the implementing regulations international banks with a small
presence in the United States. Institute of International Bankers
(IIB). The agencies believe that this comment is beyond the scope of
the current rulemaking. A third commenter claimed that the 2020
proposal improperly assumed that the implementing regulations have
certain burdens and that it did not adequately assess the costs and
benefits of the proposed revisions to the implementing regulations.
Occupy the SEC (Occupy). Contrary to the commenter's suggestions,
the Federal Register notice for the 2020 proposal contained
extensive discussion of the costs and benefits of the 2020 proposal.
See 85 FR 12151-76. This final rule contains similar analyses. See
infra, Section IV (Administrative Law Matters). Several commenters
expressed support for the comment letters submitted by other
organizations. E.g., IIB; European Banking Federation (EBF); Goldman
Sachs Group, Inc. (Goldman Sachs); and Canadian Bankers Association
(CBA). Finally, one comment was not relevant. See Charity Colleen
Crouse.
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III. Overview of the Final Rule
Similar to the 2020 proposal, the final rule clarifies and
simplifies compliance with the implementing regulations, refines the
extraterritorial application of section 13 of the BHC Act, and permits
additional fund activities that do not present the risks that section
13 was intended to address. The agencies received comments from a
diverse set of commenters: Comments from banking entities and financial
services industry trade groups were generally supportive of the 2020
proposal and recommended additional modifications, while several
organizations and individuals were generally opposed to the 2020
proposal. As described further below, the agencies have adopted many of
the proposed changes to the implementing regulations, with certain
targeted adjustments.
To reduce the extraterritorial impact of the implementing
regulations, the final rule, similar to the 2020 proposal, exempts the
activities of certain funds that are organized outside of the United
States and offered to foreign investors (qualifying foreign excluded
funds) from certain restrictions of the implementing regulations.
Specifically, the final rule codifies an existing policy statement by
the Federal banking agencies that addresses the potential issues
related to a foreign banking entity controlling a qualifying foreign
excluded fund. The final rule contains some modifications to the
proposed exemption--the anti-evasion provision and compliance program
requirements--to address comments that the proposed exemption would
have unintentionally continued to subject qualifying foreign excluded
funds to these requirements.
The final rule also revises, as proposed, but with some
modifications, several existing exclusions from the covered fund
provisions, to provide clarity and simplify compliance with the
requirements of the implementing regulations. First, the final rule
revises certain restrictions in the foreign public funds exclusion to
more closely align the provision with the exclusion for similarly
situated U.S. registered investment companies. Second, the final rule
permits loan securitizations excluded from the definition of covered
fund to hold a small amount of debt securities, consistent with past
industry practice, and codifies existing staff-level guidance regarding
this exclusion. In addition, the final rule revises the exclusion for
small business investment companies to account for the life cycle of
those companies and clarifies the scope of the exclusion for public
welfare and other investments to include rural business investment
companies and qualified opportunity funds. Finally, the final rule
clarifies the calculation of ownership interests in covered funds that
are attributed to a banking entity.
The final rule adopts--as proposed, with some modifications--
several new exclusions from the covered fund definition to more closely
align the regulation with the purpose of the statute. First, the final
rule establishes a new exclusion for funds that extend credit to permit
the same credit-related activities that banking entities can engage in
directly. In addition, the final rule creates an exclusion for venture
capital funds to help ensure that banking entities can indirectly
facilitate
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this important type of development and investment activity to the same
degree that banking entities can do so directly. Finally, the final
rule adopts two exclusions for family wealth management and customer
facilitation vehicles to provide banking entities flexibility to
provide advisory and other traditional banking services to customers
through a fund structure.
In an effort to clarify and simplify compliance with the
implementing regulations, the final rule adopts revisions to the
provisions that govern the relationship between a banking entity and a
fund and the definition of ownership interest. Specifically, the final
rule permits established, codified categories of limited low-risk
transactions between a banking entity and a related fund, including
riskless principal transactions, and allows a banking entity to engage
in certain transactions with a related fund in connection with payment,
clearing, and settlement activities. In addition, the final rule would
provide an express safe harbor for senior loans and senior debt and
provide clarity about the types of creditor rights that would be
considered within the scope of the definition of ownership interest.
Finally, the agencies are adopting revisions, as proposed, to provide
clarity regarding a banking entity's permissible investments in the
same investments as a covered fund organized or offered by such banking
entity.
Frequently Asked Questions
The staffs of the agencies have addressed several questions
concerning the implementing regulations through a series of staff
Frequently Asked Questions (FAQs).\14\ In the 2020 proposal, the
agencies indicated that the proposed rule would not modify or revoke
any previously issued staff FAQs, unless otherwise specified.\15\
Several commenters recommended codifying specific FAQs and making
explicit that other FAQs would continue to be in effect,
unmodified.\16\ Consistent with the 2020 proposal and commenters'
suggestions, the final rule does not modify or revoke any previously
issued staff FAQs, unless otherwise specified.\17\
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\14\ See https://www.occ.treas.gov/topics/capitalmarkets/financial-markets/trading-volckerrule/volcker-rule-implementation-faqs.html (OCC); https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm (Board); https://www.fdic.gov/regulations/reform/volcker/faq.html (FDIC); https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm (SEC); https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm
(CFTC).
\15\ 85 FR 12122-23.
\16\ E.g., Securities Industry and Financial Markets Association
(SIFMA); Financial Services Forum (FSF); and IIB.
\17\ 85 FR 12122-23.
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Comment Period
Since the issuance of the 2020 proposal, the COVID-19 global
pandemic has substantially disrupted activity in the United States and
in other countries. The effects of the COVID-19 disruptions have
created many challenges for households and businesses, and the agencies
received comments requesting that the agencies extend the comment
period for the 2020 proposal or delay the rulemaking more
generally.\18\ In contrast, one commenter expressed support for the
rapid approval of the 2020 proposal, to provide banking entities
regulatory relief during a period of financial stress.\19\ The agencies
announced on April 2, 2020, that they would consider comments submitted
before May 1, 2020.\20\ The agencies, however, do not believe that
further delay of the rule is warranted, given the volume, depth, and
diversity of comments submitted. The agencies believe, as well, that
the final rule may provide clarity to banking entities that will enable
banking entities to engage in financial services and other permissible
activities in a manner that both is consistent with the requirements of
section 13 of the BHC Act and will facilitate capital formation and
economic activity.
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\18\ E.g., Better Markets, Inc. (Better Markets) and Kathy
Bowman.
\19\ American Bankers Association (ABA).
\20\ https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200402a.htm.
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Effective and Compliance Dates
The Federal Register notice accompanying the finalization of the
2019 amendments provided for a rolling compliance system.\21\ The
effective date of the amendments was January 1, 2020, and firms are
required to comply with the revisions by January 1, 2021. Until the
mandatory compliance date, banking entities are required to comply with
the 2013 rule, or alternatively, a banking entity may voluntarily
comply, in whole or in part, with the 2019 amendments prior to the
compliance date.
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\21\ 84 FR 61974.
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Several commenters on the 2020 proposal suggested that the agencies
provide for voluntary early compliance with the final rule.\22\ One
commenter also suggested establishing a transition period of at least
one year.\23\
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\22\ E.g., SIFMA; FSF; Japanese Bankers Association (JBA); and
ABA.
\23\ JBA.
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The effective date for the final rule will be October 1, 2020, to
accommodate the requirements of the Riegle Community Development and
Regulatory Improvement Act.\24\ The agencies do not believe an extended
compliance or transition period is necessary because the final rule
largely tailors the regulations implementing section 13 of the BHC Act
rather than increases compliance burdens.
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\24\ See infra, Section V.D (Riegle Community Development and
Regulatory Improvement Act).
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IV. Summary of the Final Rule
A. Qualifying Foreign Excluded Funds
Since the adoption of the 2013 rule, a number of foreign banking
entities, foreign government officials, and other market participants
have expressed concerns regarding instances in which certain funds
offered and sold outside of the United States are excluded from the
covered fund definition but still could be considered banking entities
in certain circumstances (foreign excluded funds).\25\ This situation
may occur if a foreign banking entity controls the foreign fund. A
foreign banking entity could be considered to control the fund based on
common corporate governance structures abroad, such as where the fund's
sponsor selects the majority of the fund's directors or trustees, or
the foreign banking entity otherwise controls the fund for purposes of
section 13 of the BHC Act. As a result, such a fund would be subject to
the requirements of section 13 and the implementing regulations,
including restrictions on proprietary trading, restrictions on
investing in or sponsoring covered funds, and compliance obligations.
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\25\ The implementing regulations generally exclude covered
funds from the definition of ``banking entity.'' 2013 rule Sec.
__.2(c)(2)(i). However, because foreign excluded funds are not
covered funds, they can become banking entities through affiliation
with other banking entities.
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The Federal banking agencies released a policy statement on July
21, 2017 (the policy statement), to address concerns about the possible
unintended consequences and extraterritorial impact of section 13 and
the implementing regulations for foreign excluded funds.\26\ The policy
statement noted that the Federal banking agencies would not take action
against a foreign banking entity \27\ based on attribution of
[[Page 46426]]
the activities and investments of a qualifying foreign excluded fund to
a foreign banking entity, or against a qualifying foreign excluded fund
as a banking entity, for a period of one year while staffs of the
agencies considered alternative ways in which the implementing
regulations could be amended, or other appropriate action could be
taken, to address the issue. The policy statement has since been
extended and is currently scheduled to expire on July 21, 2021.\28\
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\26\ Statement regarding Treatment of Certain Foreign Funds
under the Rules Implementing Section 13 of the Bank Holding Company
Act (July 21, 2017), available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20170721a1.pdf.
\27\ ``Foreign banking entity'' was defined for purposes of the
policy statement to mean a banking entity that is not, and is not
controlled directly or indirectly by, a banking entity that is
located in or organized under the laws of the United States or any
State. Id.
\28\ Statement regarding Treatment of Certain Foreign Funds
under the Rules Implementing Section 13 of the Bank Holding Company
Act (July 17, 2019), available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20190717a1.pdf.
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For purposes of the policy statement, a ``qualifying foreign
excluded fund'' means, with respect to a foreign banking entity, an
entity that:
(1) Is organized or established outside the United States and the
ownership interests of which are offered and sold solely outside the
United States;
(2) Would be a covered fund were the entity organized or
established in the United States, or is, or holds itself out as being,
an entity or arrangement that raises money from investors primarily for
the purpose of investing in financial instruments for resale or other
disposition or otherwise trading in financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the
foreign banking entity's acquisition or retention of an ownership
interest in, or sponsorship of, the entity;
(4) Is established and operated as part of a bona fide asset
management business; and
(5) Is not operated in a manner that enables the foreign banking
entity to evade the requirements of section 13 or implementing
regulations.
To be eligible for this relief, the foreign banking entity's
acquisition or retention of any ownership interest in, or sponsorship
of, the qualifying foreign excluded fund must meet the requirements for
permitted covered fund activities and investments solely outside the
United States, as provided in section 13(d)(1)(I) of the BHC Act and
Sec. __.13(b) of the implementing regulations, as if the qualifying
foreign excluded fund were a covered fund. To provide greater clarity
and certainty to banking entities and qualifying foreign excluded
funds, and to limit the extraterritoriality of the rule, the 2020
proposal included a permanent exemption from the section 13
restrictions on proprietary trading and investing in or sponsoring
covered funds for the activities of qualifying foreign excluded funds.
The proposed exemption generally included the same eligibility criteria
from the policy statement, although it included a modified version of
the anti-evasion provision such that, in order to qualify, a fund could
not be operated in a manner that enables ``any other banking entity''
(rather than ``the foreign banking entity'') to evade the requirements
of section 13 or the implementing regulations.
The agencies requested comment on all aspects of this exemption.
Commenters were generally supportive of the 2020 proposal to exempt
qualifying foreign excluded funds from certain requirements of the
implementing regulations.\29\ Two commenters expressed opposition to
the proposed exemption.\30\
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\29\ SIFMA; Bank Policy Institute (BPI); Bundesverband
Investment und Asset Management e.V. (BVI); American Investment
Council (AIC); ABA; European Fund and Asset Management Association
(EFAMA); Shareholder Advocacy Forum (SAF); IIB; JBA; CBA; and Credit
Suisse.
\30\ Occupy and Data Boiler Technologies LLC (Data Boiler).
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Some commenters requested that qualifying foreign excluded funds be
excluded from the definition of banking entity.\31\ One commenter
expressed concern that the 2020 proposal would require qualifying
foreign excluded funds to establish section 13 of the BHC Act
compliance programs, imposing costs on qualifying foreign excluded
funds.\32\ This commenter noted that there may be situations under
section 13 of the BHC Act where a foreign banking entity controls a
qualifying foreign excluded fund, but under foreign law does not have
the necessary authority to require it to adopt a section 13 compliance
program. As such, this commenter advocated for either excluding this
type of fund from the definition of banking entity or exempting this
type of fund from the compliance program requirements under the
rule.\33\ One commenter expressed concern that a qualifying foreign
excluded fund would still need to comply with various restrictions
under section 13, including the provisions of Sec. __.14 of the
implementing regulations (i.e., Super 23A) and the compliance program
requirements.\34\
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\31\ IIB; JBA; CBA; Credit Suisse; and EBF.
\32\ JBA.
\33\ JBA.
\34\ Credit Suisse.
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Some commenters requested that the agencies change the anti-evasion
provision of the qualifying foreign excluded funds definition so that
it would only apply to the specific foreign banking entity, in a manner
consistent with the policy statement.\35\ One of these commenters
suggested, as an alternative, revising the provision so that it would
only apply to ``any affiliated banking entities.'' \36\
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\35\ IIB; JBA; Credit Suisse; and EBF.
\36\ Credit Suisse.
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One commenter requested an anti-evasion safe harbor and changes to
allow a fund to be a qualifying foreign excluded fund when a non-U.S.
banking entity serves as a management company to the fund and is
approved to provide fund management in accordance with local law.\37\
This commenter also requested that the agencies limit the requirements
in the proposed qualifying foreign excluded funds definition to only
those set forth in Sec. __.13(b) of the rule for covered fund
activities conducted by foreign banking entities solely outside the
United States, and treat as qualifying foreign excluded funds those
funds for which the foreign banking entity cannot exercise voting
rights.
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\37\ JBA.
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Pursuant to their authority under section 13(d)(1)(J) of the BHC
Act, the agencies are adopting the exemption for the activities of
qualifying foreign excluded funds substantially as proposed, but with
modifications to the anti-evasion provision and compliance program
requirements. Specifically, the agencies are exempting the activities
of qualified foreign excluded funds from the restrictions on
proprietary trading and investing in or sponsoring covered funds, if
the acquisition or retention of the ownership interest in, or
sponsorship of, the qualifying foreign excluded fund by the foreign
banking entity meets the requirements for permitted covered fund
activities and investments conducted solely outside the United States,
as provided in Sec. __.13(b) of the rule.\38\ Under the final rule, a
qualifying foreign excluded fund has the same meaning as in the policy
statement as described above and in the 2020 proposal, except for the
modification to the anti-evasion provision, as described below.
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\38\ See final rule Sec. __.13(b).
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Section 13(d)(1)(J) of the BHC Act gives the agencies rulemaking
authority to exempt activities from the prohibitions of section 13,
provided the agencies determine that the activity in question would
promote and protect the safety and soundness of the banking entity and
the financial stability of the
[[Page 46427]]
United States.\39\ For the reasons described below, the agencies have
determined that exempting the activities of qualifying foreign excluded
funds promotes and protects the safety and soundness of banking
entities and U.S. financial stability.
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\39\ 12 U.S.C. 1851(d)(1)(J).
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This relief is expected to promote and protect the safety and
soundness of such funds and their foreign banking entity sponsors by
putting them on a level playing field with their foreign competitors
that are not subject to the implementing regulations. If the activities
of these foreign funds were subject to the restrictions applicable to
banking entities, their asset management activities could be
significantly disrupted, and their foreign banking entity sponsors may
be at a competitive disadvantage to other foreign bank and non-bank
market participants conducting asset management business outside of the
United States. Exempting the activities of these foreign funds allows
their foreign banking entity sponsors to continue to conduct their
asset management business outside the United States as long as the
foreign banking entity's acquisition of an ownership interest in or
sponsorship of the fund meets the requirements in Sec. __.13(b) of the
implementing regulations. Thus, the exemption is expected to have the
effect of promoting the safety and soundness of these foreign funds and
their sponsors, while at the same time limiting the extraterritorial
impact of the implementing regulations, consistent with the purposes of
sections 13(d)(1)(H) and (I) of the BHC Act.
The exemption is also expected to promote and protect U.S.
financial stability. While qualifying foreign excluded funds have a
very limited nexus to the U.S. financial system, the exemption would
promote U.S. financial stability by providing additional capital and
liquidity to U.S. capital markets without a concomitant increase in
risk borne by U.S. entities. Because the exemption requires that the
foreign banking entity's acquisition of an ownership interest in or
sponsorship of the fund meets the requirements in Sec. __.13(b) of the
final rule, the exemption will help ensure that the risks of
investments made by these foreign funds will be booked at foreign
entities in foreign jurisdictions, thus promoting and protecting U.S.
financial stability. Additionally, subjecting such funds to the
requirements of the implementing regulations could precipitate
disruptions in foreign capital markets, which could generate spillover
effects in the U.S. financial system.
In response to comments regarding the anti-evasion provision, the
final rule specifies that the qualifying foreign excluded fund must not
be operated in a manner that enables the banking entity that sponsors
or controls the qualifying foreign excluded fund, or any other
affiliated banking entity (other than a qualifying foreign excluded
fund), to evade the requirements of section 13 of the BHC Act or the
final rule. This change is meant to clarify the scope of the anti-
evasion provision and provide certainty for banking entities that
sponsor or control the qualifying foreign excluded fund.
Consistent with feedback from several commenters, the agencies also
have modified compliance requirements with respect to qualifying
foreign excluded funds. While, under the final rule, the activities of
a qualifying foreign excluded fund are exempted from the proprietary
trading restrictions of Sec. __.3(a) and the covered fund restrictions
of Sec. __.10(a) of the final rule, the qualifying foreign excluded
fund is still a banking entity. Absent any additional changes, the
qualifying foreign excluded fund could become subject to the compliance
requirements of Sec. __.20. However, since these qualifying foreign
excluded funds are exempted from the proprietary trading requirements
of Sec. __.3(a) and covered fund restrictions of Sec. __.10(a) of the
final rule, the agencies believe that requiring a compliance program
for the fund itself is overly burdensome and unnecessary. The
requirements in Sec. __.20 are intended to ensure and monitor
compliance with the proprietary trading and covered fund provisions,
and there would be no benefit to applying these requirements to an
entity that is exempt from those provisions. Therefore, under the final
rule, qualifying foreign excluded funds are not required to have
compliance programs or comply with the reporting and additional
documentation requirements under Sec. __.20. However, any banking
entity that owns or sponsors a qualifying foreign excluded fund will
still be required to have in place appropriate compliance programs for
itself and its other subsidiaries and provide reports and additional
documentation as required by Sec. __.20.
The final rule does not amend the definition of ``banking entity''
as requested by several commenters. Because ``banking entity'' is
specifically defined in section 13 of the BHC Act, the agencies find it
appropriate to address concerns related to foreign excluded funds
through their exemptive rulemaking authority.
The agencies are not making any change regarding the applicability
of Sec. __.14 of the implementing regulations, which imposes
limitations on relationships with covered funds, with respect to
qualifying foreign excluded funds. The agencies believe it is
appropriate to retain the application of Sec. __.14 to qualifying
foreign excluded funds to limit risks that may be borne by banking
entities located in the United States through transactions with such
funds.\40\ Further, given the limited set of circumstances in which
Sec. __.14 would apply (i.e., a transaction between a foreign excluded
fund and a covered fund that is sponsored or advised by the same
banking entity), the agencies do not believe that it is overly
burdensome for a banking entity that sponsors or controls a qualifying
foreign excluded fund to ensure that it is not in violation of Sec.
__.14.
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\40\ A U.S. banking entity's exposure to a fund that would be a
qualifying foreign excluded fund with respect to a foreign banking
entity may still be a covered fund with respect to a U.S. banking
entity under Sec. __.10(b)(1)(iii) of the implementing regulations.
A U.S. banking entity's investment in and relationship with such a
fund could therefore be subject to the entirety of the applicable
prohibitions and restrictions of Subpart C of the implementing
regulations.
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B. Modifications To Existing Covered Fund Exclusions
In the preamble to the 2013 rule, the agencies acknowledged that
the covered fund definition was expansive.\41\ To effectively tailor
the covered fund provisions to the types of entities that section 13 of
the BHC Act was intended to cover, the 2013 rule excluded various types
of entities from the covered fund definition.\42\ In response to
comments received on the 2020 proposal, and based on experience
implementing the rule, the agencies are modifying certain of the
existing exclusions, as described below, to make them more
appropriately structured to effectuate the intent of the statute and
its implementing regulations.
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\41\ See 79 FR 5677.
\42\ See id.
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1. Foreign Public Funds
2013 Rule
To provide consistent treatment for U.S. registered investment
companies and their foreign equivalents, the implementing regulations
exclude foreign public funds from the definition of covered fund.\43\ A
foreign public fund
[[Page 46428]]
is generally defined under the 2013 rule as any issuer that is
organized or established outside of the United States and the ownership
interests of which are (1) authorized to be offered and sold to retail
investors in the issuer's home jurisdiction and (2) sold predominantly
through one or more public offerings outside of the United States.\44\
The agencies stated in the preamble to the 2013 rule that they
generally expect that an offering is made predominantly outside of the
United States if 85 percent or more of the fund's interests are sold to
investors that are not residents of the United States.\45\ The 2013
rule defines ``public offering'' for purposes of this exclusion to mean
a ``distribution,'' as defined in Sec. __.4(a)(3) of subpart B, of
securities in any jurisdiction outside the United States to investors,
including retail investors, provided that the distribution complies
with all applicable requirements in the jurisdiction in which such
distribution is being made; the distribution does not restrict
availability to only investors with a minimum level of net worth or net
investment assets; and the issuer has filed or submitted, with the
appropriate regulatory authority in such jurisdiction, offering
disclosure documents that are publicly available.\46\
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\43\ In adopting the foreign public fund exclusion, the
agencies' view was that it was appropriate to exclude these funds
from the ``covered fund'' definition because they are sufficiently
similar to U.S. registered investment companies. 79 FR 5678.
\44\ 2013 rule Sec. __.10(c)(1); see also 79 FR 5678.
\45\ 79 FR 5678.
\46\ 2013 rule Sec. __.10(c)(1)(iii).
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The 2013 rule places an additional condition on a U.S. banking
entity's ability to rely on the foreign public fund exclusion with
respect to any foreign fund it sponsors.\47\ The foreign public fund
exclusion is only available to a U.S. banking entity with respect to a
foreign fund sponsored by the U.S. banking entity if, in addition to
the requirements discussed above, the fund's ownership interests are
sold predominantly to persons other than the sponsoring banking entity,
the issuer (or affiliates of the sponsoring banking entity or issuer),
and employees and directors of such entities.\48\ The agencies stated
in the preamble to the 2013 rule that, consistent with the agencies'
view concerning whether a foreign public fund has been sold
predominantly outside of the United States, the agencies generally
expect that a foreign public fund would satisfy this additional
condition if 85 percent or more of the fund's interests are sold to
persons other than the sponsoring U.S. banking entity and the specified
persons connected to that banking entity.\49\
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\47\ Although the discussion of this condition generally refers
to U.S. banking entities for ease of reading, the condition also
applies to foreign subsidiaries of a U.S. banking entity. See 2013
rule Sec. __.10(c)(1)(ii) (applying this limitation ``[w]ith
respect to a banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized
under the laws of the United States or of any State and any issuer
for which such banking entity acts as sponsor'').
\48\ See 2013 rule Sec. __.10(c)(1)(ii).
\49\ 79 FR 5678.
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2020 Proposal
In the 2020 proposal, the agencies acknowledged that some of the
conditions of the 2013 rule's foreign public fund exclusion may not be
necessary to ensure consistent treatment of foreign public funds and
U.S. registered investment companies. Moreover, some conditions may
make it difficult for a non-U.S. fund to qualify for the exclusion or
for a banking entity to validate whether a non-U.S. fund qualifies for
the exclusion, resulting in certain non-U.S. funds that are similar to
U.S. registered investment companies being treated as covered funds.
To address these concerns, the 2020 proposal would have made
certain modifications to the foreign public fund exclusion. First, the
agencies proposed to replace the requirement that the fund be
authorized to be offered and sold to retail investors in the issuer's
home jurisdiction (the home jurisdiction requirement) and the
requirement that the fund interests be sold predominantly through one
or more public offerings outside of the United States, with a
requirement that the fund is authorized to offer and sell ownership
interests, and such interests are offered and sold, through one or more
public offerings outside of the United States. This change would have
permitted foreign funds to qualify for the exclusion if they are
organized in one jurisdiction but only authorized to be sold to retail
investors in another jurisdiction, as this is a fairly common way for
foreign retail funds to be organized. Also, no longer requiring a fund
to be sold predominantly through one or more public offerings was
intended to reduce the difficulty that banking entities have described
in determining and monitoring the distribution history and patterns of
a third-party sponsored fund or a sponsored fund whose interests are
sold through third-party distributors.
The agencies also proposed modifying the definition of ``public
offering'' from the implementing regulations to add a new requirement
that the distribution be subject to substantive disclosure and retail
investor protection laws or regulations, to help ensure that foreign
funds qualifying for this exclusion are sufficiently similar to U.S.
registered investment companies. Additionally, the 2020 proposal would
have only applied the condition that the distribution comply with all
applicable requirements in the jurisdiction where it is made to
instances in which the banking entity acts as the investment manager,
investment adviser, commodity trading advisor, commodity pool operator,
or sponsor. This proposed change was intended to address the potential
difficulty that a banking entity investing in a third-party sponsored
fund may have in determining whether the distribution of such fund
complied with all the requirements in the jurisdiction where it was
made.
To simplify the requirements of the exclusion and address concerns
described by banking entities with the difficulty in tracking the sale
of ownership interests to employees and their immediate family members,
the 2020 proposal would have eliminated the limitation on selling
ownership interests of the issuer to employees (other than senior
executive officers) of the sponsoring banking entity or the issuer (or
affiliates of the banking entity or issuer). This change was intended
to help align the treatment of foreign public funds with that of U.S.
registered investment companies, as the exclusion for U.S. registered
investment companies has no such limitation. The 2020 proposal would
have continued to limit the sale of ownership interests to directors or
senior executive officers of the sponsoring banking entity or the
issuer (or their affiliates), as the agencies believed that such a
requirement would be simpler for a banking entity to track.
Finally, the 2020 proposal requested comment on the appropriateness
of the expectation stated in the preamble to the 2013 rule that, for a
U.S. banking entity-sponsored foreign fund to satisfy the condition
that it be ``predominantly'' sold to persons other than the sponsoring
U.S. banking entity and certain persons connected to that banking
entity, at least 85 percent of the ownership interests in the fund
should be sold to such other persons.
Discussion of Comments and the Final Rule
The agencies are adopting all of the proposed changes and are
making certain adjustments in response to comments received, as
discussed below.
Commenters on the 2020 proposal generally supported the proposed
changes to the foreign public funds
[[Page 46429]]
exclusion.\50\ Specifically, commenters supported the elimination of
the home jurisdiction requirement and the requirement that the fund be
sold predominantly through one or more public offerings.\51\ Commenters
supported the proposed change to the ``public offering'' definition to
include a requirement that a distribution be subject to substantive
disclosure and retail investor protection laws or regulations,\52\ but
did not recommend further specifying what substantive disclosure and
investor protection requirements should apply because they generally
viewed it as unnecessary and overly prescriptive.\53\ Commenters also
supported eliminating the restriction on share ownership by employees
(other than senior executives and directors) of the U.S. banking entity
that sponsors the foreign public fund.\54\ In response to a specific
question in the 2020 proposal, one commenter indicated that the
proposed changes to the foreign public funds exclusion would not
increase the risk of evasion of the requirements of section 13 and the
implementing regulations, and thus no additional anti-evasion measures
were necessary.\55\ Another commenter stated that the proposed changes
were less than ideal but were acceptable after balancing compliance
costs and benefits.\56\
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\50\ IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; Investment Company
Institute (ICI); BVI; CBA; Committee on Capital Markets Regulation
(CCMR); Data Boiler; Goldman Sachs; Investment Adviser Association
(IAA); JBA; SAF; and U.S. Chamber of Commerce Center for Capital
Markets Competitiveness (CCMC).
\51\ IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; and CBA.
\52\ IIB; EFAMA; FSF; ICI; and BVI.
\53\ IIB; ICI; and CBA. One commenter supported this assertion
by stating that 95 percent of the world's securities markets,
including all major emerging markets, have substantive disclosure
and retail investor protection rules that are guided by the
International Organization of Securities Commissions' common
principles for retail funds and the detailed policy work that
informs those principles. ICI.
\54\ FSF.
\55\ SIFMA.
\56\ Data Boiler.
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Commenters also recommended additional changes to further align the
treatment of foreign public funds with that of U.S. registered
investment companies or to prevent evasion of the rule.\57\
Specifically, some commenters recommended eliminating the requirement
that a fund actually be sold through a public offering and, instead,
only require that a fund be authorized to be sold through a public
offering.\58\ These commenters generally viewed this requirement as
burdensome and difficult to administer and noted that U.S. registered
investment companies are not required to be sold in public
distributions. The agencies do not consider the fact that there is no
requirement for U.S. registered investment companies to be actually
sold through public offerings as a sufficient rationale for removing
this requirement from the foreign public fund exclusion. Requiring
foreign public funds to be sold through one or more public offerings is
intended to ensure that such funds are in fact public funds and thus
sufficiently similar to U.S. registered investment companies. While
there may be certain limited scenarios where a U.S. registered
investment company is not sold to retail investors, the agencies
believe that the vast majority of U.S. registered investment companies
are sold to retail investors. Furthermore, U.S. registered investment
companies are subject to robust registration, reporting, and other
requirements that are familiar to the agencies, whereas foreign public
funds are subject to a differing array of requirements depending on the
jurisdiction where they are authorized to be sold. These other
jurisdictions may have less developed requirements for retail funds,
which may increase the likelihood of a fund seeking authorization for
public distribution in certain foreign jurisdictions solely as a means
of avoiding the covered fund prohibition. The agencies believe that
eliminating this requirement would increase the risk of evasion by
permitting foreign funds that may be authorized for sale to retail
investors in a foreign jurisdiction--but are only sold through private
offerings where no substantive disclosure or retail investor
protections exist--to qualify for the exclusion. Such funds would not
be comparable to U.S. registered investment companies and would not be
the type of fund that foreign public fund exclusion was intended to
address. Accordingly, the agencies are not adopting this suggested
modification.
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\57\ One commenter recommended that the agencies create an
exclusion from the ``proprietary trading'' definition for the
activities of regulated funds, including foreign public funds, under
certain circumstances. ICI. The agencies note that such a change is
not within the scope of this rulemaking.
\58\ IIB; SIFMA; and EBF.
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One trade association commenter suggested eliminating a provision
in the ``public offering'' requirement that prohibits a distribution
from being limited to investors with a minimum net worth or net
investment assets because some of its members distribute funds,
including mutual funds, in offerings that do not meet this requirement
but that are nonetheless subject to substantive disclosure and retail
investor protection requirements. Similar to the reasons for retaining
the requirement that a foreign public fund actually be sold through one
or more public offerings, the agencies believe that retaining this
requirement is necessary to ensure that funds qualifying for this
exclusion are sufficiently similar to U.S. registered investment
companies. In fact, one of the identifying characteristics of a covered
fund is that its offerings are limited to investors with minimum net
worth or net investment assets.\59\ The agencies therefore believe that
foreign funds that limit their offerings to investors with a minimum
net worth or net investment assets are generally not sufficiently
similar to U.S. registered investment companies, and thus the agencies
are not adopting this suggested change to the ``public offering''
definition.
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\59\ Under the Investment Company Act, certain funds whose
offerings are limited to investors with minimum net worth or net
investment assets are exempt from registration as investment
companies. See 15 U.S.C. 80a-3(c)(7). These funds are generally
treated as covered funds under section 13 of the BHC Act and the
implementing regulations. See 12 U.S.C. 1851(h)(2); implementing
regulations Sec. __.10(b)(1)(i).
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One commenter opposed the proposed elimination of the requirement
in the ``public offering'' definition that a distribution comply with
all applicable requirements in the jurisdiction in which such
distribution is being made for a banking entity that does not serve as
the fund's investment manager, investment adviser, commodity trading
advisor, commodity pool operator, or sponsor.\60\ The final rule adopts
this modification as proposed, because the agencies believe the other
eligibility criteria for a fund to qualify under the foreign public
fund exclusion are sufficient to appropriately identify these funds. In
addition, the agencies recognize that it may be difficult or impossible
for a banking entity that invests in a third-party fund to know whether
the fund's distribution complied with all applicable requirements in
the jurisdiction where it was distributed.
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\60\ Data Boiler.
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One commenter recommended that the agencies require 85 percent of a
foreign public fund's ownership interests be sold to and owned by
``bona fide'' retail investors in the fund's home jurisdiction.\61\
However, for the same reasons that the agencies are eliminating the
home jurisdiction requirement and the requirement that a fund be sold
predominantly through public offerings,
[[Page 46430]]
the agencies are not adopting this requirement.
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\61\ Oleh Zadorestskyy. This commenter also suggested that the
agencies require proof that the investors were non-U.S. persons.
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Some commenters suggested that the agencies identify common foreign
fund types that are presumed to qualify for the exclusion for foreign
public funds for the purpose of improving efficiency and simplifying
compliance with the rule.\62\ Other commenters recommended that issuers
listed on an internationally-recognized exchange and available in
retail-level denominations should automatically qualify for the
exclusion for similar reasons.\63\ Although the agencies expect many
such funds will qualify for the exclusion, the agencies decline to
adopt either of these suggested changes, as both would require the
agencies' review and on-going monitoring of foreign laws and
regulations to ensure that the types of funds that would qualify under
these provisions are sufficiently similar to U.S. registered investment
companies and that their exclusion as foreign public funds would
continue to be appropriate.
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\62\ IIB and EBF.
\63\ IIB; SIFMA; BPI; ABA; FSF; and CBA.
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Some commenters recommended that the agencies entirely eliminate
the restrictions on share ownership by parties affiliated with a U.S.
banking entity sponsor of a foreign public fund.\64\ Other commenters
suggested that, if the restrictions on share ownership by banking
entities affiliated with the sponsor were retained, the restrictions on
share ownership by senior executives and directors should be
removed.\65\ The commenters generally viewed these requirements as
unnecessary and burdensome to track and monitor. As discussed in the
preamble to the 2013 rule, these requirements are intended to prevent
evasion of section 13 of the BHC Act.\66\ Additionally, the agencies
note that U.S. banking entity sponsors of foreign public funds would
need to track the ownership of such funds by their affiliates and
management officials even if the requirements were eliminated in order
to determine whether they control such funds for BHC Act purposes.\67\
Thus, for a U.S. banking entity relying on this exclusion with respect
to a fund that it sponsors, the agencies are retaining the requirement
that the fund be sold predominantly to persons other than the U.S.
banking entity sponsor, the fund, affiliates of such sponsoring banking
entity or fund, and the directors and senior executive officers of such
entities (collectively, ``U.S. banking entity sponsor and associated
parties'').
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\64\ SIFMA and FSF.
\65\ SIFMA; BPI; ICI; and CCMC.
\66\ 79 FR 5678-79.
\67\ See 12 CFR 225.2(e); 12 CFR 225.31(d)(2)(ii). If a foreign
public fund is controlled by a banking entity for BHC Act purposes,
such fund could also be being treated as a banking entity under
section 13. See implementing regulations Sec. __.2(c); FAQ 14.
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Relatedly, some commenters recommended that the agencies modify
their expectation of the level of ownership of a foreign public fund
that would satisfy the requirement that a fund be ``predominantly''
sold to persons other than its U.S. banking entity sponsor and
associated parties,\68\ which, in the preamble to the 2013 rule, the
agencies stated was 85 percent or more (which would permit the U.S.
banking entity sponsor and associated parties to own the remaining 15
percent). These commenters asserted that the relevant ownership
threshold for U.S. registered investment companies is 25 percent, and
that, for foreign public funds, the threshold should be the same. The
agencies agree that the permitted ownership level of a foreign public
fund by a U.S. banking entity sponsor and associated parties should be
aligned with the functionally equivalent threshold for banking entity
investments in U.S. registered investment companies, which is 24.9
percent.\69\ Accordingly, the agencies have amended this provision in
the final rule to require that more than 75 percent of the fund's
interests be sold to persons other than the U.S. banking entity sponsor
and associated parties.\70\
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\68\ BPI; FSF; ICI; and CCMC.
\69\ Although the implementing regulations do not explicitly
prohibit a banking entity from acquiring 25 percent or more of a
U.S. registered investment company, a U.S. registered investment
company would become a banking entity if it is affiliated with
another banking entity (other than as described in Sec.
__.12(b)(1)(ii) of the implementing regulations). See 79 FR 5732
(``[F]or purposes of section 13 of the BHC Act and the final rule, a
registered investment company . . . will not be considered to be an
affiliate of the banking entity if the banking entity owns,
controls, or holds with the power to vote less than 25 percent of
the voting shares of the company or fund, and provides investment
advisory, commodity trading advisory, administrative, and other
services to the company or fund only in a manner that complies with
other limitations under applicable regulation, order, or other
authority.'').
\70\ For a U.S. banking entity that sponsors a foreign public
fund, crossing the 24.9 percent ownership threshold (other than
during a permitted seeding period) would cause the fund to be a
covered fund (if no other exclusion applied), in which case the
banking entity would be in violation of the 3 percent per-fund
investment limit. See implementing regulations Sec.
__.12(a)(2)(ii)(A). The agencies believe that such a strict
prohibition against a U.S. banking entity acquiring 25 percent or
more of a foreign public fund that it sponsors is appropriate
because of the elevated risk of evasion by the sponsoring banking
entity, which may be able to control the investments made by the
fund.
---------------------------------------------------------------------------
One commenter recommended that, with respect to foreign public
funds sponsored by U.S. affiliates of foreign banking entities, the
agencies exclude the sponsoring U.S. banking entity's non-U.S.
affiliates and their directors and employees from the restrictions on
share ownership, provided that such non-U.S. affiliates are not
controlled by a U.S. banking entity.\71\ This commenter asserted that
there is no U.S. financial stability or safety and soundness benefit to
applying this restriction to such non-U.S. affiliates and their
directors and employees, as the risks of any such investments are borne
solely outside the United States. However, with the change described
above, which permits a U.S. banking entity sponsor and associated
parties to hold less than 25 percent of a foreign public fund, the
agencies do not believe that this change is necessary. Even if the
requirement were modified as the commenter suggested, the banking
entity and its affiliates would still be limited to owning less than 25
percent of the fund without the fund becoming a banking entity.
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\71\ IIB.
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One commenter requested that the agencies modify Sec. __.12(b)(1)
of the implementing regulations, which governs attribution of ownership
interests in covered funds to banking entities, to clarify that the
banking entity ``or an affiliate'' can provide the advisory,
administrative, or other services required in Sec. __.12(b)(1)(ii)(B)
for the non-attribution rule to apply. The commenter requested this
clarification because Sec. __.12(b)(1)(ii)(B) is cross-referenced by
FAQ 14, which, as discussed above, states that a foreign public fund
will not be treated as a banking entity if it complies with the test in
Sec. __.12(b)(1)(ii) (i.e., the banking entity holds less than 25
percent of the voting shares in the foreign public fund and provides
advisory, administrative, or other services to the fund). The agencies
confirm that the requested interpretation is correct and, accordingly,
have amended Sec. __.12(b)(1)(ii) of the implementing regulations to
clarify that the ownership limit applies to the banking entity and its
affiliates, in the aggregate, and the requirement that the banking
entity provide advisory or other services can be satisfied by the
banking entity or its affiliates.
One commenter noted that FAQ 16, which relates to the seeding
period for foreign public funds, uses 3 years as an example of the
duration of such a seeding period, and requested that the agencies
confirm that a foreign public fund's seeding period can be longer than
[[Page 46431]]
3 years.\72\ Another commenter requested that the agencies codify the
3-year seeding period in the implementing regulations.\73\ The agencies
believe that, depending on the facts and circumstances of a particular
foreign public fund, the appropriate duration of its seeding period may
vary and, under certain facts and circumstances, may exceed three
years. The agencies believe that this flexibility is appropriate and
thus decline to further specify such a limit. Another commenter
requested that the agencies codify the foreign public fund seeding
FAQ,\74\ FAQ 14, and FAQ 16, both described above, in the implementing
regulations.\75\ The agencies decline to codify these FAQs at this time
but note that the final rule does not modify or revoke any previously
issued staff FAQs, unless otherwise specified.
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\72\ IAA.
\73\ CCMC.
\74\ The foreign public fund seeding FAQ states that staffs of
the agencies would not advise that a seeding vehicle that is
operated pursuant to a written plan to become a foreign public fund
and that meets certain conditions be treated as a covered fund
during such seeding period.
\75\ IIB.
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In the final rule, the agencies are adopting the amendments to the
foreign public funds exclusion as proposed, with the additional
modifications described above. The agencies believe the revised
requirements will make the foreign public fund exclusion more effective
by expanding its availability, providing clarity, and simplifying
compliance with its requirements, while continuing to ensure that the
funds that qualify are sufficiently similar to U.S. registered
investment companies.
2. Loan Securitizations
Section 13 of the BHC Act provides that ``[n]othing in this section
shall be construed to limit or restrict the ability of a banking entity
. . . to sell or securitize loans in a manner otherwise permitted by
law.'' \76\ To effectuate this statutory mandate, the 2013 rule
excluded from the definition of covered fund loan securitizations that
issue asset-backed securities and hold only loans, certain rights and
assets that arise from the structure of the loan securitization or from
the loans supporting a loan securitization, and a small set of other
financial instruments (permissible assets).\77\
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\76\ 12 U.S.C. 1851(g)(2).
\77\ See 2013 rule Sec. __.10(c)(8). Loan is further defined as
any loan, lease, extension of credit, or secured or unsecured
receivable that is not a security or derivative. Implementing
regulations Sec. __.2(t).
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Since the adoption of the 2013 rule, several banking entities and
other participants in the loan securitization industry have commented
that the limited set of permissible assets has inappropriately
restricted their ability to use the loan securitization exclusion. In
the 2018 proposal, the agencies asked several questions regarding the
efficacy and scope of the exclusion and the Loan Securitization
Servicing FAQ.\78\ Comments focused on permitting small amounts of non-
loan assets and clarifying the treatment of leases and related assets.
---------------------------------------------------------------------------
\78\ 83 FR 33480-81.
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In response to these concerns, the 2020 proposal would have
codified the Loan Securitization Servicing FAQ and permitted loan
securitizations to hold a small amount of non-loan assets. The agencies
requested comment on all aspects of the proposed changes to the loan
securitization exclusion, and comments were generally supportive of the
proposed revisions.\79\ Several commenters also suggested revisions to
the 2020 proposal.\80\ Comments are discussed in detail below.\81\
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\79\ E.g., SIFMA; BPI; Managed Funds Association (MFA); PNC
Financial Services Group, Inc. (PNC); Goldman Sachs; Loan
Syndications and Trading Association (LSTA); and Structured Finance
Association (SFA).
\80\ E.g., SIFMA; CCMC; BPI; and IIB.
\81\ One commenter suggested that some jurisdictions' risk
retention rules may vary from the regulations implementing section
15G of the Exchange Act (15 U.S.C. 78o-11), which requires a banking
entity to retain and maintain a certain minimum interest in certain
asset-backed securities. See IIB. This commenter recommended
allowing banking entities to hold certain investments in compliance
with certain foreign laws (e.g., European risk retention rules). The
agencies understand that rules for risk retention vary across
jurisdictions. However, the agencies believe that the requested
action is outside the scope of the current rulemaking. In addition,
another commenter requested that the agencies clarify the definition
of asset-backed securities as used in the loan securitization
exclusions. See Arnold & Porter Kaye Scholer LLP (Arnold & Porter).
The agencies discuss the definition of asset-backed securities in
Section IV.C.1.iii (Credit Funds), infra.
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Servicing Assets
The implementing regulations permit loan securitizations to hold
rights or other assets (servicing assets) that arise from the structure
of the loan securitization or from the loans supporting a loan
securitization.\82\ Rights or other servicing assets are assets
designed to facilitate the servicing of the underlying loans or the
distribution of proceeds from those loans to holders of the asset-
backed securities.\83\ In response to confusion regarding the scope of
the provisions permitting servicing assets and a separate provision
limiting the types of permitted securities, the staffs of the agencies
released the Loan Securitization Servicing FAQ. The FAQ clarified that
a servicing asset may or may not be a security, but if the servicing
asset is a security, it must be a permitted security under the rule.
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\82\ Sec. Sec. __.2(t); __.10(c)(8)(i)(D); __.10(c)(8)(v).
\83\ See, e.g., FASB Statement No. 156: Accounting for Servicing
of Financial Assets, ] 61 (FAS 156).
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The 2020 proposal would have codified the Loan Securitization
Servicing FAQ in the implementing regulations to clarify the scope of
the servicing asset provision.\84\ Commenters generally supported the
codification of the Loan Securitization Servicing FAQ, indicating that
such a codification would promote transparency and ensure continued use
of the loan securitization exclusion.\85\ For the above reasons, the
final rule adopts the codification of the Loan Securitization Servicing
FAQ as proposed.
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\84\ The 2020 proposal also clarified that special units of
beneficial interest and collateral certificates meeting the
requirements of paragraph (c)(8)(v) of the exclusion that are
securities need not meet the requirements of paragraph (c)(8)(iii)
of the exclusion. See 2020 proposal Sec. __.10(c)(8)(i)(B). The
agencies are adopting this revision, as proposed.
\85\ E.g., SIFMA; PNC; and SFA. One commenter indicated that the
current Loan Securitization Servicing FAQ was sufficient and that
codifying the FAQ was not necessary; however, the commenter did not
elaborate on or justify this position. Data Boiler.
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Cash Equivalents
The loan securitization exclusion permits issuers relying on the
exclusion to hold certain types of contractual rights or assets related
to the loans underlying the securitization, including cash equivalents.
In response to questions about the scope of the cash equivalents
provision, the Loan Securitization Servicing FAQ stated that ``cash
equivalents'' means high quality, highly liquid investments whose
maturity corresponds to the securitization's expected or potential need
for funds and whose currency corresponds to either the underlying loans
or the asset-backed securities.\86\ To promote transparency and
clarity, the 2020 proposal would have codified this additional language
in the Loan Securitization Servicing FAQ regarding the meaning of
``cash equivalents.'' \87\ The agencies did not propose requiring
``cash equivalents'' to be ``short term,'' because the agencies
recognized that a loan securitization may need greater flexibility to
match the maturity of high quality, highly liquid investments to its
expected or potential need for funds. Commenters generally supported
the codification of the definition of ``cash equivalents'' in the loan
securitization
[[Page 46432]]
exclusion.\88\ The final rule adopts the codification of ``cash
equivalents'' as proposed.
---------------------------------------------------------------------------
\86\ See supra, n.14.
\87\ 2020 proposed rule Sec. __.10(c)(8)(iii)(A).
\88\ E.g., LSTA; PNC; and SIFMA. One commenter expressed
opposition to this codification but did not elaborate or justify
this position. See Data Boiler.
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Limited Holdings of Certain Debt Securities
In the preamble to the 2013 rule, the agencies declined to permit
loan securitizations to hold a certain amount of non-loan assets.\89\
The agencies supported a narrow scope of permissible assets in loan
securitizations, suggesting that such an approach would be consistent
with the purpose of section 13 of the BHC Act.\90\
---------------------------------------------------------------------------
\89\ 79 FR 5687-88.
\90\ 79 FR 5687.
---------------------------------------------------------------------------
Several commenters on the 2018 proposal disagreed with the
agencies' views and supported expanding the range of permissible assets
in an excluded loan securitization. After considering the comments
received on the 2018 proposal, the 2020 proposal would have allowed a
loan securitization vehicle to hold up to five percent of the fund's
total assets in non-loan assets. The agencies indicated that
authorizing loan securitizations to hold small amounts of non-loan
assets could, consistent with section 13 of the BHC Act, permit loan
securitizations to respond to investor demand and reduce compliance
costs associated with the securitization process without significantly
increasing risk to banking entities and the financial system.\91\ The
agencies requested comment on, among other things, the maximum amount
of permitted non-loan assets, the methodology for calculating the cap
on non-loan assets, and whether the agencies should limit the type of
assets that could be held under the non-loan asset provision.
Specifically, the agencies requested comment on whether the non-loan
asset provision should be limited to debt securities or should exclude
certain financial instruments such as derivatives and collateralized
debt obligations.
---------------------------------------------------------------------------
\91\ 85 FR 12128-29.
---------------------------------------------------------------------------
Commenters were generally supportive of allowing loan
securitizations to hold a limited amount of non-loan assets.\92\ These
commenters indicated that the requirements for the current loan
securitization exclusion are too restrictive and excessively limit use
of the exclusion and prevent issuers from responding to investor
demand, and suggested that a limited bucket of non-loan assets would
not fundamentally alter the characteristics and risks of
securitizations or otherwise increase risks in banking entities or the
financial system.\93\
---------------------------------------------------------------------------
\92\ E.g., SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs;
LSTA; BPI; and SFA.
\93\ E.g., LSTA and Goldman Sachs.
---------------------------------------------------------------------------
Several commenters recommended against limiting the type of assets
that could be held per the non-loan asset provision.\94\ For example,
one commenter stated that allowing excluded loan securitizations to
invest in any class of asset would allow those vehicles to achieve
investment goals during periods of constrained loan supply, while
another commenter indicated that such a restriction would be
unnecessary given that the low limit on non-loan assets would constrain
risks.\95\ In contrast, one commenter suggested limiting the type of
permissible assets to securities with risk characteristics similar to
loans.\96\
---------------------------------------------------------------------------
\94\ E.g., MFA; LSTA; and SFA. One commenter also requested that
the agencies make clear that the non-loan assets would not be
subject to the other provisions of the loan securitization
exclusion. LSTA.
\95\ SFA and LSTA.
\96\ JBA.
---------------------------------------------------------------------------
Numerous commenters suggested raising the cap on non-loan assets
from five percent of assets to ten percent of assets,\97\ while one
commenter indicated that a five percent cap would be sufficient.\98\
Commenters that supported an elevated limit on non-loan assets
generally argued that a ten percent limit would further reduce
compliance burdens while not materially increasing risk.\99\
---------------------------------------------------------------------------
\97\ SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman Sachs; LSTA;
and SFA.
\98\ PNC. Another commenter who generally supported the proposed
modifications to the loan securitization exclusion did not urge the
agencies to raise the cap on non-loan assets. See BPI.
\99\ E.g., LSTA; SIFMA; and Goldman Sachs.
---------------------------------------------------------------------------
Several commenters also suggested a method for calculating the cap
on non-loan assets: The par value of assets on the day they are
acquired.\100\ These commenters suggested that relying on par value is
accepted practice in the loan securitization industry and would obviate
concerns related to tracking amortization or prepayment of loans in a
securitization portfolio.\101\ One of these commenters further
specified that the limit should be calculated (1) according to the par
value of the acquired assets on the date of investment over the
securitization's total collateral pool and (2) only at the time of
investment.\102\ Another commenter indicated that the cap should be
calculated as the lower of the purchase price and par value of the non-
qualifying assets over the issuer's aggregate capital commitments plus
its subscription based credit facility.\103\ A third commenter
suggested having a separate valuation mechanism for equity securities,
which the commenter suggested should be market value upon
acquisition.\104\
---------------------------------------------------------------------------
\100\ SIFMA; BPI; ABA; and LSTA.
\101\ SIFMA and BPI.
\102\ BPI.
\103\ Goldman Sachs.
\104\ SFA.
---------------------------------------------------------------------------
Finally, two commenters opposed allowing excluded loan
securitizations to hold non-loan assets and suggested that such a
change would be contrary to the purpose of section 13 of the BHC Act or
would result in loan securitizations with differing risk
characteristics, potentially increasing monitoring costs on
investors.\105\ In addition, a commenter claimed that the 2020 proposal
to allow excluded loan securitizations to hold non-loan assets would be
contrary to section 13 of the BHC Act.\106\ Specifically, this
commenter suggested that the rule of construction in 12 U.S.C.
1851(g)(2) only permits the securitization or sale of loans and that
legislative history supports this reading of the statute.
---------------------------------------------------------------------------
\105\ JBA and Data Boiler.
\106\ Occupy.
---------------------------------------------------------------------------
The agencies previously concluded and continue to believe they have
legal authority to adopt the proposed allowance for a limited amount of
non-loan assets.\107\ Section 13(g)(2) of the BHC Act states,
``[n]othing in this section shall be construed to limit or restrict the
ability of a banking entity or nonbank financial company supervised by
the Board to sell or securitize loans in a manner otherwise permitted
by law.'' \108\ This rule of construction is permissive--it allows the
agencies to design the regulations implementing section 13 in a way
that accommodates and does not unduly ``limit or restrict'' the ability
of banking entities to sell or securitize loans. Contrary to the
commenter's argument, this provision does not mandate that any loan
securitization exclusion only relate to loans. As discussed in this
section and the preamble to the 2020 proposal,\109\ the agencies
believe that allowing excluded loan securitizations to hold limited
amounts of non-loan assets would, in fact, promote the ability of
[[Page 46433]]
banking entities to sell or securitize loans.
---------------------------------------------------------------------------
\107\ See 79 FR 5688-92 (stating, for example, that ``[t]he
[a]gencies also do not believe that they lack the statutory
authority to permit a loan securitization relying on the loan
securitization exclusion to use derivative[s,] as suggested by
[Occupy]'' and that, more broadly, the agencies have the authority
to allow excluded loan securitizations to hold non-loan assets).
\108\ 12 U.S.C. 1851(g)(2).
\109\ 85 FR 12128-29.
---------------------------------------------------------------------------
After considering the foregoing comments, the agencies are revising
the loan securitization exclusion to permit a loan securitization to
hold a limited amount of debt securities. Loan securitizations provide
an important mechanism for banking entities to fund lending programs.
Allowing loan securitizations to hold a small amount of debt securities
in response to customer and market demand may increase a banking
entity's capacity to provide financing and lending. To minimize the
potential for banking entities to use this exclusion to engage in
impermissible activities or take on excessive risk, the final rule
permits a loan securitization to hold debt securities (excluding asset-
backed securities and convertible securities), as opposed to any non-
loan assets, as the 2020 proposal would have allowed.\110\
---------------------------------------------------------------------------
\110\ Final rule Sec. __.10(c)(8)(i)(E).
---------------------------------------------------------------------------
Although several commenters supported allowing a loan
securitization to hold any non-loan asset to provide flexibility and
allow the issuer's investment manager to respond to changing market
demands, the agencies believe that limiting the assets to debt
securities is more consistent with the activities of an issuer focused
on securitizing loans, rather than engaging in other activities. The
agencies have determined, consistent with the views of another
commenter, that non-loan assets with materially different risk
characteristics from loans could change the character and complexity of
an issuer and raise the type of concerns that section 13 of the BHC Act
was intended to address. Moreover, as described further below, limiting
the assets to those with risk characteristics that are similar to loans
will allow for a simpler and more transparent calculation of the five
percent limit, which will facilitate banking entities' compliance with
the exclusion. For the same reasons, the final rule does not permit a
loan securitization to hold asset-backed securities or convertible
securities as part of its five percent allowance for debt securities.
This helps to ensure that a loan securitization will not be exposed to
complex financial instruments and will retain the general
characteristic of a loan securitization issuer.
Similarly, to reduce potential risk-taking and to ensure that the
fund is composed almost entirely of loans with minimal non-loan assets,
the final rule retains the 2020 proposal's five percent limit on non-
loan assets. Commenters differed on whether raising the limit on non-
loan assets was appropriate or necessary to ensure flexibility, and it
is not clear what benefit would accrue to issuers who could hold debt
securities of, for example, seven or ten percent versus five percent.
The amount of non-loan assets held by a fund should not be so
significant that it fundamentally changes the character of the fund
from one that is engaged in securitizing loans to one that is engaged
in investing in other types of assets.
The agencies are also clarifying the methodology for calculating
the five percent limit on non-convertible debt securities.\111\ The
2020 proposal only provided that ``the aggregate value of any such
other assets must not exceed five percent of the aggregate value of the
issuing entity's assets'' and requested comment about how the agencies
should calculate this limit.\112\ As suggested by several commenters,
the final rule specifies that the limit on non-convertible debt
securities must be calculated at the most recent time of acquisition of
such assets. Specifically, the aggregate value of debt securities held
under Sec. __.10(c)(8)(i)(E) of the final rule may not exceed five
percent of the aggregate value of loans held under Sec.
__.10(c)(8)(i)(A), cash and cash equivalents held under Sec.
__.10(c)(8)(iii)(A), and debt securities held under Sec.
__.10(c)(8)(i)(E), where the value of the loans, cash and cash
equivalents, and debt securities is calculated at par value at the time
any such debt security is purchased.\113\
---------------------------------------------------------------------------
\111\ Final rule Sec. __.10(c)(8)(i)(E)(1)-(2).
\112\ 2020 proposal Sec. __.10(c)(8)(i)(E); 85 FR 12129.
\113\ Final rule Sec. __.10(c)(8)(i)(E)(1)-(2).
---------------------------------------------------------------------------
The agencies have chosen the most recent time of acquisition of
non-convertible debt securities as the moment of calculation to
simplify the manner in which the 5 percent cap applies. This would
permit an issuer that, at some point in its life, held debt securities
in excess of five percent of its assets to qualify for the exclusion if
it came into compliance with the five percent limit prior to a banking
entity relying on the exclusion with respect to such issuer. The
agencies believe that a continuous monitoring obligation could impose
significant burdens on excluded issuers and could cause an issuer to be
disqualified from the loan securitization exclusion based on market
events not under its control. It is also unnecessary to require this
calculation at other intervals because limiting permissible assets to
those that have similar characteristics as loans addresses the
potential for evasion of the five percent limit that could arise if the
issuer held more volatile assets.\114\
---------------------------------------------------------------------------
\114\ The agencies also have authority to address acts that
function as an evasion of the requirements of the exclusion. See
implementing regulations Sec. __.21.
---------------------------------------------------------------------------
In the final rule, this measurement is based only on the value of
the loans and debt securities held under Sec. Sec. __.10(c)(8)(i)(A)
and (E) and the cash and cash equivalents held under Sec.
__.10(c)(8)(iii)(A) rather than the aggregate value of all of the
issuing entity's assets. The purpose of the five percent limit is to
ensure the investment pool of a loan securitization is composed of
loans. Therefore, the calculation takes into account the assets that
should make up the issuing entity's investment pool and excludes the
value of other rights or incidental assets, as well as derivatives held
for risk management. This further simplifies the calculation
methodology by excluding assets that may be more complex to value and
that are ancillary to the loan securitization's investment activities.
This straightforward calculation methodology will ensure that the loan
securitization exclusion remains easy to use and will facilitate
banking entities' compliance with the exclusion.
The agencies recognize that a loan securitization's transaction
agreements may require that some categories of loans, cash equivalents,
or debt securities be valued at fair market value for certain purposes.
To accommodate such situations, the exclusion provides that the value
of any loan, cash equivalent, or permissible debt security may be based
on its fair market value if (1) the issuing entity is required to use
the fair market value of such loan or debt security for purposes of
calculating compliance with concentration limitations or other similar
calculations under its transaction agreements and (2) the issuing
entity's valuation methodology values similarly situated assets, for
example non-performing loans, consistently. This provision is intended
to provide issuers with the flexibility to leverage existing
calculation methodologies while preventing issuers from using
inconsistent methodologies in a manner to evade the requirements of the
exclusion.
Leases
A commenter on the 2018 proposal suggested that the loan
securitization exclusion be expanded to cover leases and related
assets, including operating or capital leases.\115\ In response, in the
2020 proposal the agencies stated that they were ``not proposing to
separately
[[Page 46434]]
list leases within the loan securitization exclusion because leases are
included in the definition of loan and thus are permitted assets for
loan securitizations under the current exclusion.'' \116\ That same
commenter made a comment on the 2020 proposal urging the agencies to
reconsider explicitly including operating leases and leased properties
in the loan securitization exclusion.\117\ This commenter asserted that
unless the agencies specifically revise the definition of ``rights or
other assets'' to explicitly include leased property, then
securitization vehicles with operating leases that rely on the residual
property value after expiration of the lease to support their asset-
backed securities would not be able to qualify under the loan
securitization exemption, despite the 2013 rule's provisions for
special units of beneficial interest and collateral certificates.
---------------------------------------------------------------------------
\115\ See 85 FR 12128.
\116\ Id.
\117\ SFA.
---------------------------------------------------------------------------
Consistent with the 2020 proposal, the agencies are not separately
listing leases within the loan securitization exclusion because leases
are included in the definition of loan and thus are permitted assets
for loan securitizations under the current exclusion. The agencies are
also not modifying the definition of ``rights or other assets'' to
explicitly include leased property, as any residual value of such
leased property upon expiration of an operating lease should meet the
requirements to constitute an asset that is related or incidental to
purchasing or otherwise acquiring and holding loans.
3. Public Welfare and Small Business Funds
i. Public Welfare Funds
Section 13(d)(1)(E) of the BHC Act permits, among other things, a
banking entity to make and retain investments that are designed
primarily to promote the public welfare of the type permitted under 12
U.S.C. 24(Eleventh).\118\ Consistent with the statute, the implementing
regulations exclude from the definition of ``covered fund'' issuers
that make investments that are designed primarily to promote the public
welfare, of the type permitted under paragraph 11 of section 5136 of
the Revised Statutes of the United States (12 U.S.C. 24), including the
welfare of low- and moderate-income communities or families (such as
providing housing, services, or jobs) (the public welfare investment
exclusion).\119\
---------------------------------------------------------------------------
\118\ See 12 U.S.C. 1851(d)(1)(E).
\119\ Implementing regulations Sec. __.10(c)(11)(ii)(A).
---------------------------------------------------------------------------
The 2020 proposal noted that the OCC's regulations implementing 12
U.S.C. 24(Eleventh) provide that investments that receive consideration
as qualified investments under the regulations implementing the
Community Reinvestment Act (CRA) are public welfare investments for
national banks.\120\ The 2020 proposal requested comment on whether any
change should be made to clarify that all permissible public welfare
investments, under any agency's regulation, are excluded from the
covered fund restrictions.\121\ The 2020 proposal specifically asked
whether investments that would receive consideration as qualified
investments under the CRA should be excluded from the definition of
covered fund, either by incorporating these investments into the public
welfare investment exclusion or by establishing a new exclusion for
CRA-qualifying investments.\122\
---------------------------------------------------------------------------
\120\ See 85 FR 12130; 12 CFR 24.3.
\121\ See 85 FR 12130 (noting that such a change could provide
additional certainty regarding community development investments
made through fund structures).
\122\ See id.
---------------------------------------------------------------------------
In addition, the 2020 proposal requested comment on whether Rural
Business Investment Companies (RBICs) are typically excluded from the
definition of ``covered fund'' because of the public welfare investment
exclusion or another exclusion and on whether the agencies should
expressly exclude RBICs from the definition of covered fund.\123\ RBICs
are licensed under a program designed to promote economic development
and job creation in rural communities by investing in companies
involved in the production, processing, and supply of food and
agriculture-related products.\124\
---------------------------------------------------------------------------
\123\ See id.
\124\ See id.
---------------------------------------------------------------------------
The Tax Cuts and Jobs Act established the ``opportunity zone''
program to provide tax incentives for long-term investing in designated
economically distressed communities.\125\ The program allows taxpayers
to defer and reduce taxes on capital gains by reinvesting gains in
``qualified opportunity funds'' (QOF) that are required to have at
least 90 percent of their assets in designated low-income zones.\126\
The 2020 proposal requested comment on whether many or all QOFs would
meet the terms of the public welfare investment exclusion and on
whether the agencies should expressly exclude QOFs from the definition
of covered fund.\127\
---------------------------------------------------------------------------
\125\ See id.
\126\ See id.
\127\ See id.
---------------------------------------------------------------------------
Commenters generally supported clarifying that funds that make
investments that qualify for consideration under the CRA qualify for
the public welfare investment exclusion.\128\ Commenters noted that
this clarification would be consistent with the OCC's regulations
concerning public welfare investments and the CRA, provide greater
certainty, and avoid unnecessarily chilling public welfare investment
activities.\129\ One commenter stated that some banking entities have
been reluctant to invest in certain community development funds due to
uncertainty as to whether these funds were covered funds.\130\ This
commenter stated that explicitly excluding funds that qualify for
consideration under the CRA from the definition of covered fund would
eliminate this uncertainty and would help support the type of community
development efforts that the public welfare investment exclusion was
designed to promote.\131\ In addition, some commenters recommended
excluding funds that qualify for the public welfare investment
exclusion from the definition of ``banking entity.'' \132\
---------------------------------------------------------------------------
\128\ See SIFMA; FSF; BPI; ABA; PNC; Community Development
Venture Capital Alliance (CDVCA); IIB; and Data Boiler (stating that
incorporating the CRA public welfare exemption may ease some
challenges faced by communities during the current COVID pandemic,
but all PWI should not be excluded).
\129\ See SIFMA; FSF; and CDVCA.
\130\ See CDVCA.
\131\ See id.
\132\ See SIFMA; BPI; ABA; and IIB.
---------------------------------------------------------------------------
Commenters also generally favored explicitly excluding RBICs and
QOFs from the definition of ``covered fund,'' either by adopting new
exclusions, or by clarifying the scope of the public welfare investment
exclusion.\133\ Commenters stated that explicitly excluding these funds
from the definition of ``covered fund'' would be consistent with the
statutory provision permitting public welfare investments. Commenters
stated that RBICs and QOFs must make investments that are clearly
designed primarily to promote the public welfare because they are
required to invest primarily in ways that promote job creation in rural
communities (which may have significant low- and moderate-income
populations or be economically disadvantaged and in need of
revitalization or stabilization) and in economically distressed
communities, respectively.\134\ Commenters stated that
[[Page 46435]]
certain RBICs and QOFs qualify for the public welfare investment
exclusion, but providing an express exclusion for these funds would
reduce uncertainty and associated compliance burdens and would
encourage banking entities to provide capital to projects that promote
economic development in rural and low-income communities.\135\ One
commenter stated that RBICs and QOFs engage in investments that are
substantively similar or identical to those of public welfare
investment funds that are already excluded from the definition of
covered fund and of the type that Congress recognized that section 13
of the BHC Act was not designed to prohibit.\136\ Another commenter
stated that explicitly excluding RBICs would result in the provision of
valuable expertise and services to RBICs and provide funding and
assistance to small businesses and low- and moderate-income
communities.\137\ One commenter expressed skepticism about providing a
new exclusion for RBICs and QOFs but suggested that certain of these
funds may currently qualify for the public welfare investment
exclusion.\138\ Another commenter stated that it is not necessary to
expressly exclude QOFs from the definition of covered fund, noting that
these funds should be of the type primarily intended to promote the
public welfare of low- and moderate-income areas and should therefore
qualify for the current public welfare investment exclusion.\139\
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\133\ See SIFMA; FSF; ABA (addressing QOFs); and Small Business
Investor Alliance (SBIA) (addressing RBICs).
\134\ See SIFMA and FSF.
\135\ See SIFMA and FSF.
\136\ See SIFMA.
\137\ See SBIA.
\138\ See Data Boiler.
\139\ See PNC.
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After carefully considering the comments received, the agencies are
revising the public welfare investment exclusion to explicitly
incorporate funds, the business of which is to make investments that
qualify for consideration under the Federal banking agencies'
regulations implementing the CRA.\140\ Explicitly excluding these types
of investments from the definition of covered fund clarifies and gives
full effect to the statutory exemption for public welfare
investments.\141\ In addition, this clarification will reduce
uncertainty and will facilitate public welfare investments by banking
entities.
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\140\ Final rule Sec. __.10(c)(11)(ii)(A).
\141\ See 12 U.S.C. 1851(d)(1)(E). A banking entity must have
independent authority to make a public welfare investment. For
example, a banking entity that is a state member bank may make a
public welfare investment to the extent permissible under 12 U.S.C.
338a and 12 CFR 208.22.
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The agencies are also adopting explicit exclusions from the
definition of covered fund for RBICs and QOFs in Sec. __.10(c)(11) of
the final rule. These types of funds were created by Congress to
promote development in rural and low-income communities, and, due to
their similarity to SBICs and public welfare investments, the agencies
believe that section 13 of the BHC Act was not intended to restrict the
types of funds that engage in those activities. RBICs are companies
licensed under the Rural Business Investment Program, a program
designed to promote economic development and the creation of wealth and
job opportunities among individuals living in rural areas and to help
meet the equity capital investment needs primarily of smaller
enterprises located in such areas.\142\ Likewise, QOFs were developed
as part of a program to promote long-term investing in designated
economically distressed communities and are required to have at least
90 percent of their assets in designated low-income zones.\143\
Congress created RBICs and QOFs to encourage investment in rural areas,
small enterprises, and low-income areas. Providing an explicit
exclusion for these funds in the implementing regulations gives effect
to section 13 of the BHC Act's provision permitting public welfare
investments and avoids chilling the activities of funds that were not
the target of section 13 of the BHC Act.\144\ Although many of these
funds may already qualify for the public welfare investment exclusion,
the agencies are explicitly excluding these funds from the definition
of covered fund to reduce uncertainty and compliance burden. Thus,
under the final rule, a covered fund does not include an issuer that
has elected to be regulated or is regulated as a RBIC, as described in
15 U.S.C. 80b-3(b)(8)(A) or (B), or that has terminated its
participation as a RBIC in accordance with 7 CFR 4290.1900 and does not
make any new investments (other than investments in cash equivalents,
which, for the purposes of this paragraph, means high quality, highly
liquid investments whose maturity corresponds to the issuer's expected
or potential need for funds and whose currency corresponds to the
issuer's assets) after such termination.\145\ Likewise, under the final
rule, a covered fund does not include an issuer that is a QOF, as
defined in 26 U.S.C. 1400Z-2(d).\146\
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\142\ See, e.g., Rural Business Investment Company (RBIC)
Program, 85 FR 16519, 16520 (Mar. 24, 2020).
\143\ See 26 U.S.C. 1400Z-2(d).
\144\ See 12 U.S.C. 1851(d)(1)(E); 156 Cong. Rec. S5896 (daily
ed. July 15, 2010) (Statement of Sen. Merkley) (noting that Section
13(d)(1)(E) permits investments ``of the type'' permitted under 12
U.S.C. 24 (Eleventh), including ``a range of low-income community
development and other projects,'' but ``is flexible enough to permit
the [agencies] to include other similar low-risk investments with a
public welfare purpose'').
\145\ Final rule Sec. __.10(c)(11)(iii). As with SBICs,
discussed below, the final rule contemplates that an issuer that
ceases to be a RBIC during wind-down may continue to qualify for the
exclusion from the definition of ``covered fund'' for RBICs if the
issuer satisfies certain conditions designed to prevent abuse.
\146\ Final rule Sec. __.10(c)(11)(iv). As with other types of
issuers excluded from the covered fund definition, a banking entity
must have independent authority to invest in a QOF.
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The final rule does not exclude funds that qualify for the public
welfare investment exclusion from the definition of ``banking entity''
as requested by some commenters.\147\ The term ``banking entity'' is
specifically defined in section 13 of the BHC Act.\148\ In addition,
the agencies do not believe that applying the definition of banking
entity places an undue burden on banking entities' public welfare
investments. The agencies believe that banking entities are able to
design their permissible public welfare investments so as not to cause
the investment fund to become a banking entity. For public welfare
investment funds that are banking entities, the agencies believe that
the burden-reducing amendments adopted in this final rule and the 2019
amendments should mitigate concerns about compliance burdens.
---------------------------------------------------------------------------
\147\ See SIFMA and BPI.
\148\ 12 U.S.C. 1851(h)(1).
---------------------------------------------------------------------------
ii. Small Business Investment Companies
Consistent with section 13 of the BHC Act,\149\ the implementing
regulations exclude from the definition of ``covered fund'' SBICs and
issuers that have received notice from the Small Business
Administration to proceed to qualify for a license as an SBIC, which
notice or license has not been revoked.\150\ The agencies proposed
revising the exclusion for SBICs to clarify how the exclusion would
apply to SBICs that surrender their licenses during wind-down
phases.\151\ Specifically, the agencies proposed revising the exclusion
for SBICs to apply explicitly to an issuer that has voluntarily
surrendered its license to operate as an SBIC in accordance with 13 CFR
107.1900 and does not make new investments (other than investments in
cash equivalents) after such voluntary
[[Page 46436]]
surrender.\152\ The agencies explained that applying the exclusion to
an issuer that has surrendered its SBIC license is appropriate because
of the statutory exemption for investments in SBICs and because banking
entities may otherwise become discouraged from investing in SBICs due
to concerns that an SBIC may become a covered fund during its wind-down
phase.\153\ The agencies further noted that the proposed revisions
included a number of requirements designed to ensure that the exclusion
would not be abused.\154\ In particular, the exclusion would apply only
to an issuer that voluntarily surrenders its license in accordance with
13 CFR 107.1900 and that does not make any new investments (other than
investments in cash equivalents).\155\
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\149\ See 12 U.S.C. 1851(d)(1)(E) (permitting investments in
SBICs).
\150\ See implementing regulations Sec. __.10(c)(11)(i).
\151\ See 85 FR 12131.
\152\ See id.
\153\ See id.; 12 U.S.C 1851(d)(1)(E).
\154\ See 85 FR 12131.
\155\ See id.
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Most commenters that directly addressed the 2020 proposal's
revisions concerning SBICs supported the proposed revisions, stating
that the proposed revisions would provide greater certainty to banking
entities wishing to invest in SBICs and would increase investment in
small businesses.\156\ One commenter stated that revising the exclusion
for SBICs would prevent a banking entity from being forced to sell an
interest in an SBIC that became a covered fund for reasons outside of
the banking entity's control.\157\ Commenters further noted that the
proposed revisions included sufficient safeguards against evasion and
did not present safety or soundness concerns.\158\ One commenter
recommended against revising the exclusion from the definition of
covered fund for SBICs. This commenter expressed concern about frequent
buying and selling of SBICs and noted that section 13 of the BHC Act
and its implementing regulations do not prohibit a banking entity from
lending to small businesses.\159\ The commenter further expressed
concern that an SBIC that surrenders its license may be doing so
because it has failed or no longer wishes to comply with the Small
Business Administration's regulations.\160\
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\156\ See SIFMA; BPI; ABA; PNC; and SBIA.
\157\ See SBIA.
\158\ See SIFMA; BPI; and SBIA.
\159\ See SIFMA; BPI; and SBIA.
\160\ See Data Boiler.
---------------------------------------------------------------------------
After carefully considering the comments received, the agencies are
adopting the revisions to the exclusion from the definition of covered
fund for SBICs, as proposed.\161\ The revisions will provide greater
certainty to banking entities, give full effect to the provision of
section 13 of the BHC Act that permits investments in SBICs, and
support capital formation for small businesses. In response to one
commenter's concerns regarding the exclusion for SBICs,\162\ the
agencies note that a banking entity's investment in an SBIC must comply
with all applicable laws and regulations, including the prohibition
against proprietary trading under section 13 of the BHC Act and its
implementing regulations. Furthermore, as noted above, the revised
exclusion for SBICs includes safeguards designed to prevent abuse or
evasion. In particular, the exclusion would only apply to an issuer
that has voluntarily surrendered its license to operate as an SBIC in
accordance with 13 CFR 107.1900 and that does not make new investments
(other than investments in cash equivalents) after such voluntary
surrender.
---------------------------------------------------------------------------
\161\ See final rule Sec. __10(c)(11)(i).
\162\ See Data Boiler.
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C. Additional Covered Fund Exclusions
In addition to modifying certain existing exclusions, the agencies
are creating four new exclusions from the definition of ``covered
fund'' to better tailor the provision to the types of entities that
section 13 was intended to cover. These exclusions are for credit
funds, venture capital funds, family wealth management vehicles, and
customer facilitation vehicles.
General Comments
Many commenters were broadly supportive of the proposed new
exclusions from the definition of ``covered fund.'' \163\ Some
commenters recommended adopting additional exclusions for an array of
fund types and situations, including for tender bond vehicles,\164\
ownership interests erroneously acquired or retained,\165\ certain real
estate funds,\166\ and funds in their seeding period.\167\ The agencies
are declining to adopt these suggested exclusions because the requested
actions are outside the scope of the current rulemaking. In addition,
one commenter urged the agencies to redefine the definition of
``covered fund,'' to rely on a characteristics-based approach.\168\ The
agencies decline to revise the definition of ``covered fund'' for the
reasons articulated in the preamble to the 2013 rule.\169\
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\163\ E.g., SIFMA; JBA; Credit Suisse; and SAF.
\164\ SIFMA.
\165\ SIFMA and BPI.
\166\ IAA.
\167\ ABA.
\168\ JBA.
\169\ See 79 FR 5671.
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1. Credit Funds
i. Background and 2020 Proposal
In the preamble to the 2013 rule, the agencies declined to
establish an exclusion from the definition of covered fund for funds
that make loans, invest in debt, or otherwise extend the type of credit
that banking entities may provide directly under applicable banking law
(credit funds).\170\ The agencies cited concerns about whether credit
funds could be distinguished from private equity funds and hedge funds
and the possible evasion of the requirements of section 13 of the BHC
Act through the availability of such an exclusion. In addition, the
agencies suggested that some credit funds would be able to operate
using other exclusions from the definition of covered fund in the 2013
rule, such as the exclusion for joint ventures or the exclusion for
loan securitizations.\171\
---------------------------------------------------------------------------
\170\ See 79 FR 5705.
\171\ Id.
---------------------------------------------------------------------------
However, commenters on the 2018 proposal noted that many credit
funds have not been able to utilize the joint venture and loan
securitization exclusions. In response, the agencies included in the
2020 proposal a specific exclusion for credit funds. Under the 2020
proposal, a credit fund would have been an issuer whose assets consist
solely of:
Loans;
Debt instruments;
Related rights and other assets that are related or
incidental to acquiring, holding, servicing, or selling loans, or debt
instruments; and
Certain interest rate or foreign exchange
derivatives.\172\
---------------------------------------------------------------------------
\172\ 2020 proposal Sec. __.10(c)(15)(i).
---------------------------------------------------------------------------
The proposed exclusion would have been subject to certain
additional requirements to reduce evasion concerns and help ensure that
banking entities invest in, sponsor, or advise credit funds in a safe
and sound manner. For example, the proposed exclusion would have
imposed (1) certain activity requirements on the credit fund, including
a prohibition on proprietary trading; \173\ (2) disclosure and safety
and soundness requirements on banking entities that sponsor or serve as
an advisor for a credit fund; \174\ (3) safety and soundness
requirements on all banking entities that invest in or have certain
relationships with a credit
[[Page 46437]]
fund; \175\ and (4) restrictions on the banking entity's investment in,
and relationship with, a credit fund.\176\ The proposed exclusion also
would have permitted a credit fund to receive and hold a limited amount
of equity securities (or rights to acquire equity securities) that were
received on customary terms in connection with the credit fund's loans
or debt instruments.\177\
---------------------------------------------------------------------------
\173\ 2020 proposal Sec. __.10(c)(15)(ii).
\174\ 2020 proposal Sec. __.10(c)(15)(iii).
\175\ 2020 proposal Sec. __.10(c)(15)(iv).
\176\ 2020 proposal Sec. __.10(c)(15)(v).
\177\ 2020 proposal Sec. __.10(c)(15)(i)(C)(1)(iii).
---------------------------------------------------------------------------
ii. Comments
The agencies requested comment on all aspects of the proposed
credit fund exclusion. In addition, the agencies solicited comment on
specific provisions of the proposed exclusion, including the
permissibility of certain assets and requirements related to the
activities of the credit fund and the relationship between a banking
entity and a credit fund.\178\
---------------------------------------------------------------------------
\178\ See 85 FR 12133.
---------------------------------------------------------------------------
General
Commenters were generally supportive of adopting an exclusion for
credit funds, and several commenters suggested specific revisions to
the proposed exclusion.\179\ Several commenters supportive of the 2020
proposal urged the agencies not to adopt any further limitations on the
proposed exclusion and indicated that the proposed exclusion would not
increase the risk of evasion of the requirements of section 13 of the
BHC Act.\180\ Two commenters expressed general opposition to or concern
about the proposed credit fund exclusion.\181\
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\179\ E.g., CCMC; AIC; SIFMA; FSF; ABA; Arnold & Porter; and
Goldman Sachs.
\180\ E.g., SIFMA; Credit Suisse; Goldman Sachs; and Arnold &
Porter.
\181\ Better Markets and Data Boiler. One of these commenters
suggested that banking entities should instead rely on the
exclusions for joint ventures and loan securitizations. Data Boiler.
---------------------------------------------------------------------------
Asset Requirements
Commenters were generally supportive of allowing a credit fund to
invest broadly in loans and debt instruments, certain related assets,
and certain derivatives.\182\ One commenter recommended against
delineating between permissible and non-permissible types of loans and
debt instruments, arguing that credit funds should be able to extend
credit to the same degree as would be permitted for the banking entity
to extend directly.\183\ Another commenter encouraged the agencies to
clarify and expand the definition of debt instrument and derivatives,
to include all tranches of debt, collateralized loan and collateralized
debt obligations, and any derivatives related to hedging credit risk,
such as credit default swaps and total return swaps.\184\ In addition,
a commenter suggested clarifying that no specific credit standard
applies to loans held by a credit fund.\185\ One commenter also urged
the agencies to establish a safe harbor to the permissible asset
restrictions for banking entities that rely, in good faith, on a
representation by the credit fund that the credit fund only invests in
permissible assets.\186\
---------------------------------------------------------------------------
\182\ E.g., SIFMA; Arnold & Porter; and ABA. One commenter also
noted that the permissible holding period for debt previously
contracted varies depending on applicable regulations and suggested
that the agencies specify the holding period for debt previously
contracted assets owned by a credit fund and provide for an
extension process. Arnold & Porter.
\183\ SIFMA. The same commenter also urged the agencies to
permit credit funds to hold commodity forward contracts, which the
commenter argued may be an appropriate hedge for extensions of
credit to agricultural businesses. SIFMA.
\184\ Credit Suisse. See also Arnold & Porter (recommending
expanding the types of permissible derivatives, to allow for more
effective hedging and easier disposal of portfolio assets).
\185\ ABA.
\186\ Arnold & Porter.
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Two commenters recommended limiting permissible assets to only
loans or debt instruments, and not equity.\187\ In contrast, a range of
commenters argued that allowing a credit fund to receive certain
assets, like equity, related to an extension of credit would promote
the sale of loans and extensions of credit.\188\ Some of these
commenters suggested that taking equity as partial consideration for
extending credit is commonplace in the debt and loan markets and that
such a provision could ensure that credit funds are able to facilitate
loan and debt workouts and restructurings, a critical financial
intermediation function.\189\ Most commenters supportive of the 2020
proposal were generally opposed to a quantitative limit on the amount
of equity securities (or rights to acquire an equity security) received
on customary terms in connection with such loans or debt instruments
that could be held by a credit fund, citing compliance costs and
diminished flexibility,\190\ but some commenters indicated that a
limitation of 20 or 25 percent of total assets could be acceptable if
the agencies were to impose a limit.\191\
---------------------------------------------------------------------------
\187\ Data Boiler and Better Markets. One of these commenters
argued that the inclusion of non-loan instruments would be contrary
to the purpose of section 13 of the BHC Act. Data Boiler. As
indicated by the agencies in the preamble to the 2020 proposal,
taking limited amounts of non-loan or debt assets as consideration
for an extension of credit is common and is a permitted practice for
insured depository institutions. Therefore, the agencies believe it
would not be inconsistent with section 13 of the BHC Act to
facilitate the sale of loans by establishing a credit fund exclusion
that allows a credit fund to hold a limited amount of certain equity
instruments related to extensions of credit. See also the discussion
about permitting excluded loan securitizations to hold a small
amount of non-loan assets, supra Section IV.B.2 (Loan
Securitizations).
\188\ E.g., SIFMA; Credit Suisse; ABA; and Arnold & Porter.
\189\ E.g., SIFMA; Credit Suisse; and Arnold & Porter.
\190\ SIFMA; FSF; CCMC; AIC; ABA; and Goldman Sachs.
\191\ SIFMA and CCMC.
---------------------------------------------------------------------------
Commenters supportive of allowing credit funds to hold certain
related assets, such as equity, in connection with an extension of
credit suggested that the provision would not raise significant safety
and soundness or evasion concerns. For example, one commenter claimed
that such a provision would not raise the risk of evasion, in part,
because equity options received as consideration generally expire
unexercised.\192\ Other commenters argued that the activity
requirements of the exclusion would prevent a credit fund from becoming
actively involved in the purchase and sale of equity instruments.\193\
Another commenter suggested that the agencies could impose a
requirement that non-loan or non-debt assets be acquired on arms-length
terms and adhere to bank safety and soundness standards.\194\
---------------------------------------------------------------------------
\192\ Arnold & Porter.
\193\ Goldman Sachs and FSF.
\194\ ABA.
---------------------------------------------------------------------------
Separately, several commenters recommended allowing excluded credit
funds to hold any type of asset, up to a certain percentage of
aggregate assets, either 20 or 25 percent of a credit fund's total
assets.\195\ These commenters asserted that permitting a credit fund to
own equity securities and other assets would help the fund more
effectively provide credit, without altering the character of the
credit fund, and would reduce compliance burdens associated with
launching and operating a credit fund.\196\ In addition, these
commenters claimed that a limited bucket for non-loan and non-debt
assets would be consistent with the ability of banking entities and
some business development companies to invest in equity.\197\
---------------------------------------------------------------------------
\195\ SIFMA; FSF; Credit Suisse; ABA; and Goldman Sachs. One
commenter also suggested a formula for determining the cap. Goldman
Sachs.
\196\ E.g., SIFMA and Goldman Sachs.
\197\ Id.
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Banking Entity and Issuer Requirements
Generally, commenters either agreed that certain restrictions to
ensure that a credit fund is actually engaged in prudently providing
credit and credit
[[Page 46438]]
intermediation and is not operated for the purpose of evading the
provisions of section 13 of the BHC Act were appropriate or did not
object to the inclusion of these requirements.\198\ Several commenters,
however, offered revisions to the activities, sponsor or advisor,
banking entity, or investment and relationship limit requirements. For
example, several commenters requested clarification on the prohibition
on proprietary trading by an excluded credit fund contained in Sec.
__.10(c)(15)(ii)(A) of the 2020 proposal. One commenter suggested that
the definition of proprietary trading for a credit fund should depend
on the definition used by the banking entity.\199\ Another commenter
encouraged the agencies to incorporate the exclusions and exemptions
from the prohibition on proprietary trading into the credit fund
exclusion's prohibition on proprietary trading.\200\ A third commenter
recommended making explicit that exercising rights for certain related
assets, such as an equity warrant, is not proprietary trading.\201\
---------------------------------------------------------------------------
\198\ E.g., SIFMA; Better Markets; FSF; and Goldman Sachs. One
commenter also indicated that the disclosure requirement for banking
entities that sponsor or advise funds is appropriate. Arnold &
Porter.
\199\ SIFMA. For example, the commenter suggested that a credit
fund sponsored by a banking entity subject to the market risk rule
should be permitted to use the definitions of proprietary trading
and trading account in Sec. __.3(b)(1)(ii).
\200\ FSF.
\201\ Arnold & Porter.
---------------------------------------------------------------------------
Commenters also requested revisions to and clarification about the
limits on a banking entity's investment in, and relationship with, a
credit fund. One commenter argued that the imposition of Sec. __.14 of
the implementing regulations (which imposes limitations on the
relationship between a banking entity and a fund it sponsors or
advises) would be duplicative of (1) the requirement that the banking
entity not, directly or indirectly, guarantee, assume, or otherwise
insure the obligations or performance of the credit fund and (2)
certain conflict of interest, high-risk, and safety and soundness
restrictions.\202\ Another commenter claimed that there was little
benefit to imposing the requirements of Sec. __.14 (described above)
and Sec. __.15 (which imposes certain material conflicts of interest,
high-risk investments, and safety and soundness and financial stability
requirements on permitted covered fund activities) of the implementing
regulations in the context of credit funds and suggested that the
partial application of Sec. __.14, in particular, could lead to
unexpected and inappropriate outcomes, such as allowing a banking
entity to invest in the equity of a credit fund, but not the debt
instruments issued by that same credit fund.\203\ That same commenter
also recommended eliminating Sec. __.10(c)(15)(v)(B) of the 2020
proposal--which would have required that the banking entity's
investment in, and relationship with, the credit fund be conducted in
compliance with, and subject to, applicable banking laws and
regulations--because applicable banking laws and regulations apply
regardless of the banking entity's use of the credit fund
exclusion.\204\
---------------------------------------------------------------------------
\202\ SIFMA.
\203\ Arnold & Porter.
\204\ Arnold & Porter.
---------------------------------------------------------------------------
In addition, a commenter argued that banking entities that serve as
investment advisers or commodity trading advisors to credit funds
should not be subject to the disclosure and safety and soundness
requirements of Sec. __.10(c)(15)(iii) of the 2020 proposal since
investment advisers and commodity trading advisors who do not otherwise
sponsor or invest in a fund are generally not subject to section 13 of
the BHC Act. The commenter argued that Sec. __.10(c)(15)(iii) of the
2020 proposal would impose differing requirements on a credit fund
depending on whether the investment adviser or commodity trading
advisor was an insured depository institution or a bank holding
company. That commenter also claimed that the portfolio requirements in
Sec. __.10(c)(15)(iv)(B) of the 2020 proposal could require banking
entities to establish complex compliance programs to assess credit fund
compliance with state and foreign laws and that the agencies should
limit the scope of the provision to only federal banking laws and
regulations.\205\
---------------------------------------------------------------------------
\205\ Id.
---------------------------------------------------------------------------
Finally, one commenter contended that the application of certain
requirements in the exclusion is contingent on the type of banking
entity that invests in or sponsors a credit fund and urged the agencies
to make explicit that only the identity of the sponsor of the credit
fund, and not its affiliates or third-party investors, determines which
portfolio quality and safety and soundness requirements apply to the
credit fund.\206\ More generally, this commenter asked the agencies to
make explicit in the preamble to the final rule that the actions of
unaffiliated, third-party banking entities do not affect whether a
banking entity may invest in a fund.\207\
---------------------------------------------------------------------------
\206\ Id.
\207\ Id.
---------------------------------------------------------------------------
Other Comments
Commenters also submitted several miscellaneous comments about the
proposed exclusion for credit funds. One commenter requested that the
agencies clarify the definition of asset-backed securities as used in
the proposed credit fund exclusion and the current loan securitization
exclusion.\208\ That same commenter also urged the agencies to revise
the proposed credit fund exclusion to allow banking entities with more
stringent credit requirements, such as insured depository institutions,
to invest in credit funds that hold distressed debt.\209\
---------------------------------------------------------------------------
\208\ Id.
\209\ Id.
---------------------------------------------------------------------------
Finally, the 2020 proposal requested comment on whether to combine
the proposed credit fund exclusion with the loan securitization
exclusion. Commenters were generally opposed to combining the two
exclusions, citing different classes of assets in which the two types
of issuers invest and a fundamental difference in structure (loan
securitizations issue asset-backed securities, while credit funds do
not).\210\ In addition, one commenter argued that while combining the
two exclusions would increase the simplicity of the rule, such an
amalgamated exclusion could result in increased compliance burdens for
issuers who are accustomed to the lack of credit requirements in the
current loan securitization exclusion.\211\
---------------------------------------------------------------------------
\210\ SIFMA; FSF; CCMC; Credit Suisse; and Data Boiler.
\211\ Arnold & Porter.
---------------------------------------------------------------------------
iii. Final Exclusion
After consideration of the comments, the agencies are adopting the
credit fund exclusion as proposed, with certain modifications. The
agencies believe that the credit fund exclusion in the final rule (1)
addresses the application of the covered fund provisions to credit-
related activities that certain banking entities are permitted to
engage in directly and (2) is consistent with Congress's intent that
section 13 of the BHC Act limit banking entities' investment in and
relationships with hedge funds and private equity funds, but not limit
or restrict banking entities' ability to extend credit.\212\ The
agencies also believe that the credit fund exclusion in the final rule,
with the eligibility criteria described below, will address concerns
the agencies expressed in the preamble to the 2013
[[Page 46439]]
rule about the ability to administer an exclusion for credit funds and
the potential evasion of section 13 of the BHC Act.\213\ Banking
entities already have experience using and complying with the loan
securitization exclusion. Establishing an exclusion for credit funds
based on the framework provided by the loan securitization exclusion
allows banking entities to provide traditional extensions of credit
regardless of the specific form, whether directly via a loan made by a
banking entity, or indirectly through an investment in or relationship
with a credit fund that transacts primarily in loans and certain debt
instruments.
---------------------------------------------------------------------------
\212\ See 12 U.S.C. 1851(g)(2), (h)(2). Paragraph (g)(2) of
section 13 of the BHC Act makes clear that the Volcker rule is not
intended to impede banking entities' ability to extend credit by,
for example, selling loans or securitize loans. See 12 U.S.C.
1851(g)(2).
\213\ See 79 FR 5705.
---------------------------------------------------------------------------
The credit fund exclusion limits the universe of potential funds
that can rely on the exclusion by clearly specifying the types of
activities in which those funds may engage. Excluded credit funds can
transact in or hold only loans; debt instruments that would be
permissible for the banking entity relying on the exclusion to hold
directly; certain rights or assets that are related or incidental to
the loans or debt instruments, including equity securities (or rights
to acquire an equity security) received on customary terms in
connection with such loans or debt instruments; and certain interest
rate and foreign exchange derivatives. The credit fund exclusion, with
these eligibility criteria, should not raise evasion concerns.
Similarly, the agencies' expectations regarding the amount of
permissible equity securities (or rights to acquire an equity security)
held and the requirement that the credit fund not engage in activities
that would constitute proprietary trading should help to ensure that
the extensions of credit, whether directly originated or acquired from
a third party, are held by the credit fund for the purpose of
facilitating lending and not for the purpose of evading the
requirements of section 13. Finally, the restrictions on guarantees and
other limitations should eliminate the ability and incentive for either
the banking entity sponsoring a credit fund or any affiliate to provide
additional support beyond the ownership interest retained by the
sponsor. Thus, the agencies expect that, together, the criteria for the
credit fund exclusion will prevent a banking entity from having any
incentive to bail out such funds in periods of financial stress or
otherwise expose the banking entity to the types of risks that the
covered fund provisions of section 13 were intended to address.
Consistent with commenters' suggestions, the agencies are keeping
separate the credit fund exclusion and the loan securitization
exclusion because the structures and purposes of those two types of
issuers differ sufficiently to warrant different requirements. For
example, loan securitizations and credit funds have different asset
composition and different financing and legal structures. Therefore,
the agencies are finalizing a credit fund exclusion separate from the
loan securitization exclusion.
Asset Requirements
Under the final rule, a credit fund, for the purposes of the credit
fund exclusion, is an issuer whose assets consist solely of:
Loans;
Debt instruments;
Related rights and other assets that are related or
incidental to acquiring, holding, servicing, or selling loans, or debt
instruments; and
Certain interest rate or foreign exchange
derivatives.\214\
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\214\ Final rule Sec. __.10(c)(15)(i).
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Several provisions of the exclusion are similar to and modeled on
conditions in the loan securitization exclusion to ease compliance
burdens. For example, any derivatives held by the credit fund must
relate to loans, permissible debt instruments, or other rights or
assets held and reduce the interest rate and/or foreign exchange risks
related to these holdings.\215\ In addition, any related rights or
other assets held that are securities must be cash equivalents,
securities received in lieu of debts previously contracted with respect
to loans held or, unique to the credit fund exclusion, equity
securities (or rights to acquire equity securities) received on
customary terms in connection with the credit fund's loans or debt
instruments.\216\
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\215\ Final rule Sec. __.10(c)(15)(i)(D).
\216\ Final rule Sec. __.10(c)(15)(i)(C). In a minor change
from the 2020 proposal, the agencies are making clear that rights or
other assets held under paragraph (c)(15)(i)(C) of that section may
not include any derivative, other than a derivative that meets the
requirements of paragraph (c)(15)(i)(D) of that section.
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In the 2020 proposal, the agencies requested comment on whether to
impose a limit on the amount of equity securities (or rights to acquire
equity securities) that may be held by an excluded credit fund.\217\
After a review of the comments and further deliberation, the agencies
are not adopting a quantitative limit on the amount of equity
securities (or rights to acquire equity securities) that may be held by
an excluded credit fund. Any such equity securities or rights are
limited by the requirements that they be (a) received on customary
terms in connection with the fund's loans or debt instruments and (b)
related or incidental to acquiring, holding, servicing, or selling
those loans or debt instruments. The agencies generally expect that the
equity securities or rights satisfying those criteria in connection
with an investment in loans or debt instruments of a borrower (or
affiliated borrowers) would not exceed five percent of the value of the
fund's total investment in the borrower (or affiliated borrowers) at
the time the investment is made. The agencies understand that the value
of those equity securities or other rights may change over time for a
variety of reasons, including as a result of market conditions and
business performance, as well as more fundamental changes in the
business and the credit fund's corresponding management of the
investment (e.g., exchanges of debt instruments for equity in
connection with mergers and restructurings or a disposition of all
portion of the credit investment without a corresponding disposition of
the equity securities or rights due to differences in market conditions
or other factors). Accordingly, the agencies can foresee various
circumstances where the relative value of such equity securities or
rights in a borrower (or affiliated borrowers) would over the life of
the investment exceed five percent on a basis consistent with the
requirements. Nonetheless, the agencies expect that the fund's exposure
to equity securities (or other rights), individually and collectively
and when viewed over time, would be managed on a basis consistent with
the fund's overall purpose.
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\217\ 85 FR 12133.
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The agencies are also not imposing additional restrictions on the
types of equity securities (or rights to acquire an equity security)
that a credit fund may hold. The final rule prevents a banking entity
from relying on the credit fund exclusion unless any debt instruments
and equity securities (or rights to acquire an equity security) held by
the credit fund and received on customary terms in connection with the
credit fund's loans or debt instruments are permissible for the banking
entity to acquire and hold directly and a sponsor of a credit fund must
ensure that the credit fund complies with certain safety and soundness
standards.\218\ Combined with the prohibition on proprietary trading by
a credit fund,\219\ these limitations are expected to prevent evasion
of section 13 of the BHC Act and should be sufficient to prevent
[[Page 46440]]
banking entities from investing in or sponsoring credit funds that hold
excessively risky equity securities (or rights to acquire an equity
security).\220\
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\218\ Final rule Sec. __.10(c)(15)(iv)(B), (iii)(B).
\219\ Final rule Sec. __.10(c)(15)(ii)(A).
\220\ One commenter suggested requiring that equity securities
(or rights to acquire an equity security) be acquired via arms-
length market transactions and adhere to bank safety and soundness
standards. See ABA. Under the final rule, a banking entity may not
rely on the credit fund exclusion unless any equity securities (or
rights to acquire an equity security) held by the credit fund are
permissible for the banking entity to acquire and hold directly
under applicable federal banking laws and regulations. Final rule
Sec. __.10(c)(15)(iv)(B). In addition, the final rule requires that
equity securities (or rights to acquire an equity security) related
or incidental to acquiring, holding, servicing, or selling such
loans or debt instruments must be received on customary terms in
connection with such loans or debt instruments. Final rule Sec.
__.10(c)(15)(i)(C)(1)(iii). Finally, a banking entity's investment
in, and relationship with, the issuer must comply with the
limitations imposed in Sec. __.15, as if the issuer were a covered
fund. Final rule Sec. __.10(c)(15)(v)(A).
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The agencies are, however, clarifying that the provision allowing
related rights and other assets does not separately permit the holding
of derivatives. The preamble to the 2020 proposal made clear that ``any
derivatives held by the credit fund must relate to loans, permissible
debt instruments, or other rights or assets held, and reduce the
interest rate and/or foreign exchange risks related to these
holdings.'' \221\ The agencies suggested then and currently believe
that allowing a credit fund issuer to hold derivatives not related to
interest rate or foreign exchange hedging would not be necessary to
facilitate the indirect extension of credit by banking entities and may
pose the very risks that section 13 of the BHC Act was intended to
reach. To ensure that the credit fund exclusions does not inadvertently
allow the holding of certain derivatives unrelated to interest rate
and/or foreign exchange risks, the final rule explicitly excludes
derivatives from permissible related right and other assets.\222\
---------------------------------------------------------------------------
\221\ 85 FR 12132.
\222\ Final rule Sec. __.10(c)(15)(i)(C)(2).
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The agencies are not adopting a broad expansion of permissible
assets, as recommended by several commenters. Contrary to commenters'
suggestions, allowing credit funds to hold unlimited amounts of non-
debt instruments or derivatives, such as credit default or total return
swaps, could present evasion concerns and is not necessary for
effectuating the rule of construction.\223\ The agencies believe that
only those instruments that facilitate the extension of credit and
directly-related hedging activities should be permitted under the
exclusion. For example, allowing the unlimited holding of credit
default swaps by a majority owned or sponsored credit fund could raise
the risks that section 13 of the BHC Act was intended to address.
Moreover, permitting excluded credit funds to invest up to 25 percent
of total assets in any type of asset could turn the exclusion for
credit funds into an exclusion for the type of funds that section 13 of
the BHC Act was intended to address. Such a result would be contrary to
section 13 of the BHC Act.
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\223\ The agencies' rationale, in the preamble to the 2013 rule,
for limiting the permissible assets for the loan securitization
exclusion is particularly relevant. See 79 FR 5691 (``Under the
final rule as adopted, an excluded loan securitization would not be
able to hold derivatives that would relate to risks to
counterparties or issuers of the underlying assets referenced by
these derivatives because the operation of derivatives, such as
these, that expand potential exposures beyond the loans and other
assets, would not in the Agencies' view be consistent with the
limited exclusion contained in the rule of construction under
section 13(g)(2) of the BHC Act, and could be used to circumvent the
restrictions on proprietary trading and prohibitions in section
13(f) of the BHC Act. The Agencies believe that the use of
derivatives by an issuing entity for asset-backed securities that is
excluded from the definition of covered fund under the loan
securitization exclusion should be narrowly tailored to hedging
activities that reduce the interest rate and/or foreign exchange
risks directly related to the asset-backed securities or the loans
supporting the asset-backed securities because the use of
derivatives for purposes other than reducing interest rate risk and
foreign exchange risks would introduce credit risk without
necessarily relating to or involving a reduction of interest rate
risk or foreign exchange risk.'').
---------------------------------------------------------------------------
There are several additional changes recommended by commenters that
the agencies are not including in the final rule. Specifically, the
final rule does not:
Allow excluded credit funds to hold commodity forward
contracts. Although these contracts have legitimate value as hedging
instruments, the agencies do not believe this type of hedging activity
is consistent with the purpose of the exclusion for credit funds, which
is to allow banking entities to share the risks of their permissible
lending activities or to engage in permissible lending activities
indirectly through a fund structure.
Permit banking entities that are insured depository
institutions or their operating subsidiaries to invest in credit funds
through a contribution to a credit fund of troubled loans and debt
previously contracted assets from the banking entity's portfolio. The
conditions in the final rule are intended to ensure that a credit fund
generally engages in activities that the banking entity may engage in
directly and that the banking entity's investment in and relationship
with the fund are conducted in a safe and sound manner. The agencies
decline to deviate from these standards for any particular type of
credit fund because doing so could permit activities that raise the
type of concerns that section 13 of the BHC Act was intended to
address.
Further specify the holding period for securities held in
lieu of debts previously contracted held by a credit fund. Generally, a
banking entity may not rely on this exclusion unless any debt
instruments and equity securities (or rights to acquire equity
securities) held by the fund would be permissible for the banking
entity to acquire and hold directly under applicable federal banking
laws and regulations. However, the requirement that a banking entity be
able to hold a given asset directly does not apply to securities held
in lieu of debts previously contracted under the final regulations.
Because a banking entity's ability to invest in or sponsor an excluded
credit fund is not contingent on how long the credit fund holds
securities held in lieu of debts previously contracted, the agencies do
not believe it is necessary to amend the regulations to impose a
specific holding period on securities held by a credit fund in lieu of
debts previously contracted.\224\
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\224\ The agencies note that banking entities must otherwise
comply with applicable law. See infra, Additional Banking Entity
Requirements.
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Revise or expand on the definition of debt instrument. The
agencies believe that the term debt instrument already has a general
meaning that is used in the marketplace and by regulators and that a
new definition is unnecessary given this widely understood meaning and
could cause confusion.
Adopt a safe harbor for banking entities that rely, in
good faith, on a representation by the credit fund that it only invests
in permissible assets. It is the responsibility of the banking entity
to ensure that it complies with section 13 of the BHC Act and the
implementing regulations, and such responsibility cannot be substituted
solely with a representation from a credit fund.
Activity Requirements
The agencies are adopting the activity requirements for issuers in
the 2020 proposal without revision. Under the final rule, a credit fund
is not a covered fund, provided that:
The fund does not engage in activities that would
constitute proprietary trading, as defined in Sec. __.3(b)(1)(i) of
the rule, as if the fund were a banking entity; \225\ and
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\225\ Final rule Sec. __.10(c)(15)(ii)(A).
---------------------------------------------------------------------------
[[Page 46441]]
The fund does not issue asset-backed securities.\226\
---------------------------------------------------------------------------
\226\ Final rule Sec. __.10(c)(15)(ii)(B).
---------------------------------------------------------------------------
The agencies decline to adopt changes recommended by commenters
because the agencies believe the activity requirements are clear and
appropriate. The first provision explicitly references the prohibition
on proprietary trading by a banking entity in Sec. __.3 of the
implementing regulations and, in particular, the short-term intent
prong contained in Sec. __.3(b)(1)(i). For the avoidance of doubt, a
credit fund would not be able to elect a different definition of
proprietary trading or trading account. Varying the definition of
proprietary trading depending on the type of banking entity that
sponsors or invests in the credit fund, as suggested by a commenter,
could result in conflicting requirements for credit funds with multiple
banking entity investors and generally increase compliance burdens on
credit funds. The agencies also note that activities permitted under
Sec. __.10(c)(15) generally would not be considered proprietary
trading, provided that an excluded credit fund does not purchase or
sell one or more financial instruments principally for the purpose of
short-term resale, benefit from actual or expected short-term price
movements, realize short-term arbitrage profits, or hedge one or more
of the positions resulting from the purchases or sales of financial
instruments.
The agencies are not expressly incorporating the permitted
activities in Sec. Sec. __.4, __.5, and __.6 of the implementing
regulations into the text of the final credit fund exclusion. The
exclusion for credit funds is intended to allow banking entities to
share the risks of otherwise permissible lending activities.
Accordingly, the agencies would not expect that a credit fund would be
formed for the purpose of engaging, or in the ordinary course would be
engaged, in the activities permitted under Sec. Sec. __.4, __.5, and
__.6 of the implementing regulations. Nevertheless, to the extent that
a credit fund seeks to engage in any of those activities as an
exemption from the prohibition on engaging in proprietary trading, as
defined in Sec. __.3(b)(1)(i) of the final rule, and does so in
compliance with the requirements and conditions of the applicable
exemption, then the final rule would not preclude such activities.\227\
Similarly, with respect to the exclusions from the definition of
proprietary trading contained in Sec. __.3(d) of the implementing
regulations, the agencies note that the trading activities identified
in Sec. __.3(d) are by definition not deemed to be proprietary
trading, such that the performance by an excluded credit fund of those
activities would not be inconsistent with the final credit fund
exclusion.\228\
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\227\ The agencies recognize, however, that compliance with
certain requirements and conditions in Sec. Sec. __.4, __.5, and
__.6 of the implementing regulations may be inapt and/or highly
impractical in the context of a credit fund, particularly given the
asset and activity restrictions contained in Sec. __.10(c)(15). For
example, the exemptions for underwriting and market making-related
activities in Sec. __.4 require that a banking entity relying on
such exemptions, among other things, be licensed or registered to
engage in the applicable activity in accordance with applicable law.
Moreover, to the extent that a credit fund is a banking entity with
significant trading assets and liabilities (i.e., because it,
together with its affiliates and subsidiaries, has trading assets
and liabilities that equal or exceed $20 billion over the four
previous calendar quarters), it also would be required to maintain a
separate compliance program specific to those exemptions.
\228\ Similarly, trading activity that satisfies the 60-day
rebuttable presumption in Sec. __.3(b)(4) would be presumed not to
be proprietary trading for these purposes.
---------------------------------------------------------------------------
Finally, the agencies are not revising the definition of ``asset-
backed security'' in the implementing regulations. The definition of
``asset-backed security'' in the implementing regulations specifically
refers to the meaning specified in section 3(a)(79) of the Exchange Act
(15 U.S.C. 78c(a)(79)).\229\ This definition is used elsewhere in
banking law,\230\ and banking entities and others in the loan
securitization industry have adapted their operations in reliance of
the definition contained in the Exchange Act. Moreover, the 2013 rule
included the requirement that the fund issue asset backed securities as
part of the loan securitization criteria, and banking entities have
become familiar with this definition, as they have implemented and
utilized the exclusion.
---------------------------------------------------------------------------
\229\ Implementing regulations Sec. __.10(d)(2).
\230\ See 12 CFR 244 (Credit Risk Retention).
---------------------------------------------------------------------------
Requirements for a Sponsor, Investment Adviser, or Commodity Trading
Advisor
The agencies are adopting the proposed requirements for a sponsor,
investment adviser, or commodity trading advisor to an excluded credit
fund with one modification.
Investors in a credit fund that a banking entity sponsors or for
which the banking entity serves as an investment adviser or commodity
trading advisor may have expectations related to the performance of the
credit fund that raise bailout concerns. To ensure that these investors
are adequately informed of the banking entity's role in the credit
fund, the final rule requires a banking entity that acts as a sponsor,
investment adviser, or commodity trading advisor to an excluded credit
fund to provide prospective and actual investors the disclosures
specified in Sec. __.11(a)(8) of the implementing regulations.\231\
---------------------------------------------------------------------------
\231\ Final rule Sec. __.10(c)(15)(iii)(A). These disclosures
include, among other things, that losses are borne solely by
investors and not the banking entity, that investors should examine
fund documents, and that ownership interests are not insured by the
FDIC or guaranteed. Final rule Sec. __.11(a)(8).
---------------------------------------------------------------------------
Second, a banking entity that acts as a sponsor, investment
adviser, or commodity trading advisor must ensure that the activities
of the credit fund are consistent with safety and soundness standards
that are substantially similar to those that would apply if the banking
entity engaged in the activities directly.\232\ The agencies note,
contrary to the suggestion of a commenter, that this provision does not
apply to any investment adviser or commodity trading advisor to a
credit fund who does not also sponsor or acquire an ownership interest
in the credit fund. Rather, the requirements in Sec. __.10(c)(15)
apply only to a sponsor, investment adviser, or commodity trading
adviser that relies on the exclusion to sponsor or acquire an ownership
interest in the credit fund. The covered fund provisions in Sec. __.10
of the implementing regulations only affect the operations of banking
entities that, as principal, directly or indirectly, acquire or retain
any ownership interest in or sponsor a covered fund.\233\ Thus, the
safety and soundness provision only applies to banking entities that
sponsor an excluded credit fund or that have an ownership interest in
an excluded credit fund and also serve as an investment adviser or
commodity trading advisor to the fund.
---------------------------------------------------------------------------
\232\ Final rule Sec. __.10(c)(15)(iii)(B).
\233\ Implementing regulations Sec. __.10(a)(1).
---------------------------------------------------------------------------
More generally, to clarify an issue raised by some commenters, the
agencies note that whether a specific banking entity may use the credit
fund exclusion to make or have an otherwise impermissible investment in
or relationship with a credit fund is contingent on the permissible
activities of the banking entity. That is, the same fund may be a
covered fund with respect to one banking entity and an excluded credit
fund with respect to a different banking entity. A banking entity
continues to be responsible for ensuring that its particular
investment, sponsorship, or adviser activities comply with section 13
of the BHC Act and its implementing regulations. This principle applies
to paragraphs (iii), (iv), and (v) of the credit fund exclusion.
[[Page 46442]]
The final rule moves the requirement that the banking entity must
comply with Sec. __.14 of the implementing regulations to Sec.
__.10(c)(15)(iii). This organizational change is in response to
commenters that requested the agencies confirm that that the Sec.
__.14 limitations do not apply to a banking entity that merely invests
in a credit fund, as opposed to a banking entity that sponsors or
advises the fund. The agencies believe this change is appropriate
because the limitations on banking entities' relationships with a
covered fund in Sec. __.14 only apply when a banking entity serves,
directly or indirectly, as the investment manager, investment adviser,
commodity trading advisor, or sponsor to a covered fund.\234\ In
addition, the agencies appreciate that mere investment by a banking
entity in a credit fund does not raise the type of concerns Super 23A
was intended to address, and thus the agencies are applying Sec. __.14
only when a banking entity acts as a sponsor, investment adviser, or
commodity trading advisor to a credit fund, in each case as though the
credit fund were a covered fund.\235\ The limitations in Sec. __.15 of
the implementing regulations regarding material conflicts of interest,
high-risk investments, and safety and soundness and financial stability
remain applicable to banking entities' investment in, and relationship
with, excluded credit funds.
---------------------------------------------------------------------------
\234\ Final rule Sec. __.14(a)(1).
\235\ Final rule Sec. __.10(c)(15)(iii)(C).
---------------------------------------------------------------------------
Additional Banking Entity Requirements
As provided in the 2020 proposal, a banking entity may not rely on
the credit fund exclusion if it guarantees the performance of the
fund.\236\ In a revision to the 2020 proposal, under the final rule a
banking entity may not rely on the credit fund exclusion if the fund
holds any debt instruments or equities (or rights to acquire an equity
security) received on customary terms in connection with loans or debt
instruments held by the credit fund that the banking entity is not
permitted to acquire and hold directly under applicable federal banking
laws and regulations.\237\ This change is to clarify, as suggested by a
commenter, that this requirement is specific only to federal banking
laws and regulations. Whether a credit fund's holdings are permissible
for a banking entity to hold under state or foreign laws is not
relevant to compliance with section 13 of the BHC Act. That said, the
agencies note that banking entities must comply with the laws of the
jurisdiction applicable to its activities and operations and should be
cognizant of whether a credit fund it sponsors or in which it invests
complies with the laws of the jurisdictions in which the credit fund
operates.\238\
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\236\ Final rule Sec. __.10(c)(15)(iv).
\237\ Final rule Sec. __.10(c)(15)(iv)(B).
\238\ For example, banking entities that are organized under
state or foreign laws may, depending on the nature of the
organization, need to comply with other laws.
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Investment and Relationship Limits
Finally, the agencies are adopting the proposed provisions related
to a banking entity's investment in and relationship with a credit fund
with one revision. Under the final rule, a banking entity's investment
in, and relationship with, the issuer must comply with the limitations
in Sec. __.15 of the implementing regulations regarding material
conflicts of interest, high-risk investments, and safety and soundness
and financial stability, in each case as though the credit fund were a
covered fund.\239\
---------------------------------------------------------------------------
\239\ Final rule Sec. __.10(c)(15)(v)(A).
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In addition, a banking entity's investment in, and relationship
with, a credit fund must be conducted in compliance with, and subject
to, applicable banking laws and regulations, including the safety and
soundness standards applicable to the banking entity.\240\ The agencies
believe it is important to highlight that the requirements applicable
to the banking entity also govern the ability of the banking entity to
invest in a fund that relies on the credit fund exclusion as well as
the types of transactions that a banking entity may conduct with such
funds.\241\ This means, for example, that a banking entity that invests
in or has a relationship with a credit fund is subject to capital
charges and other requirements under applicable banking law.\242\
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\240\ Final rule Sec. __.10(c)(15)(v)(B).
\241\ The agencies also note that Sec. __.10(c)(15)(v)(B) does
not impose any additional burdens and should not generate confusion.
\242\ For example, a banking entity's investment in or
relationship with a credit fund could be subject to the regulatory
capital adjustments and deductions relating to investments in
financial subsidiaries or in the capital of unconsolidated financial
institutions, if applicable. See 12 CFR 217.22.
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2. Venture Capital Funds
i. Venture Capital Funds
2020 Proposal
The 2020 proposal included an exclusion for ``qualifying venture
capital funds.'' \243\ As described in the 2020 proposal, venture
capital funds that provide capital to small and start-up businesses are
covered funds unless they can rely on an exclusion other than section
3(c)(1) or 3(c)(7) to avoid registration under the Investment Company
Act of 1940 (Investment Company Act) or qualify for an exclusion under
the implementing regulations.
---------------------------------------------------------------------------
\243\ 2020 proposal Sec. __.10(c)(16).
---------------------------------------------------------------------------
Under the 2020 proposal, the exclusion would have been available to
``qualifying venture capital funds,'' which the 2020 proposal defined
as an issuer that meets the definition in 17 CFR 275.203(l)-1 (Rule
203(l)-1), as well as several additional criteria. Specifically, the
agencies proposed to exclude from the definition of covered fund an
issuer that:
Is a venture capital fund as defined in Rule 203(l)-1; and
Does not engage in any activity that would constitute
proprietary trading, under Sec. __.3(b)(1)(i), as if it were a banking
entity.
With respect to any banking entity that acts as sponsor, investment
adviser, or commodity trading advisor to the issuer, and that relies on
the exclusion to sponsor or acquire an ownership interest in the
qualifying venture capital fund, the banking entity would have been
required to:
Provide in writing to any prospective and actual investor
the disclosures required under Sec. __.11(a)(8), as if the issuer were
a covered fund; and
Ensure that the activities of the issuer are consistent
with the safety and soundness standards that are substantially similar
to those that would apply if the banking entity engaged in the
activities directly.
In addition, a banking entity that relied on the exclusion would
not have been permitted, directly or indirectly, to guarantee, assume,
or otherwise insure the obligations or performance of the issuer.
Finally, the 2020 proposal would have required a banking entity's
ownership interest in or relationship with a qualifying venture capital
fund to:
Comply with the limitations imposed in Sec. __.14 (except
the banking entity may acquire and retain any ownership interest in the
issuer) and Sec. __.15 of the implementing regulations, as if the
issuer were a covered fund; and
Be conducted in compliance with and subject to applicable
banking laws and regulations, including applicable safety and soundness
standards.
[[Page 46443]]
Comments
Several commenters supported an exclusion for venture capital
funds.\244\ Some of these commenters argued the Volcker Rule has
severely impacted investment in venture funds and businesses and that
venture capital is a critical financing source for innovative
businesses.\245\ These commenters described their view of the positive
economic impact of venture capital investment.\246\ For example, these
commenters said companies funded with venture capital promote research
and development and job creation.\247\ Similarly, several commenters
argued that venture capital investments by banking entities can
contribute to economic growth, innovation, and job creation.\248\ At
least one commenter said increased venture capital investment may
increase employment by small employers.\249\
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\244\ Representatives Gonzalez, Steil, Stivers, Barr, Hill,
Riggleman, Zeldin, Davidson, Budd, Gooden, Rose, Emmer, Timmons,
Posey, Kustoff, and Loudermilk (Gonzalez et al.); Crapo; FSF; SIFMA;
CCMC; IIB; Goldman Sachs; Credit Suisse; AIC; National Venture
Capital Association (NVCA); ABA; and SAF.
\245\ E.g., Gonzalez et al. and NVCA.
\246\ Gonzalez et al.; NVCA; and CCMC.
\247\ Id.
\248\ E.g., FSF; SIFMA; and Goldman Sachs.
\249\ SAF.
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Several commenters said an exclusion for venture capital funds
would benefit underserved regions where venture capital funding is not
readily available currently.\250\ One commenter said venture capital
fund sizes are often too small for institutional investors, and banks
have historically served an important source of investment for small
and regional venture capital funds.\251\ This commenter said the loss
of banking entities as limited partners in venture capital funds has
had a disproportionate impact on cities and regions with emerging
entrepreneurial ecosystems areas outside of Silicon Valley and other
traditional technology centers.\252\ Two commenters noted that an
exclusion for venture capital funds would promote investments in and
financing to small businesses and start-ups in a broad range of
geographic areas, industries, and sectors.\253\
---------------------------------------------------------------------------
\250\ FSF; SIFMA; CCMC; and NVCA.
\251\ NVCA.
\252\ Id.
\253\ FSF and SIFMA.
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Commenters said that an exclusion for venture capital funds would
promote the safety and soundness of banking entities.\254\ One
commenter said the exclusion would allow banks to diversify and to
compete with non-banking entities.\255\ Commenters also said that the
proposed exclusion allows banking entities to make investments
indirectly through a fund structure that they could make directly \256\
and incorporates criteria and activity restrictions that address any
concerns about safety and soundness or evasion.\257\
---------------------------------------------------------------------------
\254\ FSF; SIFMA; and Goldman Sachs.
\255\ SIFMA.
\256\ NVCA.
\257\ FSF and SIFMA.
---------------------------------------------------------------------------
Several commenters supported defining a qualifying venture capital
fund by reference to Rule 203(l)-1 as proposed.\258\ These commenters
also said the rule should not incorporate additional criteria as
discussed in the preamble to the 2020 proposal, such as additional
limitations on revenues or qualifying investments.\259\ These
commenters said additional criteria are unnecessary to ensure that the
fund is a bona fide venture capital fund and could unnecessarily limit
the scope of qualifying venture capital funds.\260\ On the other hand,
one commenter said the rule should include additional criteria to
ensure qualifying venture capital funds serve the public interest and
do not cause the harms at which section 13 of the Bank Holding Company
Act was directed.\261\ One commenter argued defining venture capital
fund by reference to Rule 203(l)-1 would be too narrow because it would
exclude shares of emerging growth companies (EGCs) from being
classified as qualifying investments and would not reflect certain
companies that operate as venture investors and are exempt from having
to register as an investment company but may not meet the technical
definition of a venture capital fund under Rule 203(l)-1 (e.g., startup
incubators).\262\
---------------------------------------------------------------------------
\258\ SIFMA; NVCA; FSF; and ABA.
\259\ SIFMA; NVCA; FSF; and ABA.
\260\ Id.
\261\ Better Markets.
\262\ CCMC.
---------------------------------------------------------------------------
While supporting an exclusion for qualifying venture capital funds
generally, a few commenters recommended revisions to the proposed
exclusion.\263\ Some commenters proposed changes to the requirement
that the fund not engage in any activity that would constitute
proprietary trading, under Sec. __.3(b)(1)(i), as if it were a banking
entity.\264\ One of these commenters said qualifying venture capital
funds should be permitted to engage in permitted proprietary trading
consistent with Sec. Sec. __.4, __.5, and __.6 of the implementing
regulations.\265\ Another commenter said the definition of proprietary
trading for funds should be the same as the definition that applies to
the banking entity and that having two definitions is not reasonable or
cost-effective.\266\
---------------------------------------------------------------------------
\263\ FSF and SIFMA.
\264\ FSF and SIFMA.
\265\ FSF.
\266\ SIFMA.
---------------------------------------------------------------------------
Commenters also supported changes to the requirement that the
banking entity's investment in and relationship with qualifying venture
capital funds must comply with Sec. __.14 of the implementing
regulations. One commenter recommended eliminating the requirement that
would apply Sec. __.14 to a banking entity's relationship with a
venture capital fund.\267\ This commenter said that other proposed
conditions adequately address bailout and safety and soundness
concerns.\268\ Other commenters said the agencies should clarify that
Sec. __.14 does not apply to a banking entity that simply invests in a
qualifying venture capital fund (as opposed to a banking entity that
sponsors or advises the fund).\269\
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\267\ SIFMA.
\268\ Id.
\269\ NVCA and ABA.
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Other commenters did not support the proposed exclusion for
qualifying venture capital funds.\270\ One of these commenters said if
the agencies do adopt an exclusion for qualifying venture capital
funds, the exclusion must include additional requirements to ensure
that excluded venture capital funds serve the public interest and do
not cause the harms at which section 619 of the Dodd-Frank Act was
directed. Specifically, this commenter said the rule should: (1)
Restrict all fund investments to ``qualifying investments'' or at least
very significantly restrict investments in non-qualifying investments
(e.g., limit them to no more than five percent of the fund's aggregate
capital), (2) impose a minimum securities holding period and portfolio
company revenue limitation of $35 million (or a similarly appropriate
and low figure) to ensure the fund is truly focused on medium-to-long
term venture (as opposed to growth stage) investments, and (3)
quantitatively limit the use of leverage as a key means for
distinguishing excluded venture capital funds from statutorily
prohibited activities involving private equity funds.\271\
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\270\ Better Markets and Data Boiler. Another commenter said an
exemption for venture capital funds was not supported by the 2020
proposal and not permitted under the law. Occupy.
\271\ Better Markets.
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[[Page 46444]]
Final Exclusion
The final rule adopts the proposed exclusion for qualifying venture
capital funds with one clarifying change. The exclusion for qualifying
venture capital funds will be available to an issuer that:
Is a venture capital fund as defined in Rule 203(l)-1; and
Does not engage in any activity that would constitute
proprietary trading, under Sec. __.3(b)(1)(i), as if it were a banking
entity. \272\
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\272\ Final rule Sec. __.10(c)(16)(i).
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With respect to any banking entity that acts as sponsor, investment
adviser, or commodity trading advisor to the issuer, and that relies on
the exclusion to sponsor or acquire an ownership interest in the
qualifying venture capital fund, the banking entity will be required
to:
Provide in writing to any prospective and actual investor
the disclosures required under Sec. __.11(a)(8), as if the issuer were
a covered fund;
Ensure that the activities of the issuer are consistent
with the safety and soundness standards that are substantially similar
to those that would apply if the banking entity engaged in the
activities directly; and
Comply with the restrictions imposed in Sec. __.14
(except the banking entity may acquire and retain any ownership
interest in the issuer), as if the issuer were a covered fund.\273\
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\273\ Final rule Sec. __.10(c)(16)(ii).
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Like the 2020 proposal, a banking entity that relies on the
exclusion may not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of the issuer.\274\
---------------------------------------------------------------------------
\274\ Final rule Sec. __.10(c)(16)(iii).
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Finally, like the 2020 proposal, the final rule requires a banking
entity's ownership interest in or relationship with a qualifying
venture capital fund to:
Comply with the limitations imposed in Sec. __.15 of the
implementing regulations, as if the issuer were a covered fund; and
Be conducted in compliance with and subject to applicable
banking laws and regulations, including applicable safety and soundness
standards.\275\
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\275\ Final rule Sec. __.10(c)(16)(iv).
---------------------------------------------------------------------------
The agencies believe the exclusion for qualifying venture capital
funds will support capital formation, job creation, and economic
growth, particularly with respect to small businesses and start-up
companies. These banking entity investments in qualifying venture
capital funds can benefit the broader financial system by improving the
flow of financing to small businesses and start-ups. The agencies
expect that the new exclusion for qualifying venture capital funds will
provide banking entities with an additional avenue for providing
funding to smaller businesses, which can help to support job creation
and economic growth.
As described further below, the requirements of the exclusion,
including the SEC's definition of venture capital fund in Rule 203(l)-
1, address the concerns the agencies expressed in the preamble to the
2013 rule that the activities and risk profiles of venture capital
funds are not readily distinguishable from those of funds that section
13 of the BHC Act was intended to capture. Accordingly, the agencies
determined these requirements will give effect to the language and
purpose of section 13 of the BHC Act without allowing banking entities
to evade the requirements of section 13.
An exclusion for qualifying venture capital funds is permitted by
the statutory language of section 13 of the BHC Act. As the agencies
discussed in the preamble to the 2013 final rule, the language,
structure, and purpose of section 13 of the BHC Act authorize the
agencies to adopt a tailored definition of ``covered fund'' that
focuses on vehicles used for purposes that were the target of the funds
prohibition.\276\ The agencies do not believe the fact that Congress
expressly distinguished venture capital funds from other types of
private funds in other contexts is dispositive. In this context, the
agencies do not believe that the differences in how the terms private
equity fund and venture capital fund are used in the Dodd-Frank Act
prohibit this exclusion. Rather, the text of section 619 and the Dodd-
Frank Act as a whole indicate that venture capital funds were not the
intended target of the funds prohibition. The plain language of the
statutory prohibition applies to hedge funds and private equity
funds.\277\ This language is silent with respect to venture capital
funds. In Title IV of the Dodd-Frank Act, Congress mandated specific
treatment for venture capital funds for purposes of the registration
requirements under the Investment Advisers Act of 1940 (``Advisers
Act'').\278\ This provision suggests that Congress knew how to accord
specific treatment for venture capital funds. Yet, Congress did not
list venture capital funds among the types of funds that were
restricted under section 13.\279\ That Congress did not intend to
prohibit venture capital fund investments is further supported by the
legislative history of section 13, in which several Members of Congress
specifically addressed venture capital funds in the context of the
funds prohibition.\280\
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\276\ 79 FR 5671.
\277\ 12 U.S.C. 1851(a)(1)(B).
\278\ 15 U.S.C. 80b-3(l).
\279\ In the preamble to the 2013 final rule, the agencies cited
to Congressional reports related to Title IV that characterized
venture capital funds as ``a subset of private investment funds
specializing in long-term equity investment in small or start-up
businesses.'' 79 FR 5704 (quoting S. Rep. No. 111-176 (2010)).
However, there is no indication in the statutory text itself that
Congress intended to treat venture capital funds identically to
private equity funds. Moreover, the agencies did not address the
difference in terminology that Congress used in section 402 of the
Dodd-Frank Act (``private funds'') and section 619 (``hedge funds''
and ``private equity funds''). The difference between these two
terms--specifically, the broader term ``private funds'' used in
Title IV--may indicate why Congress found it necessary to exclude
venture capital explicitly in section 407 but not in section 619.
\280\ See 156 Cong. Rec. E1295 (daily ed. July 13, 2010)
(statement of Rep. Eshoo) (``the purpose of the Volcker Rule is to
eliminate risk-taking activities by banks and their affiliates while
at the same time preserving safe, sound investment activities that
serve the public interest . . . Venture capital funds do not pose
the same risk to the health of the financial system. They promote
the public interest by funding growing companies critical to
spurring innovation, job creation, and economic competitiveness. I
expect the regulators to use the broad authority in the Volcker Rule
wisely and clarify that funds . . . such as venture capital funds,
are not captured under the Volcker Rule and fall outside the
definition of `private equity.' ''); 156 Cong. Rec. S5905 (daily ed.
July 15, 2010) (statement of Sen. Dodd) (confirming ``the purpose of
the Volcker rule is to eliminate excessive risk taking activities by
banks and their affiliates while at the same time preserving safe,
sound investment activities that serve the public interest'' and
stating ``properly conducted venture capital investment will not
cause the harms at which the Volcker rule is directed. In the event
that properly conducted venture capital investment is excessively
restricted by the provisions of section 619, I would expect the
appropriate Federal regulators to exempt it using their authority
under section 619[d][1](J) . . .''); and 156 Cong. Rec. S6242 (daily
ed. July 26, 2010) (statement of Sen. Scott Brown) (``One other area
of remaining uncertainty that has been left to the regulators is the
treatment of bank investments in venture capital funds. Regulators
should carefully consider whether banks that focus overwhelmingly on
lending to and investing in start-up technology companies should be
captured by one-size-fits-all restrictions under the Volcker rule. I
believe they should not be. Venture capital investments help
entrepreneurs get the financing they need to create new jobs.
Unfairly restricting this type of capital formation is the last
thing we should be doing in this economy.'').
---------------------------------------------------------------------------
Like the 2020 proposal, the final rule incorporates the definition
of venture capital fund from Rule 203(l)-1. Most commenters accepted or
supported the proposed approach to incorporate the definition of
venture capital fund in Rule 203(l)-1.\281\ For the reasons discussed
in the 2020 proposal,\282\ the agencies believe this definition
[[Page 46445]]
accurately identifies venture capital funds and addresses the concerns
the agencies identified in declining to adopt an exclusion for venture
capital funds in the 2013 rule.
---------------------------------------------------------------------------
\281\ SIFMA; NVCA; FSF; ABA; and Goldman Sachs.
\282\ 85 FR 12135-12136.
---------------------------------------------------------------------------
The SEC has defined ``venture capital fund'' as any private fund
\283\ that:
---------------------------------------------------------------------------
\283\ For purposes of 17 CFR 275.203(l)-1, ``private fund'' is
defined as ``an issuer that would be an investment company, as
defined in section 3 of the Investment Company Act, but for section
3(c)(1) or 3(c)(7) of that Act.'' 15 U.S.C. 80b-2(a)(29).
---------------------------------------------------------------------------
Represents to investors and potential investors that it
pursues a venture capital strategy;
Immediately after the acquisition of any asset, other than
qualifying investments or short-term holdings, holds no more than 20
percent of the amount of the fund's aggregate capital contributions and
uncalled committed capital in assets (other than short-term holdings)
that are not qualifying investments, valued at cost or fair value,
consistently applied by the fund;
Does not borrow, issue debt obligations, provide
guarantees or otherwise incur leverage, in excess of 15 percent of the
private fund's aggregate capital contributions and uncalled committed
capital, and any such borrowing, indebtedness, guarantee or leverage is
for a non-renewable term of no longer than 120 calendar days, except
that any guarantee by the private fund of a qualifying portfolio
company's obligations up to the amount of the value of the private
fund's investment in the qualifying portfolio company is not subject to
the 120 calendar day limit;
Only issues securities the terms of which do not provide a
holder with any right, except in extraordinary circumstances, to
withdraw, redeem or require the repurchase of such securities but may
entitle holders to receive distributions made to all holders pro rata;
and
Is not registered under section 8 of the Investment
Company Act, and has not elected to be treated as a business
development company pursuant to section 54 of that Act.\284\
---------------------------------------------------------------------------
\284\ 17 CFR 275.203(l)-1(a).
---------------------------------------------------------------------------
``Qualifying investment'' is defined in the SEC's regulation to be:
(1) An equity security issued by a qualifying portfolio company that
has been acquired directly by the private fund from the qualifying
portfolio company; (2) any equity security issued by a qualifying
portfolio company in exchange for an equity security issued by the
qualifying portfolio company described in (1); or (3) any equity
security issued by a company of which a qualifying portfolio company is
a majority-owned subsidiary, as defined in section 2(a)(24) of the
Investment Company Act, or a predecessor, and is acquired by the
private fund in exchange for an equity security described in (1) or
(2).\285\
---------------------------------------------------------------------------
\285\ 17 CFR 275.203(l)-1(c)(3).
---------------------------------------------------------------------------
``Qualifying portfolio company,'' in turn, is defined in the SEC's
regulation to be a company that: (1) At the time of any investment by
the private fund, is not reporting or foreign traded and does not
control, is not controlled by or under common control with another
company, directly or indirectly, that is reporting or foreign traded;
(2) does not borrow or issue debt obligations in connection with the
private fund's investment in such company and distribute to the private
fund the proceeds of such borrowing or issuance in exchange for the
private fund's investment; and (3) is not an investment company, a
private fund, an issuer that would be an investment company but for the
exemption provided by 17 CFR 270.3a-7, or a commodity pool.\286\ The
SEC explained that the definitions of ``qualifying investment'' and
``qualifying portfolio company'' reflect the typical characteristics of
investments made by venture capital funds and that these definitions
work together to cabin the definition of venture capital fund to only
the funds that Congress understood to be venture capital funds during
the passage of the Dodd-Frank Act.\287\
---------------------------------------------------------------------------
\286\ 17 CFR 275.203(l)-1(c)(4).
\287\ See Exemptions for Advisers to Venture Capital Funds,
Private Fund Advisers With Less Than $150 Million in Assets Under
Management, and Foreign Private Advisers, 76 FR 39646, 39657 (Jul.
6, 2011).
---------------------------------------------------------------------------
In the preamble to the regulation adopting this definition of
venture capital fund, the SEC explained that the definition's criteria
distinguish venture capital funds from other types of funds, including
private equity funds and hedge funds. For example, the SEC explained
that it understood the criteria for ``qualifying portfolio companies''
to be characteristic of issuers of portfolio securities held by venture
capital funds and, taken together, would operate to exclude most
private equity funds and hedge funds from the venture capital fund
definition.\288\ The SEC also explained that the criteria for
``qualifying investments'' under the SEC's regulation would help to
differentiate venture capital funds from other types of private funds,
such as leveraged buyout funds.\289\ The SEC further explained that its
regulation's restriction on the amount of borrowing, debt obligations,
guarantees or other incurrence of leverage was appropriate to
differentiate venture capital funds from other types of private funds
that may engage in trading strategies that use financial leverage and
may contribute to systemic risk.\290\
---------------------------------------------------------------------------
\288\ 76 FR 39656.
\289\ See, e.g., 76 FR 39653 (explaining that a limitation on
secondary market purchases of a qualifying portfolio company's
shares would recognize ``the critical role this condition played in
differentiating venture capital funds from other types of private
funds'').
\290\ 76 FR 39662. See also 76 FR 39657 (``We proposed these
elements of the qualifying portfolio company definition because of
the focus on leverage in the Dodd-Frank Act as a potential
contributor to systemic risk as discussed by the Senate Committee
report, and the testimony before Congress that stressed the lack of
leverage in venture capital investing.'').
---------------------------------------------------------------------------
This definition of venture capital fund helps to distinguish the
investment activities of venture capital funds from those of hedge
funds and private equity funds, which was one of the agencies' primary
concerns in declining to adopt an exclusion for venture capital funds
in the 2013 rule. Further, this definition includes criteria reflecting
the characteristics of venture capital funds that the agencies believe
may pose less potential risk to a banking entity sponsoring or
investing in venture capital funds and to the financial system--
specifically, the smaller role of leverage financing and a lesser
degree of interconnectedness with the public markets.\291\ These
characteristics help to address the concern expressed in the preamble
to the 2013 rule that the activities and risk profiles for banking
entities regarding sponsorship of, and investment in, venture capital
fund activities are not readily distinguishable from those funds that
section 13 of the BHC Act was intended to capture.
---------------------------------------------------------------------------
\291\ 76 FR 39662.
---------------------------------------------------------------------------
One commenter said requiring that a fund satisfy the requirements
of Rule 203(l)-1 would have the effect of making the exclusion too
narrow. This commenter said the exclusion for qualifying venture
capital funds should permit investments in EGCs and, more generally,
should ``reflect the evolving nature of the venture capital industry
and not rely solely on the existing SEC definition.'' \292\ The final
rule does not modify the requirement that a qualifying venture capital
fund must satisfy the requirements of Rule 203(l)-1. These requirements
focus the exclusion on the types of less mature and start-up portfolio
companies that characterize traditional venture capital activities. At
the same time, the definition of qualifying venture capital fund does
not preclude investments in EGCs because a qualifying venture capital
fund could make investments in EGCs within the 20 percent limit for
non-qualifying investments. Because the requirement that a qualifying
venture capital fund
[[Page 46446]]
must satisfy the requirements of Rule 203(l)-1 does not preclude
investments in EGCs and helps to distinguish qualifying venture capital
funds from the type of funds that section 13 of the BHC Act was
intended to restrict, the agencies have determined to adopt the
requirement that a qualifying venture capital fund must be a venture
capital fund as defined in Rule 203(l)-1.
---------------------------------------------------------------------------
\292\ CCMC.
---------------------------------------------------------------------------
The final rule adopts the requirement that a qualifying venture
capital fund may not engage in any activity that would constitute
proprietary trading under Sec. __.3(b)(1)(i), as if the issuer were a
banking entity.\293\ As described in the 2020 proposal, this
requirement helps to promote the specific purposes of section 13 of the
BHC Act.\294\ The agencies are not adopting any changes to this
requirement, as recommended by some commenters. The agencies are not
expressly incorporating the permitted activities in Sec. Sec. __.4,
__.5, and __.6 of the implementing regulations into the text of the
qualifying venture capital fund exclusion. The exclusion for qualifying
venture capital funds is intended to allow banking entities to share
the risks of otherwise permissible long-term venture capital
activities. Accordingly, the agencies would not expect that a
qualifying venture capital fund would be formed for the purpose of
engaging, or in the ordinary course would be engaged, in the activities
permitted under Sec. Sec. __.4, __.5, and __.6 of the implementing
regulations. Moreover, such activities could reflect a purpose other
than making long-term venture capital investments. Nevertheless, to the
extent that a qualifying venture capital fund seeks to engage in any of
those activities as an exemption from the prohibition on engaging in
proprietary trading, as defined in Sec. __.3(b)(1)(i) of the final
rule, and does so in compliance with the requirements and conditions of
those permitted activities, then the final rule would not preclude such
activities.\295\ Similarly, with respect to the exclusions from the
definition of proprietary trading in Sec. __.3(d) of the implementing
regulations, the agencies note that that the trading activities
identified in Sec. __.3(d) are by definition not deemed to be
proprietary trading, such that the performance by an qualifying fund of
those activities would not be inconsistent with the final qualifying
venture capital fund exclusion.\296\
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\293\ Final rule Sec. __.10(c)(16)(i)(B).
\294\ 85 FR 12136.
\295\ As the agencies noted in the discussion of the final
credit fund exclusion, compliance with certain requirements and
conditions in __.4, __.5, and __.6 of the implementing regulations
may be inapt and/or highly impractical in the context of a
qualifying venture capital fund, particularly given the activity
restrictions contained in Sec. __.10(c)(16). For example, the
exemptions for underwriting and market making-related activities in
__.4 require that a banking entity relying on such exemptions, among
other things, be licensed or registered to engage in the applicable
activity in accordance with applicable law. Moreover, to the extent
that a qualifying venture capital fund is a banking entity with
significant trading assets and liabilities (i.e., because it,
together with its affiliates and subsidiaries, has trading assets
and liabilities that equal or exceeds $20 billion over the four
previous calendar quarters), it also would be required to maintain a
separate compliance program specific to those exemptions.
\296\ Similarly, and consistent with the discussion of the final
credit fund exclusion, trading activity that satisfies the 60-day
rebuttable presumption in Sec. __.3(b)(4) would be presumed not to
be proprietary trading for these purposes.
---------------------------------------------------------------------------
The final rule does not define proprietary trading by reference to
the prong of paragraph __.3(b)(1) that would apply to the banking
entity, as recommended by some commenters, because the agencies do not
believe this change would be effective or simplify the exclusion.
Unlike some banking entities, venture capital funds (that are not
themselves banking entities) are not subject to the market risk capital
rule, and thus there is generally no need to evaluate a venture capital
fund's investments under the market risk capital framework. Moreover,
applying the prong that would apply to the relevant banking entity
could result in one venture capital fund becoming subject to both
prongs. The agencies believe this would complicate evaluation of a
qualifying venture capital fund's eligibility for the exclusion, both
for banking entities and the agencies. The agencies do not agree with
one commenter's argument that requiring funds sponsored by banking
entities that are subject to the market risk capital rule test to apply
the short-term intent test for purposes of the covered funds provisions
would introduce unnecessary complexity and compliance costs for these
banking entities. As the agencies described in the preamble to the 2019
final rule, the Federal banking agencies' market risk capital rule
\297\ incorporates the same short-term intent standard as the short-
term intent test in Sec. __.3(b)(1)(i).\298\ Therefore, market risk
capital rule covered banking entities continue to apply the short-term
intent standard as part of their compliance with the market risk
capital rule. Similar processes may be employed to apply the short-term
intent standard to qualifying venture capital funds.
---------------------------------------------------------------------------
\297\ See 12 CFR part 3, subpart F; part 217, subpart F; part
324, subpart F.
\298\ 84 FR 61986.
---------------------------------------------------------------------------
The final rule adopts the requirement that a banking entity that
serves as a sponsor, investment adviser, or commodity trading advisor
to a qualifying venture capital fund may not rely on the exclusion for
qualifying venture capital funds unless it provides the disclosures
required under Sec. __.11(a)(8) to prospective and actual investors in
the fund. This requirement promotes one of the purposes of section 13
of the BHC Act, which is to prevent banking entities from bailing out
funds that they sponsor or advise. The final rule also adopts the
requirement that a banking entity that serves as a sponsor, investment
adviser, or commodity trading advisor to a qualifying venture capital
fund must ensure the activities of the qualifying venture capital fund
are consistent with safety and soundness standards that are
substantially similar to those that would apply if the banking entity
engaged in the activity directly. Therefore, a banking entity may not
rely on this exclusion to sponsor or invest in an investment fund that
exposes the banking entity to the type of high-risk trading and
investment activities that the covered fund provisions of section 13 of
the BHC Act were intended to restrict.
In the final rule, the requirement that the banking entity must
comply with Sec. __.14 of the implementing regulations is moved to
Sec. __.10(c)(16)(ii). This change clarifies that this requirement
applies to a banking entity that acts as sponsor, investment adviser,
or commodity trading adviser to the qualifying venture capital fund and
does not apply to a banking entity that merely invests in a qualifying
venture capital fund.
The final rule does not eliminate the requirement that a banking
entity's investment in or relationship with a qualifying venture
capital fund must comply with Sec. __.14 of the implementing
regulations, as recommended by one commenter. The agencies do not agree
that applying the requirements of Sec. __.14 is duplicative of the
requirement that the banking entity not directly or indirectly
guarantee, assume, or otherwise insure the obligations or performance
of the issuer. In addition to prohibiting guarantees, Sec. __.14 also
prohibits other types of transactions that function as extensions of
credit or that could raise the type of bail-out concerns that section
13 of the BHC Act was intended to address. The agencies also do not
agree that applying the requirements of Sec. __.14 is duplicative of
the requirement that the banking entity's investment in and
relationships with
[[Page 46447]]
the qualifying venture capital fund must comply with the backstop
provisions in Sec. __.15. The backstop provisions in Sec. __.15
address high-risk assets and high-risk trading strategies, and material
conflicts of interest, but do not address extensions of credit that may
not entail a ``substantial financial loss'' to the banking entity. The
agencies do not expect that applying Sec. __.14 to a banking entity
that sponsors or advises a qualifying venture capital fund will unduly
interfere with the effectiveness of the exclusion. The final rule
incorporates revisions to Sec. __.14 that will improve banking
entities' ability to enter into certain ordinary course transactions
with sponsored and advised funds.\299\ The agencies expect these
changes will mitigate concerns that applying the requirements of Sec.
__.14 to qualifying venture capital funds will limit the exclusion's
utility.\300\
---------------------------------------------------------------------------
\299\ See infra, Section IV.D (Limitations on Relationships with
a Covered Fund).
\300\ The commenter that recommended eliminating the requirement
that the banking entity's investment in or relationship with a
qualifying venture capital fund said that doing so would ``limit the
utility and related benefits of the qualifying venture capital fund
exclusion, regardless of the proposed new exceptions to Super 23A.''
SIFMA. However, the commenter did not provide any examples or
further explain how the utility of the exclusion would be impacted.
---------------------------------------------------------------------------
The final rule adopts the requirement that the banking entity must
not guarantee, assume, or otherwise insure the obligations or
performance of a qualifying venture capital fund.\301\ The final rule
also adopts the requirements that a banking entity's ownership in or
relationship with a qualifying venture capital fund must comply with
the limitations in Sec. __.15 of the implementing regulations, as if
the issuer were a covered fund, and be conducted in compliance with,
and subject to, applicable banking laws and regulations, including
applicable safety and soundness standards.\302\ These requirements
promote several of the purposes of section 13 of the BHC Act. The
requirement that the banking entity not guarantee, assume, or otherwise
ensure the obligations or performance of a qualifying venture capital
fund promotes the purpose of preventing banking entities from bailing
out the fund. The requirements that a banking entity's ownership in or
relationship with a qualifying venture capital fund must comply with
the limitations in Sec. __.15 of the implementing regulations, as if
the issuer were a covered fund, and be conducted in compliance with,
and subject to, applicable banking laws and regulations, including
applicable safety and soundness standards, prevent a qualifying venture
capital fund from being used to expose a banking entity to the type of
high-risk trading and investment activities that the covered fund
provisions of section 13 of the BHC Act were intended to restrict. To
the extent a fund would expose a banking entity to a high-risk assets
or a high-risk trading strategy, the fund would not be a qualifying
venture capital fund. Therefore, prior to making an investment in a
qualifying venture capital fund, a banking entity would need to ensure
that the fund's investment mandate and strategy would satisfy the
requirements of Sec. __.15. In addition, a banking entity would need
to monitor the activities of a qualifying venture capital fund to
ensure it satisfies these requirements on an ongoing basis.
---------------------------------------------------------------------------
\301\ Final rule Sec. __.10(c)(16)(iii).
\302\ Final rule Sec. __.10(c)(16)(iv).
---------------------------------------------------------------------------
The agencies do not believe that any additional conditions to the
exclusion for qualifying venture capital funds are necessary. One
commenter said that the exclusion should (1) restrict all fund
investments to ``qualifying investments'' or at least very
significantly restrict investments in non-qualifying investments (e.g.,
limit them to no more than five percent of the fund's aggregate
capital), (2) impose a minimum securities holding period and portfolio
company revenue limitation of $35 million (or a similarly appropriate
and low figure) to ensure the fund is truly focused on medium-to-long
term venture (as opposed to growth stage) investments, and (3)
quantitatively limit the use of leverage as a key means for
distinguishing excluded venture capital funds from statutorily
prohibited activities involving private equity funds.\303\ The agencies
have determined not to impose any additional criteria for the reasons
discussed below.
---------------------------------------------------------------------------
\303\ Better Markets.
---------------------------------------------------------------------------
First, the agencies decline to limit a qualifying venture capital
fund's non-qualifying investments to five percent or less of total
assets. The agencies agree with commenters that it is necessary to
provide some amount of flexibility for a venture capital fund to make
investments that deviate from the typical form of venture capital
investment activity. For example, the agencies understand that certain
common venture capital fund activities, such as secondary acquisition
of portfolio company shares from founders, are not qualifying
investments under Rule 203(l)-1. The agencies agree with commenters, as
well as with the rationale the SEC provided in the 2011 adopting
release, that said providing flexibility for this type of non-
qualifying investment is consistent with the overall goal of
identifying funds engaged in a venture capital strategy. In making this
determination, the agencies find it significant that the SEC considered
this issue as part of its 2011 rulemaking and concluded that a 20
percent bucket for non-qualifying investments was appropriate.\304\
Moreover, all activities of a qualifying venture capital fund,
including any investments that would be non-qualifying investments
under Rule 203(l)-1, will be subject to the other requirements in Sec.
__.10(c)(16), including the requirement that the fund not engage in
proprietary trading and not result in a material exposure by the
banking entity to a high-risk asset or high-risk trading strategy.
---------------------------------------------------------------------------
\304\ 76 FR 39683.
---------------------------------------------------------------------------
The agencies also decline to impose additional requirements, such
as a minimum securities holding period or a portfolio company revenue
limitation. The agencies believe a minimum securities holding period is
unnecessary in light of the requirements that the fund (1) represent to
investors and potential investors that it pursues a venture capital
strategy \305\ and (2) not engage in any activity that would constitute
proprietary trading under Sec. __.3(b)(1)(i), as if it were a banking
entity.\306\
---------------------------------------------------------------------------
\305\ 17 CFR 275.203(l)-(1)(a)(1).
\306\ Final rule Sec. __.10(c)(16)(i)(B).
---------------------------------------------------------------------------
The agencies also considered whether to include a portfolio company
revenue limitation, as discussed in the preamble to the 2020 proposal.
Most commenters did not support imposing a revenue limitation, while
one commenter supported imposing a limitation of $35 million. After
considering all comments received, the agencies determined that a
revenue limit could unnecessarily disadvantage certain companies
because the revenues of startups can vary greatly based on industry and
geography. The agencies determined it would be unnecessarily
restrictive to create a revenue limit that could limit funding to
otherwise eligible portfolio companies. Again, the agencies found it
significant that the SEC expressly considered this issue as part of the
2011 rulemaking and determined that any ``single factor test could
ignore the complexities of doing business in different industries or
regions'' and ``could inadvertently restrict venture capital funds from
funding otherwise promising young small companies.'' \307\ In addition,
the definition of ``qualifying portfolio company'' in the SEC's rule
[[Page 46448]]
incorporates appropriate standards that distinguish newer ventures from
more established companies. In particular, a ``qualifying portfolio
company'' may not be ``reporting or foreign traded'' and may not
control, be controlled by or under common control with another company
that is reporting or foreign traded.\308\ A ``reporting or foreign
traded'' company for these purposes means a company that is subject to
the reporting requirements under section 13 or 15(d) of the Securities
Exchange Act of 1934 or having a security listed or traded on any
exchange or organized market operating in a foreign jurisdiction.\309\
In addition to publicly offered companies, this definition excludes
issuers if they have more than $10 million in total assets and a class
of equity securities, such as common stock, that is held of record by
either 2,000 or more persons or 500 or more persons who are not
accredited investors.\310\ In adopting the ``reporting or foreign
traded'' requirement of Rule 203(l)-1, the SEC explained that it found
``a key consideration by Congress'' was that venture capital funds
``are less connected with the public markets and may involve less
potential systemic risk.'' \311\ This condition that qualifying
portfolio companies not be capitalized by the public markets serves to
limit the type of companies in which a qualifying venture capital fund
may invest.
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\307\ 76 FR 39649.
\308\ 17 CFR 275.203(l)-1(c)(4).
\309\ 17 CFR 275.203(l)-1(c)(5).
\310\ 15 U.S.C. 78l(g).
\311\ 76 FR 39656.
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Finally, the agencies determined it is unnecessary to include an
additional quantitative limit on the use of leverage because the
exclusion incorporates a leverage limit. Specifically, Rule 203(l)-1
provides that a venture capital fund may not borrow or otherwise incur
leverage in excess of 15 percent of the fund's aggregate capital
contributions and uncalled capital commitments, and then only on a
short-term basis. Because the exclusion already incorporates a limit on
leverage for a qualifying venture capital fund, it is not necessary for
the final rule to incorporate an additional limit on leverage.
ii. Long-Term Investment Funds
In the preamble to the 2020 proposal, the agencies asked whether
the final rule should include an exclusion for long-term investment
funds. In the preamble, the agencies asked if an exclusion should be
provided for issuers (1) that make long-term investments that a banking
entity could make directly, (2) that hold themselves out as entities or
arrangements that make investments that they intend to hold for a set
minimum time period, such as two years, (3) whose relevant offering and
governing documents reflect a long-term investment strategy, and (4)
that meet all other requirements of the proposed qualifying venture
capital fund exclusion (other than that the issuers would be venture
capital funds as defined in Rule 203(l)-1.
Several commenters supported an exclusion for long-term investment
funds.\312\ Many of these commenters said an exclusion for qualifying
long-term investment funds would help to close gaps in the availability
of financing that exist under the implementing regulations while
promoting and protecting the safety and soundness of the banking entity
and the financial stability of the U.S.\313\ These commenters said the
exclusion would allow banking entities to diversify their assets and
income streams, thereby reducing the overall risk of their assets and
operations and increasing their resiliency against failure.\314\
Several of these commenters supported an exclusion for long-term
investment funds because they said it would allow banking entities to
do indirectly through a fund structure the same activities they may
conduct directly.\315\ Some commenters said long-term investment
vehicles do not engage in short-term proprietary trading or the high-
risk activities that section 619's backstop provisions are intended to
address.\316\
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\312\ Gonzalez et al.; Crapo; FSF; SIFMA; CCMC; CCMR; IIB;
Goldman Sachs; AIC; and ABA. One commenter said the final rule
should exclude an issuer with the following characteristics: (1) Its
investment strategy or business purpose is to invest in assets in
which a financial holding company would be permitted to invest
directly; (2) it holds itself out to investors as acquiring and
holding long-term assets for at least two years; (3) it does not
engage in activities that would constitute impermissible proprietary
trading (as defined in the implementing regulations) if conducted
directly by a banking entity; and (4) if it is sponsored by a
banking entity, (A) the sponsoring banking entity and its affiliates
cannot, directly or indirectly, guarantee, assume or otherwise
insure its obligations, (B) it must comply with the disclosure
obligations under Sec. __.11(a)(8) of the rule and (C) the
sponsoring banking entity must comply with the limitations imposed
by Sec. __.14 (except that the banking entity may acquire and
retain any ownership interest in the issuer) and Sec. __.15, as if
the vehicle were a covered fund. The commenter said these conditions
would adequately address concerns regarding evasion, promote long-
term capital formation, and exclude certain entities that are
inadvertently captured by the definition of ``covered fund'' such as
certain incubators. Goldman Sachs.
\313\ SIFMA; AIC; and CCMR. One commenter said an exclusion for
long-term investment funds is necessary because the proposed
exclusion for qualifying venture capital funds would not address
incubators and other issuers that do not hold themselves out as
pursuing a venture capital strategy. Goldman Sachs. Two commenters
said excluding long-term investment funds would provide certainty
for banking entities that hold interests in ``inadvertent'' or
``accidental'' investment companies. SIFMA and Goldman Sachs.
\314\ Id.
\315\ FSF; CCMR; AIC; CCMC; and SIFMA.
\316\ ABA and CCMC.
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One commenter said the rule should not establish an exclusion for
long-term investment vehicles because section 619 of the Dodd-Frank Act
was put in place to reorient banks away from risky speculative
activities and toward responsible lending to businesses and
households.\317\
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\317\ Robert Rutowski.
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The final rule does not include an exclusion for long-term
investment funds. After reviewing all comments received, the agencies
determined that it remains difficult to distinguish effectively such
funds from the type of funds that section 13 of the BHC Act was
designed to restrict. A general exclusion for long-term investment
funds would be too broad of an approach for addressing specific types
of issuers, such as inadvertent investment companies and incubators
that do not hold themselves out as engaging in a venture capital
strategy, as described by some commenters. An exclusion based primarily
on the length of time that an issuer holds its investments could be
overbroad because it could also permit funds that are engaged in the
type of investment activity that section 13 of the BHC Act was designed
to restrict. Moreover, the agencies believe the exclusions for credit
funds and qualifying venture capital funds will improve banking
entities' ability to provide long-term financing through certain fund
structures in a manner that is consistent with the statute.
3. Family Wealth Management Vehicles
The agencies are adopting an exclusion from the definition of
``covered fund'' under Sec. __.10(b) of the rule for any entity that
acts as a ``family wealth management vehicle.'' This exclusion is
available to an entity that is not, and does not hold itself out as
being, an entity or arrangement that raises money from investors
primarily for the purpose of investing in securities for resale or
other disposition or otherwise trading in securities. For family wealth
management vehicles that are trusts, the grantor(s) must be family
customers.\318\ For non-trust family
[[Page 46449]]
wealth management vehicles, family customers must own a majority of the
voting interests (directly or indirectly) as well as a majority of
interests in the entity. Ownership of non-trust family wealth
management vehicles is generally limited to family customers and up to
five closely related persons of the family customers.\319\ However,
there is a de minimis ownership allowance that permits one or more
entities, including a banking entity, that are not family customers or
closely related persons, to acquire or retain, as principal, up to an
aggregate 0.5 percent of the family wealth management vehicle's
outstanding ownership interests for the purpose of and to the extent
necessary for establishing corporate separateness or addressing
bankruptcy, insolvency, or similar concerns.\320\
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\318\ Under Sec. __.10(c)(17)(iii)(B) of the final rule, a
``family customer'' is a ``family client,'' as defined in Rule
202(a)(11)(G)-1(d)(4) of the Advisers Act (17 CFR 275.202(a)(11)(G)-
1(d)(4)); or any natural person who is a father-in-law, mother-in-
law, brother-in-law, sister-in-law, son-in-law or daughter-in-law of
a family client, or a spouse or spousal equivalent of any of the
foregoing. All terms defined in Rule 202(a)(11)(G)-1 of the Advisers
Act (17 CFR 275.202(a)(11)(G)-1) have the same meaning in the family
wealth management vehicle exclusion.
\319\ Under Sec. __.10(c)(17)(iii)(A) of the final rule,
``closely related person'' means ``a natural person (including the
estate and estate planning vehicles of such person) who has
longstanding business or personal relationships with any family
customer.''
\320\ This 0.5 percent ownership interest represents the
aggregate amount of a family wealth management vehicle's ownership
interests that may be acquired or retained by all entities that are
neither a family customer nor a closely related person.
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In addition, a banking entity may rely on the exclusion only if the
banking entity: (1) Provides bona fide trust, fiduciary, investment
advisory, or commodity trading advisory services to the entity; (2)
does not, directly or indirectly, guarantee, assume, or otherwise
insure the obligations or performance of such entity; (3) complies with
the disclosure obligations under Sec. __.11(a)(8), as if such entity
were a covered fund, provided that the content may be modified to
prevent the disclosure from being misleading and the manner of
disclosure may be modified to accommodate the specific circumstances of
the entity; (4) does not acquire or retain, as principal, an ownership
interest in the entity, other than up to an aggregate 0.5 percent of
the family wealth management vehicle's outstanding ownership interests
for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns; (5) complies with the requirements of Sec. Sec. __.14(b) and
__.15, as if such entity were a covered fund; and (6) except for
riskless principal transactions as defined in Sec. __.10(d)(11),\321\
complies with the requirements of 12 CFR 223.15(a), as if such banking
entity and its affiliates were a member bank and the entity were an
affiliate thereof.\322\
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\321\ ``Riskless principal transaction'' means a transaction in
which a banking entity, after receiving an order to buy (or sell) a
security from a customer, purchases (or sells) the security in the
secondary market for its own account to offset a contemporaneous
sale to (or purchase from) the customer. Final rule Sec.
__.10(d)(11). The allowance for riskless principal transactions in
the final rule does not affect the independent application of the
Board's Regulation W (12 CFR part 223).
\322\ Final rule Sec. __.10(c)(17)(ii).
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In the 2020 proposal, the agencies requested comment on whether to
exclude family wealth management vehicles from the definition of
``covered fund.'' \323\ Several commenters supported this exclusion
stating, generally, that it would reduce uncertainty for banking
entities about the permissibility of providing traditional banking,
investment management, and trust and estate planning services to family
wealth management vehicle clients.\324\ As discussed below, other
commenters opposed the exclusion or recommended revisions to it.\325\
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\323\ 85 FR 12120.
\324\ See, e.g., Goldman Sachs; FSF; CCMR; IAA; ABA; BPI; PNC;
and SIFMA.
\325\ See, e.g., Better Markets, Data Boiler; SIFMA; BPI; ABA.
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The agencies believe that the exclusion for family wealth
management vehicles will appropriately allow banking entities to
structure services or transactions for customers, or to otherwise
provide traditional customer-facing banking and asset management
services, through a vehicle, even though such a vehicle may rely on
section 3(c)(1) or 3(c)(7) of the Investment Company Act or would
otherwise be a covered fund under the implementing regulations.\326\
The agencies believe the exclusion for family wealth management
vehicles will effectively tailor the definition of covered fund by
permitting banking entities to continue to provide traditional banking
and asset management services that do not involve the types of risks
section 13 of the BHC Act was designed to address. As the agencies
noted in the preamble to the 2013 rule, section 13 and the implementing
regulations were designed in part to permit banking entities to
continue to provide client-oriented financial services, including asset
management services.\327\ Furthermore, the agencies believe that the
provisions of the exclusion will work together to sufficiently reduce
the likelihood that these vehicles could be used to evade the
requirements of section 13 or the implementing regulations.
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\326\ Several commenters supported the exclusion, with two
stating that many family wealth management vehicles do not rely on
the exclusions in 3(c)(1) and (c)(7) of the Investment Company Act
and are not covered funds under the implementing regulations. See
ABA and PNC. Banking entities that sponsor or invest in family
wealth management vehicles that are not subject to the covered funds
provisions under section 13 of the BHC Act or the implementing
regulations would not need to rely on this exclusion.
\327\ See 79 FR 5541 (describing the 2013 rule as ``permitting
banking entities to continue to provide, and to manage and limit the
risks associated with providing, client-oriented financial services
that are critical to capital generation for businesses of all sizes,
households and individuals, and that facilitate liquid markets.
These client-oriented financial services, which include
underwriting, market making, and asset management services, are
important to the U.S. financial markets and the participants in
those markets.'').
---------------------------------------------------------------------------
One of the commenters that opposed the exclusion expressed concern
with the agencies adding an exclusion from the definition of ``covered
fund'' that they believed would only benefit a few wealthy
families.\328\ Banking entities may provide asset management services
to families through a trust structure. The agencies believe that
banking entities should have flexibility to offer such asset management
services to families through a fund structure subject to appropriate
limits. As noted above, the agencies believe the exclusion for family
wealth management vehicles will effectively tailor the definition of
covered fund by permitting banking entities to continue to provide
traditional banking and asset management services that do not involve
the types of risks section 13 was designed to address.
---------------------------------------------------------------------------
\328\ See Better Markets.
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The agencies continue to believe that the exclusion for family
wealth management vehicles is consistent with section 13(d)(1)(D),
which permits banking entities to engage in transactions on behalf of
customers, when those transactions would otherwise be prohibited under
section 13.\329\ The exclusion will similarly allow banking entities to
provide traditional services to customers through vehicles used to
manage the wealth and other assets of those customers and their
families.
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\329\ 12 U.S.C. 1851(d)(1)(D).
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Another commenter suggested that, rather than providing an
exclusion for family wealth management vehicles through a rulemaking,
the agencies should instead provide no-action relief on a case-by-case
basis.\330\ The agencies do not believe that a case-by case approach
would further the aims of section 13 or the implementing regulations.
The agencies believe that a case-by-case approach would be
[[Page 46450]]
unnecessarily burdensome and difficult to administer. This approach
would also unnecessarily deviate from the agencies' treatment of other
excluded entities under the implementing regulations and hinder
transparency and consistency.
---------------------------------------------------------------------------
\330\ Data Boiler.
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The agencies believe that the adopted exclusion for a family wealth
management vehicle will appropriately distinguish it from the type of
entity that the covered funds provisions of section 13 of the BHC Act
were intended to capture. The exclusion requires that a family wealth
management vehicle not raise money from investors primarily for the
purpose of investing in securities for resale or other disposition or
otherwise trading in securities. This aspect of the exclusion will help
to differentiate family wealth management vehicles from covered funds,
which raise money from investors for this purpose.
In addition, the family wealth management vehicle exclusion
contains ownership limits designed to ensure that the vehicle is used
to manage the wealth and other assets of customers and their families.
One such limit is the definition of ``family customer.'' As proposed,
the definition of ``family customer'' is based on the definition of
``family client'' in rule 202(a)(11)(G)-1(d)(4) under the Advisers Act
(the family office rule), and also incorporates certain in-laws and
their spouses and spousal equivalents. Several commenters supported
this approach,\331\ however, one commenter suggested that the agencies
exclude in-laws, their spouses and their spousal equivalents from the
definition of ``family customer.'' \332\ The agencies believe that in-
laws, their spouses and spousal equivalents share the same close
familial relations as others included in the definition of ``family
client.'' Furthermore, the agencies believe that the final rule's
definition of ``family customer'' reflects the types of relationships
typically present in family wealth management vehicles.\333\ Reflecting
those relationships prevents unnecessary constraints on the utility of
the exclusion and will allow banking entities to provide traditional
banking services to these clients.
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\331\ See, e.g., SIFMA; BPI; and ABA.
\332\ See Better Markets.
\333\ See, e.g., SIFMA; BPI; and ABA.
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Another ownership limit designed to ensure that a family wealth
management vehicle is used to manage the wealth and other assets of
customers and their families is the requirement that a majority of the
interests in the entity are owned by family customers.\334\ The
inclusion of this limit in the final rule is a modification from the
2020 proposal which only required family customers to own a majority of
the voting interests (directly or indirectly) in the entity. One
commenter suggested this modification to ensure that the exclusion is
not used to evade the intent of section 13 and the implementing
regulations.\335\ The agencies believe this modification is an
appropriate means of ensuring that the exclusion is used by banking
entities that are providing services to family wealth management
vehicles, rather than to hedge funds or private equity funds.
---------------------------------------------------------------------------
\334\ Final rule Sec. __.10(c)(17)(i)(B)(2).
\335\ See ABA.
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Another commenter suggested additional ownership limits for family
wealth management vehicles, including limits on the vehicle's ability
to restructure, to prevent evasion of the prohibitions of section 13
and the implementing regulations.\336\ However, as discussed above, the
agencies believe that the requirements of the exclusion, along with the
conditions a banking entity must meet in order to rely on it, will help
to ensure that banking entities will not be able to use family wealth
management vehicles as a means to evade section 13 and the implementing
regulations.
---------------------------------------------------------------------------
\336\ See Data Boiler.
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Another ownership limit designed to ensure that a family wealth
management vehicle is used to manage the wealth and other assets of
customers and their families is the requirement that only up to five
closely related persons of family customers may hold ownership
interests in the vehicle.\337\ The agencies proposed to permit three
closely related persons to hold ownership interests. Several commenters
supported allowing a finite number of closely related persons of family
customers to hold ownership interests.\338\ However, some commenters
suggested that the proposed limit of three closely related persons did
not reflect the typical manner in which family wealth management
vehicles are constituted and would unnecessarily constrain the
availability of the exclusion.\339\ These commenters recommended that
the agencies modify the proposed rule to allow for up to ten closely
related persons to invest in family wealth management vehicles.\340\
One of these commenters stated that increasing the number of closely
related persons would allow banking entities to provide traditional
wealth management and estate planning services to family wealth
management vehicles and that the other conditions imposed by the
proposed rule would keep such vehicles from evading the covered fund
provisions of the implementing regulations.\341\ The commenter further
noted that a limit of ten closely related persons would align the
exclusion with the numerical limitation of unaffiliated owners provided
for in the joint venture exclusion.\342\
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\337\ Final rule Sec. __.10(c)(17)(i)(B)(3).
\338\ See, e.g., BPI; SIFMA; PNC; and ABA.
\339\ See, e.g., BPI; SIFMA; ABA; and PNC.
\340\ See, e.g., SIFMA; BPI; ABA; and PNC.
\341\ See SIFMA.
\342\ See SIFMA.
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The final rule will allow up to five closely related persons to
hold ownership interests in a family wealth management vehicle.
Commenters indicated that many family wealth management vehicles
currently include more than three closely related persons.\343\ The
agencies believe that the final rule will more closely align the
exclusion with the current composition of family wealth management
vehicles, thereby increasing the utility of the exclusion without
allowing such a large number of non-family customer owners to suggest
the entity is in reality a hedge fund or private equity fund.
Additionally, the agencies believe that requiring family customers to
own a majority of the interests in the family wealth management vehicle
will serve as an additional safeguard against evasion of the provisions
of section 13 of the BHC Act.
---------------------------------------------------------------------------
\343\ See, e.g., BPI; ABA; and PNC.
---------------------------------------------------------------------------
As proposed, the final rule's definition of ``closely related
person'' is ``a natural person (including the estate and estate
planning vehicles of such person) who has longstanding business or
personal relationships with any family customer.'' \344\ One commenter
suggested that the definition of ``closely related person'' should
include only persons with personal relationships with family customers
and not also business relationships.\345\ The agencies believe that it
is not practical or worthwhile to exclude business relationships from
the definition of ``closely related person'' because it would require
banking entities to engage in an assessment of relationships that are
likely to include elements common in both personal and business
relationships. The agencies also believe that requiring these
relationships to be ``longstanding'' will help ensure that they are
bona fide established relationships and not simply related to the
planned investment activities through the family wealth management
vehicle.
---------------------------------------------------------------------------
\344\ Final rule Sec. __.10(c)(17)(iii)(A).
\345\ See, e.g., Better Markets.
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[[Page 46451]]
In a change to the 2020 proposal, the final rule permits any
entity, or entities--not only banking entities--to acquire or retain,
as principal, up to an aggregate 0.5 percent of the entity's
outstanding ownership interests, for the purpose of and to the extent
necessary for establishing corporate separateness or addressing
bankruptcy, insolvency, or similar concerns.\346\ Some commenters
requested that the agencies include this modification because often,
family wealth management vehicles use unaffiliated third parties--such
as third-party trustees or similar service providers--when structuring
family wealth management vehicles.\347\ The agencies believe that
permitting de minimis ownership by non-banking entity third parties is
appropriate and in some cases necessary to reflect the typical
structure of family wealth management vehicles. The de minimis
ownership provision recognizes that ownership by an entity other than a
family customer or closely related person may be necessary under
certain circumstances--such as establishing corporate separateness or
addressing bankruptcy, insolvency, or similar matters. Whether the
entity that owns a de minimis amount is a banking entity or some other
third party does not raise any concerns that are not sufficiently
addressed by the aggregate ownership limit and the narrow circumstances
in which such entities may take an ownership interest. The agencies
recognize that without this modification, family wealth management
vehicles may be forced to engage in less effective and/or efficient
means of structuring and organization because the exclusion would limit
the vehicle's access to some customary service providers that have
traditionally taken small ownership interests for structuring purposes.
The agencies are therefore expanding the types of entities that may
acquire or retain the de minimis ownership interest to include any
third party. However, the aggregate de minimis amount and the purpose
for which it may be owned is unchanged from the 2020 proposal.
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\346\ Final rule Sec. __.10(c)(17)(i)(C).
\347\ See, e.g., SIFMA and BPI.
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As stated above, under the final rule, a banking entity may only
rely on the exclusion with respect to a family wealth management
vehicle if the banking entity meets certain conditions.\348\ The
agencies believe that, collectively, the conditions of the exclusion
will help to ensure that family wealth management vehicles are used for
client-oriented financial services provided on arms-length, market
terms, and to prevent evasion of the requirements of section 13 of the
BHC Act and the implementing regulations. In addition, these conditions
are based on existing conditions in other provisions of the
implementing regulations,\349\ which the agencies believe will
facilitate banking entities' compliance with the exclusion.
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\348\ Final rule Sec. __.10(c)(17)(ii).
\349\ See implementing regulations Sec. Sec. __.11(a)(5)
(imposing, as a condition of the exemption for organizing and
offering a covered fund, that a banking entity and its affiliates do
not, directly or indirectly, guarantee, assume, or otherwise insure
the obligations or performance of the covered fund or of any covered
fund in which such covered fund invests); __.11(a)(8) (imposing, as
a condition of the exemption for organizing and offering a covered
fund, that the banking entity provide certain disclosures to any
prospective and actual investor in the covered fund);
__.10(c)(2)(ii) (allowing, as a condition of the exclusion from the
covered fund definition for wholly-owned subsidiaries, for the
holding of up to 0.5 percent of outstanding ownership interests by a
third party for limited purposes); and __.14(b) (subjecting certain
transactions with covered funds to section 23B of the Federal
Reserve Act).
---------------------------------------------------------------------------
As proposed, the agencies are not applying Sec. __.14(a), which
applies section 23A of the Federal Reserve Act to banking entities'
relationships with covered funds, to family wealth management vehicles
because the agencies understand that the application of Sec. __.14(a)
to family wealth management vehicles could prohibit banking entities
from providing the full range of banking and asset management services
to customers using these vehicles.\350\ The agencies are, however,
applying Sec. Sec. __.14(b) and __.15 to family wealth management
vehicles, as proposed, because the agencies continue to believe that it
will help ensure that banking entities and their affiliates' exposure
to risk remains appropriately limited.
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\350\ See SIFMA (stating that it agreed with the agencies'
approach of not applying Sec. __.14 to relationships between
banking entities and family wealth management vehicles because doing
so would prevent banking entities from making ordinary extensions of
credit and entering into a number of other transactions with family
wealth management vehicles that are critical to the banking entity
providing traditional asset management and estate planning
services).
---------------------------------------------------------------------------
The agencies are also adopting a prohibition, with modifications
described below, on banking entity purchases of low-quality assets from
family wealth management vehicles that would be prohibited under
Regulation W concerning transactions with affiliates (12 CFR
223.15(a))--as if such banking entity were a member bank and the entity
were an affiliate thereof--to prevent banking entities from ``bailing
out'' family wealth management vehicles.\351\ Regulation W (12 CFR
223.15(a)) provides that a member bank may not purchase a low-quality
asset from an affiliate unless, pursuant to an independent credit
evaluation, the member bank had committed itself to purchase the asset
before the time the asset was acquired by the affiliate.\352\ Several
commenters requested clarification that the exclusion permits banking
entities to engage in riskless principal transactions to purchase
assets--including low quality assets for purposes of section 223.15 of
the Board's Regulation W--from family wealth management vehicles.\353\
Commenters stated that the need for such asset purchases may arise as a
result of a family customer's preferences and that permitting the
banking entities to engage in such purchases may facilitate the family
customer's sale of the asset.\354\ Commenters stated that allowing
these transactions would pose minimal market or credit risk to a
banking entity because the banking entity would purchase and sell the
same asset contemporaneously.\355\ Furthermore, one commenter stated
that without clarity on the permissiveness of riskless principal
transactions, family wealth management vehicles would be forced to
obtain the services of a third-party service provider to sell low
quality assets, which would increase costs and operational complexity
of the family wealth management vehicles without furthering the aims of
section 13 of the BHC Act or the implementing regulations.\356\
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\351\ Final rule Sec. __.10(c)(17)(ii)(F).
\352\ 12 CFR 223.15(a).
\353\ See, e.g., BPI and SIFMA.
\354\ See, e.g., BPI and SIFMA.
\355\ See, e.g., SIFMA and BPI.
\356\ See SIFMA.
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The agencies believe that permitting a banking entity to engage in
riskless principal transactions that involve the purchase of low-
quality assets from a family wealth management vehicle is unlikely to
pose a substantive risk of evading section 13 of the BHC Act. In a
riskless principal transaction, the riskless principal (the banking
entity) buys and sells the same security contemporaneously, and the
asset risk passes promptly from the customer (family wealth management
vehicle, in this context) through the riskless principal to a third-
party.\357\ The agencies are adopting the condition that banking
entities and their affiliates comply with the requirements of 12 CFR
223.15(a), as if such banking entity and its affiliates were a member
bank and the entity were an affiliate. However, in a change from the
2020 proposal and in response to the concerns raised by
[[Page 46452]]
commenters, the condition will explicitly exclude from those
requirements transactions that meet the definition of riskless
principal transactions as defined in Sec. __.10(d)(11). The definition
of riskless principal transactions adopted in Sec. __.10(d)(11) is
similar to the definition adopted in the Board's Regulation W, as this
definition is appropriately narrow and generally familiar to banking
entities.\358\ The agencies expect that, together, the adopted criteria
for the family wealth management vehicle exclusion will prevent a
banking entity from being able to bail out such entities in periods of
financial stress or otherwise expose the banking entity to the types of
risks that the covered fund provisions of section 13 were intended to
address.
---------------------------------------------------------------------------
\357\ See 67 FR 76597.
\358\ 12 CFR 223.3(ee).
---------------------------------------------------------------------------
Several commenters requested that the agencies remove the condition
that banking entities and their affiliates comply with the disclosure
obligations under Sec. __.11(a)(8) of the final rule, as if the
vehicle were a covered fund, because such disclosures would not apply
to a vehicle that a banking entity was not organizing and offering
pursuant to Sec. __.11(a) of the final rule and therefore would be
confusing.\359\ In particular, these commenters stated that the
required disclosure under Sec. __.11(a)(8) concerning the banking
entity's ``ownership interests'' in the fund and referencing the fund's
``offering documents'' may create confusion in circumstances where the
banking entity does not own an interest in the family wealth management
vehicle, or where such vehicles do not have offering documents. Also,
commenters requested confirmation from the agencies that banking
entities would be permitted to (i) modify the required disclosures to
reflect the specific circumstances of their relationship with, and the
particular structure of, their family wealth management vehicle
clients; and (ii) satisfy the written disclosure requirement by means
other than including such disclosures in the governing document(s) of
the family wealth management vehicle(s).\360\
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\359\ See, e.g., ABA and PNC.
\360\ See, e.g., BPI.
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The agencies are adopting the condition that banking entities and
their affiliates comply with the disclosure obligations under Sec.
__.11(a)(8) of the final rule with respect to family wealth management
vehicles. However, in a change from the 2020 proposal and in response
to the concerns raised by commenters, the condition will explicitly
permit banking entities and their affiliates to modify the content of
such disclosures to prevent the disclosure from being misleading and
also permit banking entities to modify the manner of disclosure to
accommodate the specific circumstances of the entity.\361\ The
obligations under Sec. __.11(a)(8) of the final rule apply in
connection with the exemption for organizing and offering covered
funds, which would typically require the preparation and distribution
of offering documents. The agencies, however, understand that many
family wealth management vehicles may not have offering documents. The
agencies have an interest in providing family wealth management vehicle
customers with the substance of the disclosure, rather than a concern
with the specific wording of the disclosure or with the document in
which the disclosure is provided. Accordingly, the agencies have
provided that the content of the disclosure may be modified to prevent
the disclosure from being misleading and the manner of disclosure may
be modified to accommodate the specific circumstances of the family
wealth management vehicle.
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\361\ In the 2020 proposal, the agencies had indicated that for
purposes of the proposed exclusion, a banking entity could satisfy
these written disclosure obligations in a number of ways and could
modify the specific wording of the disclosures in Sec. __.11(a)(8)
to accurately reflect the specific circumstances of the family
wealth management vehicle.
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For example, Sec. __.11(a)(8) requires disclosure that an investor
``should read the fund offering documents before investing in the
covered fund.'' In order to accurately reflect the specific
circumstances of a family wealth management vehicle for which there are
no offering documents, the modified provision will allow the banking
entity to revise this disclosure to reference the appropriate
disclosure documents, if any, provided in connection with the vehicle.
Similarly, the agencies understand the specific wording of the
disclosures in Sec. __.11(a)(8) of the rule may need to be modified to
accurately reflect the specific circumstances of the banking entity's
relationship with the family wealth management vehicle. For example, a
banking entity that holds no ownership interest in the family wealth
management vehicle may modify the disclosure required in Sec.
__.11(a)(8)(i)(A) to reflect its lack of ownership. Moreover, Sec.
__.11(a)(8) requires that the banking entity provide these disclosures,
``such as through disclosure in the . . . offering documents.'' The
agencies expect that a banking entity could satisfy these disclosure
delivery obligations in a number of ways, such as by including them in
the family wealth management vehicle's governing documents, in account
opening materials or in supplementary materials (e.g., a separate
disclosure document provided by the banking entity solely for purposes
of complying with this exclusion and providing the required
disclosures).
4. Customer Facilitation Vehicles
The agencies are adopting an exclusion from the definition of
``covered fund'' under Sec. __.10(b) of the rule for any issuer that
acts as a ``customer facilitation vehicle.'' The customer facilitation
vehicle exclusion will, as proposed, be available for any issuer that
is formed by or at the request of a customer of the banking entity for
the purpose of providing such customer (which may include one or more
affiliates of such customer) with exposure to a transaction, investment
strategy, or other service provided by the banking entity.\362\
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\362\ Final rule Sec. __.10(c)(18)(i).
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A banking entity may only rely on the exclusion with respect to an
issuer provided that: (1) All of the ownership interests of the issuer
are owned by the customer (which may include one or more of its
affiliates) for whom the issuer was created; \363\ and (2) the banking
entity and its affiliates: (i) Maintain documentation outlining how the
banking entity intends to facilitate the customer's exposure to such
transaction, investment strategy, or service; (ii) do not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of such issuer; (iii) comply with the disclosure
obligations under Sec. __.11(a)(8), as if such issuer were a covered
fund, provided that the content may be modified to prevent the
disclosure from being misleading and the manner of disclosure may be
modified to accommodate the specific circumstances of the issuer; (iv)
do not acquire or retain, as principal, an ownership interest in the
issuer, other than up to an aggregate 0.5 percent of the issuer's
outstanding ownership interests for the purpose of and to the extent
necessary for establishing corporate separateness or addressing
bankruptcy, insolvency, or similar concerns; (v) comply with the
[[Page 46453]]
requirements of Sec. Sec. __.14(b) and __.15, as if such issuer were a
covered fund; and (vi) except for riskless principal transactions as
defined in Sec. __.10(d)(11), comply with the requirements of 12 CFR
223.15(a), as if such banking entity and its affiliates were a member
bank and the entity were an affiliate thereof.\364\
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\363\ Notwithstanding this condition, up to an aggregate 0.5
percent of the issuer's outstanding ownership interests may be
acquired or retained by one or more entities that are not customers
if the ownership interest is acquired or retained by such parties
for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or
similar concerns. Final rule Sec. __.10(c)(18)(ii)(B).
\364\ Final rule Sec. __.10(c)(18)(ii).
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The agencies continue to believe that this exclusion will
appropriately allow banking entities to structure certain types of
services or transactions for customers, or to otherwise provide
traditional customer-facing banking and asset management services,
through a vehicle, even though such a vehicle may rely on section
3(c)(1) or 3(c)(7) of the Investment Company Act or would otherwise be
a covered fund under the final rule. Most commenters that addressed
this exclusion were supportive,\365\ stating that it would provide
banking entities with greater flexibility to meet client needs and
objectives.\366\ Some commenters found the exclusion's conditions to be
reasonable and sufficient.\367\ However, two commenters recommended
that the agencies impose additional limitations on the exclusion.\368\
One of these commenters argued that the exclusion would permit, and
possibly encourage, banking entities to increase their risk exposures
through the use of customer facilitation vehicles, and the agencies
should minimize such risk exposures and promote risk monitoring and
management.\369\
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\365\ See, e.g., SIFMA; BPI; ABA; Credit Suisse; FSF; Goldman
Sachs; and IAA.
\366\ See, e.g., SIFMA; BPI; ABA; and Goldman Sachs.
\367\ See, e.g., SIFMA; FSF; and SAF.
\368\ See Better Markets and Data Boiler.
\369\ See Better Markets.
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The agencies continue to believe that these vehicles do not expose
banking entities to the types of risks that section 13 of the BHC Act
was intended to restrict, and that this exclusion is consistent with
section 13(d)(1)(D), which permits banking entities to engage in
transactions on behalf of customers, when such transactions would
otherwise be prohibited under section 13. The agencies have elsewhere
tailored the 2013 rule to allow banking entities to meet their
customers' needs.\370\ This exclusion will similarly allow banking
entities to provide customer-oriented financial services through a
vehicle when that vehicle's purpose is to facilitate a customer's
exposure to those services.\371\ As stated in the 2020 proposal, the
agencies do not believe that section 13 of the BHC Act was intended to
interfere unnecessarily with the ability of banking entities to provide
services to their customers simply because the customer may prefer to
receive those services through a vehicle or through a transaction with
a vehicle instead of directly with the banking entity.\372\ Some
commenters agreed, stating that customer facilitation vehicles would
not expose banking entities to the types of risks that section 13 was
intended to prohibit or limit, particularly given that such vehicles
will be subject to a number of conditions, as discussed below.\373\
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\370\ For example, the agencies in 2019 amended the exemption
for risk-mitigating hedging activities to allow banking entities to
acquire or retain an ownership interest in a covered fund as a risk-
mitigating hedge when acting as an intermediary on behalf of a
customer that is not itself a banking entity to facilitate the
exposure by the customer to the profits and losses of the covered
fund. See 2019 amendments Sec. __.13(a)(1)(ii). See also 2019
amendments Sec. __.3(d)(11) (excluding from the definition of
``proprietary trading'' the entering into of customer-driven swaps
or customer-driven security-based swaps and matched swaps or
security-based swaps under certain conditions).
\371\ This exclusion does not require that the customer
relationship be pre-existing. In other words, the exclusion will be
available for an issuer that is formed for the purpose of
facilitating the exposure of a customer of the banking entity where
the customer relationship begins only in connection with the
formation of that issuer. The agencies took a similar approach to
this question in describing the exemption for activities related to
organizing and offering a covered fund under Sec. __.11(a) of the
2013 rule. See 79 FR 5716. The agencies indicated that section
13(d)(1)(G), under which the exemption under Sec. __.11(a) was
adopted, did not explicitly require that the customer relationship
be pre-existing. Similarly, section 13(d)(1)(D) does not explicitly
require a pre-existing customer relationship.
\372\ 85 FR 12120.
\373\ See SIFMA and ABA.
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The exclusion will, as proposed, require that the vehicle be formed
by or at the request of the customer.\374\ One commenter suggested that
the agencies remove this requirement, arguing that it would inhibit a
banking entity's ability to provide customers with services in a timely
manner.\375\ However, the agencies continue to believe that this
requirement is an important component of the exclusion because it helps
differentiate customer facilitation vehicles from covered funds that
are organized and offered by the banking entity. As stated in the 2020
proposal, the requirement will not preclude a banking entity from
marketing its customer facilitation vehicle services or discussing with
its customers prior to the formation of such vehicles the potential
benefits of structuring such services through a vehicle.\376\
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\374\ Final rule Sec. __.10(c)(18)(i).
\375\ SIFMA (stating that requiring a banking entity to wait for
a customer to request formation would delay the banking entity's
ability to provide services to the customer without any
corresponding regulatory benefit).
\376\ 85 FR 12120.
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As in the 2020 proposal, the agencies are not specifying the types
of transaction, investment strategy or other service that a customer
facilitation vehicle may be formed to facilitate.\377\ One commenter
recommended specifying that the exclusion only allow vehicles to be
formed for extensions of intraday credit, and payment, clearing, and
settlement services, and only for purposes of operational
efficiency.\378\ Another commenter argued that attempting to specify
may prevent banking entities from being able to appropriately respond
to a customer's requests.\379\ The agencies continue to believe that
providing flexibility enhances the utility of this exclusion.
Specifically, the agencies note that the purpose of this exclusion is
to allow banking entities to provide customer-oriented financial
services through vehicles, providing customers with exposure to a
transaction, investment strategy, or other service that the banking
entity may provide to such customers directly. Limiting the type of
transaction, investment strategy, or service for which the customer
facilitation vehicle may be formed would interfere with this purpose.
Accordingly, the agencies are adopting this requirement as proposed.
---------------------------------------------------------------------------
\377\ Final rule Sec. __.10(c)(18)(i).
\378\ See Data Boiler.
\379\ See SIFMA.
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Under the final rule, similar to the 2020 proposal, a banking
entity will be able to rely on the customer facilitation vehicle
exclusion only under certain conditions, as stated above.\380\
Commenters supported most of the conditions, stating that the exclusion
imposes reasonable conditions that provide safeguards.\381\ Commenters
also suggested modifications to certain conditions, as discussed
below.\382\ The agencies are adopting the conditions, largely as
proposed. However, the agencies are modifying the conditions that
relate to de minimis ownership of the vehicle, the requirements of 12
CFR 223.15(a), and the disclosure obligations under Sec. __.11(a)(8),
as discussed below.
---------------------------------------------------------------------------
\380\ Final rule Sec. __.10(c)(18)(ii).
\381\ See, e.g., SIFMA; FSF; and SAF.
\382\ See, e.g., SIFMA; BPI; and FSF.
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As proposed, the exclusion would have permitted banking entities
and their affiliates to acquire or retain, as principal, an ownership
interest in the issuer up to 0.5 percent of the issuer's outstanding
ownership interests, for the purpose of and to the extent necessary
[[Page 46454]]
for establishing corporate separateness or addressing bankruptcy,
insolvency, or similar concerns.\383\ Similar to their request for
family wealth management vehicles, commenters suggested that the
agencies specifically allow any party that is unaffiliated with the
customer, rather than only the banking entities and their affiliates,
to own this de minimis interest.\384\ For the same reasons as discussed
above with respect to family wealth management vehicles, the agencies
are modifying the de minimis ownership provision such that up to an
aggregate 0.5 percent of the issuer's outstanding ownership interests
may be acquired or retained by one or more entities that are not
customers if the ownership interest is acquired or retained by such
parties for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns.\385\
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\383\ See 2020 proposed rule Sec. __.10(c)(18)(ii)(B)(4).
\384\ See SIFMA; BPI; and FSF.
\385\ Final rule Sec. __.10(c)(18)(ii)(B).
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The agencies are adopting, with modifications, the condition for a
banking entity to comply with the requirements of 12 CFR 223.15(a), as
if such banking entity were a member bank and the issuer were an
affiliate thereof.\386\ As discussed above, several commenters
recommended that the agencies clarify that the family wealth management
vehicle exclusion permits banking entities to engage in riskless
principal transactions to purchase assets--including low quality assets
for purposes of section 223.15 of the Board's Regulation W--from family
wealth management vehicles.\387\ One such commenter also suggested
that, for purposes of consistency, the agencies should similarly
clarify that banking entities are permitted to engage in such riskless
principal transactions with customer facilitation vehicles.\388\
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\386\ Final rule Sec. __.10(c)(18)(ii)(C)(6). 12 CFR 223.15(a)
provides that a member bank may not purchase a low-quality asset
from an affiliate unless, pursuant to an independent credit
evaluation, the member bank had committed itself to purchase the
asset before the time the asset was acquired by the affiliate. 12
CFR 223.15(a).
\387\ See, e.g., BPI and SIFMA. See supra, Section IV.C.3
(Family Wealth Management Vehicles).
\388\ See BPI.
---------------------------------------------------------------------------
The purpose of the proposed requirement that a customer
facilitation vehicle must comply with 12 CFR 223.15(a) was the same for
both the family wealth management vehicle and the customer facilitation
vehicle exclusions--to help ensure that the exclusions do not allow
banking entities to ``bail out'' either vehicle.\389\ For the same
reasons discussed above with respect to family wealth management
vehicles, the agencies have modified the requirement to exclude from
the requirements of 12 CFR 223.15(a) transactions that meet the
definition of riskless principal transactions as defined in Sec.
__.10(d)(11).\390\ Similar to the agencies' approach with respect to
family wealth management vehicles, the agencies expect that, together,
the adopted criteria for this exclusion will prevent a banking entity
from being able to bail out customer facilitation vehicles in periods
of financial stress or otherwise expose the banking entity to the types
of risks that the covered fund provisions of section 13 of the BHC Act
were intended to address.
---------------------------------------------------------------------------
\389\ See 85 FR 12120.
\390\ Final rule Sec. __.10(c)(18)(ii)(C)(6).
---------------------------------------------------------------------------
The agencies are modifying the condition that the banking entity
and its affiliates comply with the disclosure obligations under Sec.
__.11(a)(8), as if such issuer were a covered fund, to provide
clarification that the content of the disclosure may be modified to
prevent the disclosure from being misleading and the manner of
disclosure may be modified to accommodate the specific circumstances of
the issuer.\391\ Commenters requested that the agencies provide such
clarification in the context of family wealth management vehicles.\392\
Although the agencies did not receive any comments with respect to this
condition in the context of this exclusion, the agencies are similarly
modifying this condition under this exclusion. The agencies believe
that these disclosures will provide important information to the
customers for whom these vehicles will be used to provide services--
whether they are family customers under the family wealth management
vehicle exclusion or other customers under this exclusion. The
agencies' treatment of this condition for family wealth management
vehicles, as described above, will similarly apply to this condition
for customer facilitation vehicles.\393\
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\391\ Final rule Sec. __.10(c)(18)(ii)(C)(3).
\392\ See supra, Section IV.C.3 (Family Wealth Management
Vehicles).
\393\ Id.
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The agencies are adopting, as proposed, the condition that all of
the ownership interests of the issuer are owned by the customer (which
may include one or more of the customer's affiliates) for whom the
issuer was created (other than a de minimis interest that may be held
by others, as discussed above).\394\ The agencies continue to believe
that this condition is appropriate to prevent banking entities from
using this exclusion for customer facilitation vehicles to evade the
restrictions of section 13 of the BHC Act. To help track compliance, a
banking entity and its affiliates will, as proposed, have to maintain
documentation outlining how the banking entity intends to facilitate
the customer's exposure to a transaction, investment strategy, or
service.\395\
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\394\ Final rule Sec. Sec. __.10(c)(18)(ii)(A)-(B).
\395\ Final rule Sec. __.10(c)(18)(ii)(C)(1).
---------------------------------------------------------------------------
The agencies are also adopting, as proposed, the condition that the
banking entity and its affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure the obligations or performance
of such issuer.\396\ The agencies continue to believe that this
condition is appropriate and consistent with the goal of preventing
banking entities from bailing out their customer facilitation vehicles.
Commenters generally agreed, supporting the condition as one that is
reasonable and appropriate in addressing the agencies' potential
evasion concerns.\397\
---------------------------------------------------------------------------
\396\ Final rule Sec. __.10(c)(18)(ii)(C)(2).
\397\ See, e.g., SIFMA; FSF; and Data Boiler.
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Finally, the agencies are adopting, as proposed, the condition that
the banking entity and its affiliates comply with the requirements of
Sec. Sec. __.14(b) and __.15, as if such issuer were a covered
fund.\398\ The agencies requested comment in the 2020 proposal whether
this exclusion should also require that the banking entity and its
affiliates comply with the requirements of all of Sec. __.14. One
commenter argued that requiring compliance with the requirements of all
of Sec. __.14 would eliminate the utility of this exclusion.\399\ The
same commenter supported the condition, as proposed, stating that
requiring compliance with only Sec. __.14(b), which would apply the
requirements in section 23B of the Federal Reserve Act, and the
application of the prudential backstops under Sec. __.15 would serve
as adequate safeguards to avoid the risk of bailout or other evasion
concerns.\400\ The agencies continue to believe that this condition
will help ensure that banking entities and their affiliates' exposure
to risk remains appropriately limited.
---------------------------------------------------------------------------
\398\ Final rule Sec. __.10(c)(18)(ii)(C)(5).
\399\ See FSF (stating that if banking entities were required to
comply with all of Sec. __.14, they would not be able to enter into
swaps and other covered transactions with the customer facilitation
vehicle for their clients, many of whom seek such transactions
through the use of such vehicles).
\400\ See FSF.
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The agencies continue to believe that, collectively, the conditions
on the exclusion will help to ensure that
[[Page 46455]]
customer facilitation vehicles are used for customer-oriented financial
services provided on arms-length, market terms, and to prevent evasion
of the requirements of section 13 of the BHC Act and the final rule.
The agencies also continue to believe that the adopted conditions will
be consistent with the purposes of section 13.
As in the 2020 proposal, the agencies will not apply Sec. __.14(a)
to customer facilitation vehicles because the agencies understand that
this would prohibit banking entities from providing the full range of
banking and asset management services to customers using these
vehicles. Commenters generally supported this approach,\401\ and one
noted that applying Sec. __.14(a) to these vehicles would undo any
practical utility of the exclusion.\402\
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\401\ See, e.g., SIFMA and BPI.
\402\ See SIFMA.
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D. Limitations on Relationships With a Covered Fund
In the 2020 proposal, the agencies proposed to amend the
regulations implementing section 13(f)(1) of the BHC Act to permit
banking entities to engage in a limited set of covered transactions
with covered funds for which the banking entity directly or indirectly
serves as investment manager, investment adviser, or sponsor, or that
the banking entity organizes and offers pursuant to section 13(d)(1)(G)
of the BHC Act (such funds, related covered funds).\403\
---------------------------------------------------------------------------
\403\ See 2020 proposal Sec. __.14(a)(2), (3); 85 FR 12143-
12146.
---------------------------------------------------------------------------
Section 13(f)(1) of the BHC Act generally prohibits a banking
entity from entering into a transaction with a related covered fund
that would be a covered transaction as defined in section 23A of the
Federal Reserve Act as if the banking entity was a member bank and the
covered fund was an affiliate.\404\ The 2020 proposal would have
amended the application of section 13(f)(1) of the BHC Act in limited
circumstances, by allowing a banking entity to enter into certain
covered transactions with a related covered fund that would be
permissible without limit for a state member bank to enter into with an
affiliate under section 23A of the Federal Reserve Act. In addition,
the 2020 proposal would have allowed a banking entity to enter into
short-term extensions of credit with, and purchase assets from, a
related covered fund in connection with payment, clearing, and
settlement activities. The agencies invited comment on the past
interpretation of section 13(f)(1) of the BHC Act,\405\ and the
proposed amendments to the regulations implementing section
13(f)(1).\406\
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\404\ 12 U.S.C. 1851(f)(1); see also 12 U.S.C. 371c. Section
13(f)(3) of the BHC Act also provides an exemption for prime
brokerage transactions between a banking entity and a covered fund
in which a covered fund managed, sponsored, or advised by that
banking entity has taken an ownership interest. 12 U.S.C.
1851(f)(3). In addition, section 13(f)(2) subjects any transaction
permitted under section 13(f) (including a permitted prime brokerage
transaction) between a banking entity and covered fund to section
23B of the Federal Reserve Act. 12 U.S.C. 1851(f)(2); see 12 U.S.C.
371c-1.
\405\ In the preamble to the 2013 rule, the agencies noted that
``[s]ection 13(f) of the BHC Act does not incorporate or reference
the exemptions contained in section 23A of the FR Act or the Board's
Regulation W.'' 79 FR 5746.
\406\ 85 FR 12145-46.
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As described in the 2020 proposal, the agencies believe the
statutory rulemaking authority under paragraph (d)(1)(J) of section 13
of the BHC Act permits the agencies to determine that banking entities
may enter into covered transactions with related covered funds that
would otherwise be prohibited by section 13(f)(1) of the BHC Act,
provided that the rulemaking complies with applicable statutory
requirements.\407\ This interpretation of the agencies' rulemaking
authority is supported both by the inclusion of other covered
transactions within the permitted activities listed in paragraph (d)(1)
of section 13 and by the manner in which section 13(f)(1) of the BHC
Act is incorporated in the list of permitted activities in paragraph
(d)(1), as described below.
---------------------------------------------------------------------------
\407\ 12 U.S.C. 1851(b)(2), (d)(1)(J), (d)(2).
---------------------------------------------------------------------------
Section 23A of the Federal Reserve Act limits the aggregate amount
of covered transactions between a member bank and its affiliates, while
section 13(f)(1) of the BHC Act generally prohibits covered
transactions between a banking entity and a related covered fund, with
no minimum amount of permissible covered transactions.\408\ Despite the
general prohibition on certain covered transactions in section
13(f)(1), section 13 also authorizes a banking entity to own an
interest in a related covered fund, which would be a ``covered
transaction'' for purposes of section 23A of the Federal Reserve
Act.\409\ In addition to this apparent conflict between paragraphs
13(d) and (f) with respect to covered fund ownership, there are other
elements of these paragraphs that introduce ambiguity about the
interpretation of the term ``covered transaction'' as used in section
13(f) of the BHC Act. For example, despite the general prohibition on
covered funds, another part of section 13 permits a bank entity ``to
acquire or retain an ownership interest in a covered fund in accordance
with the requirements of section 13.'' \410\ In the preamble to the
2013 rule, the agencies specifically interpreted section 13 to allow
such investments noting that a contrary interpretation would make the
specific language that permits covered transactions between a banking
entity and a related covered fund ``mere surplusage.'' \411\ The
statute also prohibits a banking entity that organizes or offers a
hedge fund or private equity fund from directly or indirectly
guaranteeing, assuming, or otherwise insuring the obligations or
performance of the fund (or of any hedge fund or private equity fund in
which such hedge fund or private equity fund invests).\412\ To the
extent that section 13(f) prohibits all covered transactions between a
banking entity and a related covered fund, however, the independent
prohibition on guarantees in section 13(d)(1)(G)(v) would seem to be
unnecessary and redundant.\413\
---------------------------------------------------------------------------
\408\ 12 U.S.C. 371c, 12 U.S.C. 1851(f)(1). The term ``covered
transaction'' is defined in section 23A of the Federal Reserve Act
to mean, with respect to an affiliate of a member bank, (1) a loan
or extension of credit to the affiliate, including a purchase of
assets subject to an agreement to repurchase; (2) a purchase of or
an investment in securities issued by the affiliate; (3) a purchase
of assets from the affiliate, except such purchase of real and
personal property as may be specifically exempted by the Board by
order or regulation; (4) the acceptance of securities or other debt
obligations issued by the affiliate as collateral security for a
loan or extension of credit to any person or company; (5) the
issuance of a guarantee, acceptance, or letter of credit, including
an endorsement or standby letter of credit, on behalf of an
affiliate; (6) a transaction with an affiliate that involves the
borrowing or lending of securities, to the extent that the
transaction causes a member bank or a subsidiary to have credit
exposure to the affiliate; or (7) a derivative transaction, as
defined in paragraph (3) of section 5200(b) of the Revised Statutes
of the United States (12 U.S.C. 84(b)), with an affiliate, to the
extent that the transaction causes a member bank or a subsidiary to
have credit exposure to the affiliate. See 12 U.S.C. 371c(b)(7), as
amended by Pub. L. 111.203, section 608 (July 21, 2010). Section
13(f) of the BHC Act does not alter the applicability of section 23A
of the Federal Reserve Act and the Board's Regulation W to covered
transactions between insured depository institutions and their
affiliates.
\409\ 12 U.S.C. 1851(d)(1)(G); (d)(4).
\410\ 79 FR 5746.
\411\ Id.
\412\ 12 U.S.C. 1851(d)(1)(G)(v).
\413\ See 12 U.S.C. 371c(b)(7)(E); 12 CFR 223.3(h)(4).
---------------------------------------------------------------------------
Although the agencies previously expressed doubt about their
ability to permit banking entities to enter into covered transactions
with related covered funds pursuant to their authority under section
13(d)(1)(J) of the BHC Act,\414\ the activities permitted pursuant to
paragraph (d) specifically contemplate allowing a banking entity to
enter into certain covered
[[Page 46456]]
transactions with related funds.\415\ The exceptions in section
13(f)(1) are also expressly incorporated into the statutory list of
permitted activities, specifically in section 13(d)(1)(G)(iv).\416\ By
virtue of the conflict between paragraphs (d) and (f) of section 13,
and the inclusion of specific covered transactions within the permitted
activities in paragraph (d) of section 13, the agencies continue to
believe that the authority granted pursuant to paragraph (d)(1)(J) to
determine that other activities are not prohibited by the statute
authorizes the agencies to exercise rulemaking authority to determine
that banking entities may enter into covered transactions with related
covered funds that would otherwise be prohibited by section 13(f)(1) of
the BHC Act, provided that the rulemaking complies with applicable
statutory requirements.\417\
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\414\ See 76 FR 68912 n.313.
\415\ 12 U.S.C. 1851(d)(1)(G); (d)(4).
\416\ 12 U.S.C. 1851(d)(1)(G)(iv).
\417\ 12 U.S.C. 1851(b)(2), (d)(1)(J), (d)(2).
---------------------------------------------------------------------------
Several commenters expressed support for the proposed amendments to
the regulations implementing section 13(f)(1) of the BHC Act that would
have permitted a banking entity to engage in a limited set of covered
transactions with a related covered fund.\418\ Some commenters
recommended that the agencies clarify whether a banking entity may
enter into exempt transactions with a related covered fund in the
circumstance where such transactions would be exempt from section 23A
of the Federal Reserve Act only if a bank entered into such
transactions with a securities affiliate.\419\ A few commenters also
recommended that the agencies adopt a new exclusion allowing a banking
entity to offer other types of extensions of credit to a related
covered fund, including extensions of credit in the ordinary course of
business.\420\ Other commenters recommended that the agencies clarify
that section 13(f)(1) does not apply outside of the United States.\421\
The commenters noted that such an approach would limit the
extraterritorial effect of section 13(f)(1), and would better align
section 13(f)(1) with the manner in which section 23A of the Federal
Reserve Act applies outside of the United States.
---------------------------------------------------------------------------
\418\ See, e.g., ABA; BPI; CBA; Data Boiler; EBF; FSF; IIB; PNC;
and SIFMA.
\419\ ABA; BPI; FSF; and SIFMA.
\420\ BPI and PNC.
\421\ CBA; EBF; and IIB.
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As discussed below, the final rule adopts the proposed amendments
from the 2020 proposal with minor modifications. The agencies believe
that, under certain circumstances, it is appropriate to permit banking
entities to enter into certain covered transactions with related
covered funds, in the manner described in the amendments to Sec. __.14
of the implementing regulations. Consistent with the 2020 proposal,
these amendments do not modify the definition of ``covered
transaction'' but instead authorize banking entities to engage in
limited transactions with related covered funds. Any transactions
permitted by these revisions must still meet the eligibility
requirements for the particular transaction, and the banking entity
must also comply with certain conflict of interest, high-risk, and
safety and soundness restrictions with respect to such transactions.
The agencies are also expressly providing that a banking entity may
enter into certain riskless principal transactions with a related
covered fund, as described below.
Exempt Transactions Under Section 23A and the Board's Regulation W;
Riskless Principal Transactions
The final rule adopts the amendments to the regulations
implementing section 13(f)(1) of the BHC Act to permit banking entities
to enter into exempt transactions permitted under section 23A and the
Board's Regulation W. Specifically, the final rule permits a banking
entity to engage in certain covered transactions with a related covered
fund that would be exempt from the quantitative limits, collateral
requirements, and low-quality asset prohibition under section 23A of
the Federal Reserve Act, including certain transactions that would be
exempt pursuant to section 223.42 of the Board's Regulation W.\422\
---------------------------------------------------------------------------
\422\ See 12 U.S.C. 371c(d); 12 CFR 223.42.
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Section 23A of the Federal Reserve Act is designed to protect
against a depository institution suffering losses in transactions with
affiliates, and to limit the ability of a depository institution to
transfer to its affiliates the ``subsidy'' arising from the depository
institution's access to the Federal safety net.\423\ Nevertheless, a
member bank may enter into certain ``exempt'' covered transactions set
forth in section 23A of the Federal Reserve Act and the Board's
Regulation W, without regard to the quantitative limits, collateral
requirements, and low-quality asset prohibition of section 23A and the
Board's Regulation W, provided such transactions meet the criteria
specified in Regulation W.\424\
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\423\ For a brief background on section 23A of the Federal
Reserve Act, see Transactions Between Member Banks and Their
Affiliates, 67 FR 76560-765561 (December 12, 2002).
\424\ See 12 U.S.C. 371c(d); 12 CFR 223.42.
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Under the Board's Regulation W, a member bank may enter into
certain exempt covered transactions only with a securities affiliate.
Specifically, under these exempt covered transactions, a member bank
may enter into transactions to purchase marketable securities, to
purchase municipal securities, and to enter into riskless principal
transactions only with a securities affiliate.\425\ In permitting such
transactions under Regulation W, the Board previously concluded that
the condition that such transactions were permissible only with a
securities affiliate was an important consideration that helped justify
the exemption, noting that securities affiliates generally must be
registered as broker-dealers, and are therefore subject to SEC
supervision and examination, and are required to keep detailed records
concerning each securities transaction.\426\
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\425\ 12 CFR 223.42(f), (g), (m).
\426\ 67 FR 76591 (December 12, 2002); see 67 FR 76593, 76597.
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The exempt transactions specified in section 23A of the Federal
Reserve Act and Regulation W are structured in a manner so as not to
present the same concerns about a depository institution suffering
losses or transferring the subsidy arising from the depository
institution's access to the Federal safety net. The agencies believe
that the same rationale that supports the exemptions in section 23A of
the Federal Reserve Act and the Board's Regulation W also supports
exempting such transactions from the prohibition on covered
transactions between a banking entity and related covered funds under
section 13(f)(1) of the BHC Act, provided that such transactions are
subject to the same requirements and conditions specified in Regulation
W. In particular, the agencies note that these exemptions generally do
not present significant risks of loss and serve important public policy
objectives.\427\
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\427\ For example, intraday extensions of credit are exempt
covered transactions under section 23A of the Federal Reserve Act.
The Board previously has noted that ``[i]ntraday overdrafts and
other forms of intraday credit generally are not used as a means of
funding or otherwise providing financial support for an affiliate.
Rather, these credit extensions typically facilitate the settlement
of transactions between an affiliate and its customers when there
are mismatches between the timing of funds sent and received during
the business day.'' 67 FR 76596.
---------------------------------------------------------------------------
Several commenters recommended that the agencies clarify whether a
banking entity may enter into certain transactions with a related
covered fund that would be permissible under the Board's Regulation W
if entered into between a bank and a securities affiliate,
[[Page 46457]]
even if the covered fund would not meet the eligibility criteria to be
a ``securities affiliate'' under the Board's Regulation W.\428\ As
noted above, Regulation W imposes various conditions and requirements
on transactions that a bank enters into with its affiliates, and
permits a bank to enter into transactions involving the purchase of
marketable securities, the purchase of municipal securities, and
riskless principal transactions only with an affiliate that is a
``securities affiliate'' as defined in Regulation W. With respect to
purchases of marketable securities and municipal securities, the final
rule follows the approach adopted in Regulation W, and permits a
banking entity to enter into such covered transactions with a related
covered fund only if those transactions would meet all of the
eligibility criteria to qualify as exempt transactions under Regulation
W, including the requirement that the related covered fund meets the
requirements to be a securities affiliate.\429\ As noted above, the
exempt transactions specified in Regulation W include various limits
and conditions that both limit the risks of such transactions and allow
the Federal banking agencies to monitor compliance. Generally, the
final rule retains the eligibility criteria for exempt covered
transactions defined in Regulation W. The agencies believe that these
conditions serve important policies, and appropriately limit the scope
of the exempt transactions permissible under the implementing
regulations.
---------------------------------------------------------------------------
\428\ ABA; BPI; FSF; and SIFMA. Under the Board's Regulation W,
a ``securities affiliate'' is defined as ``[a]n affiliate of the
member bank that is registered with the Securities and Exchange
Commission as a broker or dealer; or . . . [a]ny other securities
broker or dealer affiliate of a member bank that is approved by the
Board.'' 12 CFR 223.3(gg).
\429\ In addition to requiring that an affiliate be a securities
affiliate, the exemptions under Regulation W permitting a bank to
purchase marketable securities or municipal securities in certain
circumstances require the bank to retain records about the
underlying transaction. See 12 CFR 223.42(f)(6), (g)(3)(iii)(B).
---------------------------------------------------------------------------
The final rule permits banking entities to enter into riskless
principal transactions with a related covered fund, including in
circumstances where the covered fund is not a ``securities affiliate.''
\430\ In a riskless principal transaction, the riskless principal (the
banking entity) buys and sells the same security contemporaneously, and
the asset risk passes promptly from the affiliate (the related covered
fund) through the riskless principal to a third party.\431\ In
permitting such transactions under Regulation W, the Board previously
found that there was no regulatory benefit to subjecting riskless
principal transactions to section 23A of the Federal Reserve Act,
because such transactions closely resemble securities brokerage
transactions, and these transactions do not allow the affiliate to
transfer risk to the affiliate acting as a riskless principal.\432\
---------------------------------------------------------------------------
\430\ Cf. 12 CFR 223.42(m).
\431\ See 67 FR 76597.
\432\ Id.
---------------------------------------------------------------------------
Although the 2020 proposal would have permitted a banking entity to
enter into a riskless principal transaction with a covered fund
provided it met the criteria in Regulation W, the final rule adopts a
standalone exception to differentiate riskless principal transactions
specifically from other transactions that would be exempt transactions
under the Board's Regulation W.\433\ In connection with permitting
banking entities to enter into riskless principal transactions with
related covered funds in a separate exception from Super 23A, the
agencies are defining riskless principal transactions in Sec. __.10 of
the regulations. The definition of riskless principal transactions
adopted in the final rule is similar to the definition adopted in the
Board's Regulation W, as this definition is appropriately narrow and
generally familiar to banking entities.\434\
---------------------------------------------------------------------------
\433\ 12 CFR 223.42.
\434\ See 12 CFR 223.3(ee).
---------------------------------------------------------------------------
In addition, and as discussed in more detail below, banking
entities may separately rely on the independent exception for
acquisitions of assets in connection with payment, clearing, and
settlement services. The agencies expect that in many instances,
subject to other applicable laws and regulations, a banking entity may
be able to engage in acquisitions of assets in connection with payment,
clearing, and settlement services, without relying on the exception
permitting banking entities to enter into covered transactions with
their related covered funds that would be exempt under Regulation W.
Short-Term Extensions of Credit and Acquisitions of Assets in
Connection With Payment, Clearing, and Settlement Services
The final rule adopts the proposed amendments in the 2020 proposal
that would have permitted a banking entity to provide short-term
extensions of credit to, and purchase assets from, a related covered
fund, subject to appropriate limits. Under the final rule, each short-
term extension of credit or purchase of assets must be made in the
ordinary course of business in connection with payment transactions;
securities, derivatives, or futures clearing; or settlement services.
In addition, each extension of credit must be required to be repaid,
sold, or terminated no later than five business days after it was
originated. Additionally, the proposed five business day criterion is
consistent with the Federal banking agencies' capital rules and would
generally limit banking entities to transactions with normal settlement
periods, which have lower risk of delayed settlement or failure, when
providing short-term extensions of credit.\435\ Each short-term
extension of credit must also meet the same requirements applicable to
intraday extensions of credit under section 223.42(l)(1)(i) and (ii) of
the Board's Regulation W (as if the extension of credit was an intraday
extension of credit, regardless of the duration of the extension of
credit). Under these requirements, the banking entity making a short-
term extension would have to meet the same requirements as it would to
engage in an intraday extension of credit under Regulation W (and as
incorporated in the implementing regulations). Specifically, the
banking entity would need to have policies and procedures to manage the
credit exposure and must have no reason to believe that the related
covered fund will have difficulty repaying the extension of credit in
accordance with its terms. Finally, each extension of credit or
purchase of assets permitted by these revisions must also comply with
certain conflict of interest, high-risk, and safety and soundness
restrictions, and must otherwise be permissible for the banking entity
to enter into with the fund.\436\
---------------------------------------------------------------------------
\435\ See 78 FR 62110 (October 11, 2013). While the Federal
banking agencies require firms to track and monitor the credit risk
exposure for transactions involving securities, foreign exchange
instruments, and commodities that have a risk of delayed settlement,
this requirement does not apply to other types of transactions which
may be used in providing a short-term extension of credit (e.g.,
repo-style transactions). Additionally, banking entities typically
monitor credit extensions by counterparty, and not by transaction
type. Thus, the final rule is consistent with the approach taken in
the Federal banking agencies' capital rule, without imposing an
additional compliance burden without a corresponding benefit. See,
e.g., 12 CFR 3.2; 217.2; 324.2 (defining derivative contract to
include unsettled securities with a contractual settlement or
delivery lag that is longer than the lesser of the market standard
for the particular instrument or five business days); 12 CFR
3.38(d); 217.38(d); 324.38(d) (noting that an institution must hold
risk-based capital against any delivery-versus-payment or payment-
versus-payment transaction with a normal settlement period if the
counterparty has not made delivery within five business days after
settlement).
\436\ For example, an investment fund with respect to which a
member bank or its affiliate is an investment adviser may be subject
to additional restrictions under Section 23A of the Federal Reserve
Act. See 12 U.S.C. 371c(b)(1)(D).
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[[Page 46458]]
The agencies do not believe it would be appropriate to permit
banking entities to enter into other covered transactions with a
related covered fund, outside of the exceptions noted above. Although
some commenters recommended expanding this exception to allow banking
entities to enter into limited amounts of covered transactions with
related covered funds, the agencies believe that permitting banking
entities to engage in other covered transactions with related covered
funds would potentially raise the concerns that paragraph 13(f)(1) was
intended to address.
The agencies also do not believe that it would be appropriate to
limit the application of section 13(f)(1) to the United States as some
commenters recommended, at this time. The agencies note that other
amendments in the final rule (for example, amendments to the treatment
of foreign excluded funds and foreign public funds) may help address
some of the commenters' concerns about the extraterritorial application
of section 13(f)(1).
Impact of the Amendments on Safety and Soundness and U.S. Financial
Stability
The agencies expect that the amendments in the final rule described
above would generally promote and protect the safety and soundness of
banking entities and U.S. financial stability. In comments previously
submitted to the agencies, banking entities that sponsor or serve as
the investment adviser to covered funds have argued that the inability
to engage in any covered transactions with such funds, particularly
those types of transactions that are expressly exempted under section
23A of the Federal Reserve Act and the Board's Regulation W, has
limited the services that they or their affiliates can provide. The
commenters said that amending the regulations to permit limited covered
transactions with related covered funds would not create any new
incentives for the banking entity to financially support the related
covered fund in times of stress and would not otherwise permit the
banking entity to indirectly engage in proprietary trading through the
related covered fund.\437\ For example, when a banking entity sponsors
or advises a covered fund, the prohibition on covered transactions
between the banking entity (and its affiliates) and the covered fund
may limit the ability of the banking entity and its affiliates to
provide other services, such as trade settlement services, to the
covered fund.
---------------------------------------------------------------------------
\437\ See 85 FR 12144.
---------------------------------------------------------------------------
As discussed below, the agencies believe that the exceptions in the
final rule would generally promote and protect the safety and soundness
of banking entities and U.S. financial stability by allowing banking
entities to reduce operational risk.
Currently, the restrictions under section 13(f)(1) of the BHC Act
substantially limit the ability of a banking entity to both (1)
organize and offer a covered fund, or act as an investment adviser to
the covered fund, and (2) provide custody or other services to the
fund. As a result, a third party is required to provide other necessary
services for the fund's operation, including payment, clearing, and
settlement services that are generally provided by the fund's
custodian, even when the banking entity sponsor of the fund typically
provides those services to other funds it sponsors. This is the case
even when the third party may not offer the same quality of services
available through an affiliate, or where the third party may charge
more for the same services that could be provided by an affiliate. This
increases the potential for problems at the third-party service
provider (e.g., an operational failure or a disruption to normal
functioning) to affect the banking entity or the fund, which were
required to use the third-party service provider as a result of the
restrictions under section 13(f)(1). Those problems may then spread
among financial institutions or markets and thereby threaten the
stability of the U.S. financial system. By amending Sec. __.14(a),
therefore, the final rule allows a banking entity to reduce both
operational risk and interconnectedness to other financial institutions
by directly providing a broader array of services to a fund it
organizes and offers, or advises. The agencies believe that reducing
these risks will promote and protect the safety and soundness of
banking entities.\438\
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\438\ The agencies believe that the same rationales that
supported exempting certain covered transactions in section 23A of
the Federal Reserve Act and the Board's Regulation W also support
permitting a banking entity to engage in those exempt covered
transactions with a related covered fund, subject to the same terms
and conditions as applicable under section 23A and Regulation W.
---------------------------------------------------------------------------
The final rule also would promote and protect U.S. financial
stability by reducing interconnectedness among firms. The provision of
custodial services among depository institutions in the United States
is highly concentrated, with the four largest providers, all of which
remain subject to the Volcker Rule, holding more than 85 percent of
custodial assets. Requiring a banking entity that organizes and offers
a covered fund to use a third party to provide these services could
increase the interconnections between these firms and the risk that
distress at one banking entity would be spread to the others. The
authorized covered transactions would permit banking entities to
provide a more comprehensive suite of services to related covered
funds, reducing interconnectedness by reducing the need to rely on
third parties to provide such services.
The final rule also retains important limits on the transactions
that a banking entity may enter into with a related covered fund,
including limitations that apply to transactions within the new
exceptions in the regulations implementing Sec. __.14(a). As specified
in the statute, such activities are permissible only ``to the extent
permitted by any other provision of Federal or state law, and subject
to the limitations under section 13(d)(2) of the BHC Act and any
restrictions or limitations that the appropriate Federal banking
agencies, the Securities and Exchange Commission, and the Commodity
Futures Trading Commission, may determine . . .'' \439\ Section
13(d)(2) of the BHC Act also imposes additional restrictions on any
activities authorized pursuant to section (d)(1), including those
activities authorized by rulemaking pursuant to section (d)(1)(J).\440\
---------------------------------------------------------------------------
\439\ 12 U.S.C. 1851(d)(1).
\440\ 12 U.S.C. 1851(d)(2); see also 2013 rule Sec. Sec. __.7
and __.15.
---------------------------------------------------------------------------
Sections __.14(b) and __.14(c) of the regulations implementing
section 13 of the BHC Act both generally require that a banking entity
may enter into certain transactions specified in section 23B of the
Federal Reserve Act (including ``covered transactions'' as defined in
section 23A of the Federal Reserve Act) with related covered funds only
on terms and under circumstances that are substantially the same (or at
least as favorable) as to the banking entity as those prevailing at the
time for comparable transactions with or involving other nonaffiliated
companies, or in the absence of comparable transactions, on terms and
under circumstances that the banking entity in good faith would offer
to, or would apply to, nonaffiliated companies.\441\
---------------------------------------------------------------------------
\441\ 12 U.S.C. 1851(f)(2); see 12 U.S.C. 371c-1(a)(1).
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[[Page 46459]]
The agencies therefore have determined that the amendments to Sec.
__.14(a) of the final rule, in the manner described above, would
promote and protect both the safety and soundness of banking entities,
and U.S. financial stability.
E. Ownership Interest
1. Definition of ``Ownership Interest''
The 2013 rule defines an ``ownership interest'' in a covered fund
to mean any equity, partnership, or other similar interest. Some
banking entities have expressed concern about the inclusion of the term
``other similar interest'' in the definition of ``ownership interest,''
and have indicated that the definition of this term could lead to the
inclusion of debt instruments that have standard covenants within the
definition of ownership interest. Under the 2013 rule, ``other similar
interest'' is defined as an interest that:
Has the right to participate in the selection or removal
of a general partner, managing member, member of the board of directors
or trustees, investment manager, investment adviser, or commodity
trading advisor of the covered fund (excluding the rights of a creditor
to exercise remedies upon the occurrence of an event of default or an
acceleration event);
Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
Has the right to receive the underlying assets of the
covered fund after all other interests have been redeemed and/or paid
in full (excluding the rights of a creditor to exercise remedies upon
the occurrence of an event of default or an acceleration event);
Has the right to receive all or a portion of excess spread
(the positive difference, if any, between the aggregate interest
payments received from the underlying assets of the covered fund and
the aggregate interest paid to the holders of other outstanding
interests);
Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
Receives income on a pass-through basis from the covered
fund, or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
Any synthetic right to have, receive, or be allocated any
of the rights above.\442\
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\442\ 2013 rule Sec. __.10(d)(6)(i).
---------------------------------------------------------------------------
This definition focuses on the attributes of the interest and
whether it provides a banking entity with economic exposure to the
profits and losses of the covered fund, rather than its form. Under the
2013 rule, a debt interest in a covered fund can be an ownership
interest if it has the same characteristics as an equity or other
ownership interest (e.g., provides the holder with certain voting
rights; the right or ability to share in the covered fund's profits or
losses; or the ability, directly or pursuant to a contract or synthetic
interest, to earn a return based on the performance of the fund's
underlying holdings or investments).
In the 2018 proposal, the agencies requested comment on all aspects
of the 2013 rule's application to securitization transactions,
including the definition of ownership interest. Specifically, the
agencies asked whether there were any modifications that should be made
to the 2013 rule's definition of ownership interest.\443\ Among other
things, the agencies requested comments on whether they should modify
Sec. __.10(d)(6)(i)(A) to provide that the ``rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event'' include the right to participate in the removal of
an investment manager for cause, or to nominate or vote on a nominated
replacement manager upon an investment manager's resignation or
removal.\444\
---------------------------------------------------------------------------
\443\ 83 FR 33481.
\444\ Id.
---------------------------------------------------------------------------
A number of comments received on the 2018 proposal supported the
agencies' suggestion to modify Sec. __.10(d)(6)(i)(A) and to expressly
permit creditors to participate in the removal of an investment manager
for cause, or to nominate or vote on a nominated replacement manager
upon an investment manager's resignation or removal without causing an
interest to become an ownership interest.\445\ However, a few of these
commenters on the 2018 proposal noted that this modification would not
address all issues with the condition as banks sometimes have
contractual rights to participate in the selection or removal of a
general partner, managing member or member of the board of directors or
trustees of a borrower that are not limited to the exercise of a remedy
upon an event of default or other default event.\446\ Therefore, these
commenters proposed eliminating the ``other similar interest'' clause
from the definition altogether or, alternatively, replacing the
definition of ownership interest with the definition of ``voting
securities'' from the Board's Regulation Y.
---------------------------------------------------------------------------
\445\ See, e.g., SFIG; JBA; LSTA; and IAA.
\446\ See SFIG.
---------------------------------------------------------------------------
A number of commenters on the 2018 proposal argued that debt
interests issued by covered funds and loans to third-party covered
funds not advised or managed by a banking entity should be excluded
from the definition of ownership interest.\447\ Other commenters
suggested reducing the scope of the definition of ownership interest to
apply only to equity and equity-like interests that are commonly
understood to indicate a bona fide ownership interest in a covered
fund.\448\ One other commenter asked the agencies to clarify conditions
under the ``other similar interest'' clause.\449\ Specifically, the
commenter asked the agencies to clarify whether the right to receive
all or a portion of the spread extends to using the excess spread or
any debt repaid from collections on underlying assets of a special
purpose entity to pay principal or interest that is otherwise owed is
not an ownership interest. Another commenter asked the agencies not to
modify the definition of ownership interest as, the commenter argued,
there is nothing under section 13 of the BHC Act that limits or
restricts the ability of a banking entity or nonbank financial company
to sell or securitize loans in a manner permitted by law.\450\
---------------------------------------------------------------------------
\447\ See, e.g., Capital One et al. and BPI.
\448\ See, e.g., ABA and CAE.
\449\ See SFIG.
\450\ See Data Boiler.
---------------------------------------------------------------------------
In response to comments received on the 2018 proposal and in order
to provide clarity about the types of interests that would be
considered within the scope of the definition of ownership interest,
the 2020 proposal would have amended the parenthetical in Sec.
__.10(d)(6)(i)(A) to specify that creditors' remedies upon the
occurrence of an event of default or an acceleration event, which
include, for example, the right to participate in the removal of an
investment manager for cause or to nominate or vote on a nominated
replacement manager upon an occurrence of an event of default, would
not be considered an ownership interest for this reason alone.\451\ The
2020 proposal also sought comment on whether it would be appropriate to
[[Page 46460]]
further allow for an interest to confer the right to participate in any
removal of an investment manager for cause, or to nominate or vote on a
nominated replacement manager upon an investment manager's resignation
or removal, whether or not an event of default or an acceleration event
has occurred, without that interest being deemed an ownership interest.
Such additional ``for cause'' termination events may include the
insolvency of the investment manager, the breach by the investment
manager of certain representations or warranties, or the occurrence of
a ``key person'' event or a change in control with respect to the
investment manager.
---------------------------------------------------------------------------
\451\ The definition of ``ownership interest'' in the
implementing regulations is independent from the definition of
``voting securities'' in the Board's Regulation Y.
---------------------------------------------------------------------------
Commenters on the 2020 proposal generally supported the proposed
amendment to the definition of ownership interest to specify that
creditors' remedies upon the occurrence of an event of default or an
acceleration event include the right to participate in the removal of
an investment manager for cause or to nominate or vote on a nominated
replacement manager upon an occurrence of an event of default. In the
view of these commenters, the proposed clarification would
appropriately recognize that the ability of a holder to vote on removal
or appointment of managers for cause is not a right limited to equity
holders. However, many of these commenters asserted that creditors'
rights are also provided to debt holders in circumstances other than an
event of default or acceleration. These commenters therefore
recommended the proposed amendments be expanded to include additional
for cause events that are independent of an event of default or
acceleration, such as the insolvency of the investment manager or
breach of the investment management or collateral management
agreement.\452\
---------------------------------------------------------------------------
\452\ See, e.g., SIFMA.
---------------------------------------------------------------------------
In light of comments received on the 2020 proposal, the agencies
recognize that it is customary for debt holders to hold certain rights
to participate in the removal or replacement of an investment manager
for cause that may be triggered by events other than default or
acceleration events. The agencies believe that debt interests that
include the rights of a creditor to participate in the for-cause
removal or replacement of an investment manager under certain
circumstances do not necessarily constitute the type of interest
Section 13 of the BHC Act is intended to capture as an ownership
interest. The agencies are therefore finalizing, with certain
modifications, the amendments to Sec. __.10(d)(6)(i)(A) in order to
provide clarity about the types of creditor rights that may attach to
an interest without that interest being deemed an ownership interest.
The agencies have modified the scope of the definition of ownership
interest in the final rule to allow for certain additional rights of
creditors that are not triggered exclusively by an event of default or
acceleration to attach to a debt interest without such interests being
deemed ownership interests. In addition to such rights arising under
events of default or acceleration, under the final rule, the definition
of ownership interest does not include rights of a creditor to
participate in the removal or replacement of an investment manager for
cause in connection with:
(1) The bankruptcy, insolvency, conservatorship or receivership of
the investment manager;
(2) the breach by the investment manager of any material provision
of the covered fund's transaction agreements applicable to the
investment manager;
(3) the breach by the investment manager of material
representations or warranties;
(4) the occurrence of an act that constitutes fraud or criminal
activity in the performance of the investment manager's obligations
under the covered fund's transaction agreements;
(5) the indictment of the investment manager for a criminal
offense, or the indictment of any officer, member, partner or other
principal of the investment manager for a criminal offense materially
related to his or her investment management activities;
(6) a change in control with respect to the investment manager;
(7) the loss, separation or incapacitation of an individual
critical to the operation of the investment manager or primarily
responsible for the management of the covered fund's assets; or
(8) other similar events that constitute ``cause'' for removal of
an investment manager, provided that such events are not solely related
to the performance of the covered fund or to the investment manager's
exercise of investment discretion under the covered fund's transaction
agreements.
The 2020 proposal also would have provided a safe harbor from the
definition of ownership interest, as suggested by some commenters to
the 2018 proposal.\453\ The safe harbor was intended to address
concerns of commenters to the 2018 proposal that some ordinary debt
interests could be construed as an ownership interest. The 2020
proposal, therefore, would have provided that any senior loan or other
senior debt interest that meets all of the following characteristics
would not be considered to be an ownership interest:
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\453\ See SFIG.
---------------------------------------------------------------------------
(1) The holders of such interest do not receive any profits of the
covered fund but may only receive: (i) Interest payments which are not
dependent on the performance of the covered fund; and (ii) fixed
principal payments on or before a maturity date (which may include
prepayment premiums intended solely to reflect, and compensate holders
of the interest for, foregone income resulting from an early
prepayment);
(2) The entitlement to payments on the interest is absolute and may
not be reduced because of the losses arising from the covered fund,
such as allocation of losses, write-downs or charge-offs of the
outstanding principal balance, or reductions in the principal and
interest payable; and
(3) The holders of the interest are not entitled to receive the
underlying assets of the covered fund after all other interests have
been redeemed and/or paid in full (excluding the rights of a creditor
to exercise remedies upon the occurrence of an event of default or an
acceleration event).
Commenters on the 2020 proposal generally supported the proposed
safe harbor from the definition of ownership interest for certain
senior loans or senior debt interests that do not have
equity[hyphen]like characteristics.\454\ However, certain commenters
also requested that the agencies clarify that the safe harbor is
available to senior loans and senior debt interests where repayment of
principal may vary as a result of acceleration or amortization
provisions.\455\ Additionally, certain commenters also requested that
the agencies clarify that the reference to senior loans or senior debt
interests in the proposed safe harbor includes all exposures that would
meet the definition of ``investment grade'' found in 12 CFR part 1 and
implementing guidelines, as long as such exposures comply with the
proposed conditions.\456\
---------------------------------------------------------------------------
\454\ See, e.g., SIFMA; BPI; LSTA; Mortgage Bankers Association;
and PNC.
\455\ See SIFMA.
\456\ See, e.g., LSTA and SFA.
---------------------------------------------------------------------------
The agencies intended for the proposed conditions of the safe
harbor to provide clarity and predictability to banking entities by
enabling them to determine more readily whether an interest would be an
ownership interest under the regulations implementing section 13 of the
BHC Act. After considering comments received, the
[[Page 46461]]
agencies have included the conditions from the 2020 proposal for the
safe harbor with a modification to Sec. __.10(d)(6)(ii)(B)(1)(ii). The
modification requires that the senior loan or senior debt interest
involves, among other things, repayment of a fixed principal amount, on
or before a maturity date, in a contractually-determined manner (which
may include prepayment premiums intended solely to reflect, and
compensate holders of the interest for, forgone income resulting from
an early prepayment). The agencies believe this modification will
provide additional clarity that the safe harbor is available to senior
loan and senior debt interests where contractual principal payments
vary over the life of a senior loan or senior debt interest for reasons
such as amortization and acceleration provided that the total amount of
principal required to be repaid over the life of the instrument does
not change. The agencies believe this modification to the safe harbor
under the final rule will ensure that debt interests that do not have
equity-like characteristics are not considered ownership interests.
Additionally, the agencies believe that the conditions are rigorous
enough to prevent banking entities from evading the prohibition on
acquiring or retaining an ownership interest in a covered fund.
Further, in response to certain commenters' request that the
agencies clarify that the reference to senior loans or senior debt
interests in the proposed safe harbor includes all exposures that would
meet the definition of ``investment grade'' found in 12 CFR part 1 and
implementing guidelines, the agencies have determined that such a
provision would be inappropriate for purposes of the safe harbor
conditions in the final rule. Unlike the safe harbor provisions in the
final rule regarding ownership interests, such a provision would not
ensure that debt interests that have equity-like characteristics are
treated as ownership interests for purposes of subpart C of the final
rule.
In response to the 2020 proposal, one commenter requested that the
agencies modify the condition in Sec. __.10(d)(6)(i)(B) of the
implementing regulations and Sec. __.10(d)(6)(ii)(B)(1) of the 2020
proposal, which states that an interest that has the right to receive a
share of the income, gains or profits of the covered fund is considered
an ownership interest, to clarify that the condition would not include
amounts payable to securitization noteholders in accordance with a
contractual priority of payments, commonly referred to as a
``waterfall,'' so long as such amounts are limited to fixed principal
and interest determined on a fixed or typical index floating rate
basis.\457\ Specifically, the commenter suggested a modification to
this condition to clarify that the term ``profit'' is intended to mean
``net profits'' out of concern for the potential ambiguity of how the
condition would apply to amounts received by securitization noteholders
in accordance with the securitization's waterfall of payment. Another
commenter disagreed with any revision to the 2020 proposed rule that
would only cover as an ownership interest an interest which has the
right to receive a share of the ``net'' income, gains or profits of the
covered fund.\458\ The final rule does not modify Sec.
__.10(d)(6)(i)(B) of the implementing regulations or Sec.
__.10(d)(6)(ii)(B)(1) of the 2020 proposal. However, the agencies
clarify that a debt interest in a covered fund would not be considered
an ownership interest solely because the interest is entitled to
receive an allocation of collections from the covered fund's underlying
financial assets in accordance with a contractual priority of payments.
---------------------------------------------------------------------------
\457\ See SFA.
\458\ See Data Boiler.
---------------------------------------------------------------------------
2. Fund Limits and Covered Fund Deduction
The 2020 proposal included amendments to the implementing
regulations to better align the manner in which a banking entity
calculates the aggregate fund limit and covered fund deduction with the
manner in which it calculates the per fund limit, as it relates to
investments by employees of the banking entity. Specifically,
consistent with how investments by employees and directors are treated
generally under the existing rule of construction in Sec.
__.12(b)(1)(iv), the 2020 proposal would have modified Sec. Sec.
__.12(c) and __.12(d) to require attribution of amounts paid by an
employee or director to acquire a restricted profit interest only when
the banking entity has financed the acquisition.
The 2013 rule excludes from the definition of ownership interest
certain restricted profit interests.\459\ To be excluded from the
definition of ownership interest, the restricted profit interest must
also meet various other conditions, including that any amounts invested
in the covered fund--including amounts paid by the entity, an employee
of the entity, or former employee of the entity--are within the
applicable limits under Sec. __.12 of the 2013 rule.\460\
---------------------------------------------------------------------------
\459\ 2013 rule Sec. __.10(d)(6)(ii). Under the 2013 rule, the
exclusion from the definition of ownership interest is limited to
restricted profit interests held by an entity, employee, or former
employee in a covered fund for which the entity or employee serves
as investment manager, investment adviser, commodity trading
advisor, or other service provider. As noted in the preamble to the
2013 rule, the term ``restricted profit interest'' was used to avoid
any confusion from using the term ``carried interest,'' which is
used in other contexts. The proposed rule would focus on the
treatment of restricted profit interests for purposes of calculating
compliance with the aggregate fund limit and covered fund deduction
but would not address in any way the treatment of such profit
interests under other laws, including under Federal income tax law.
See 79 FR 5706, n.2091.
\460\ 2013 rule Sec. __.10(d)(6)(ii)(C).
---------------------------------------------------------------------------
Under Sec. __.12 of the 2013 rule, different calculation
methodologies apply for purposes of calculating compliance with the per
fund limit, the aggregate fund limit, and the covered fund
deduction.\461\ For purposes of calculating a banking entity's
compliance with the aggregate fund limit and the covered fund
deduction, the banking entity must include any amounts paid by the
banking entity or an employee in connection with obtaining a restricted
profit interest in the covered fund.\462\
---------------------------------------------------------------------------
\461\ 2013 rule Sec. __.12(b)(1)(iv). As noted in the preamble
to the 2013 rule, the attribution to a banking entity of ownership
interests acquired by an employee or director using financing
provided by the banking entity ensures that funding provided by the
banking entity to acquire ownership interests in the fund, whether
provided directly or indirectly, is counted against the per fund
limit and aggregate fund limit. See 79 FR 5733.
\462\ 2013 rule Sec. __.10(d)(6)(C); Sec. Sec. __.12(c)(1),
(d). See also 12 U.S.C. 1851(d)(1)(G).
---------------------------------------------------------------------------
The agencies did not receive comments on the proposed change in the
treatment of restricted profit interests. Several commenters
recommended that the agencies eliminate the per fund limit, the
aggregate fund limit, and the covered fund deduction with respect to
any ownership interest held by a banking entity in any covered fund, if
that interest is held pursuant to underwriting and market making
activities.\463\
---------------------------------------------------------------------------
\463\ BPI; FSF; IIB; and SIFMA.
---------------------------------------------------------------------------
With respect to the proposed change in the treatment of restricted
profit interests, the agencies continue to believe that it is
appropriate for a banking entity to count amounts invested by the
banking entity (or its affiliates) to acquire restricted profit
interests in a fund organized and offered by the banking entity for
purposes of the aggregate fund limit and covered fund deduction.
However, the agencies believe attribution of employee and director
ownership of restricted profit interests to a banking entity may not be
necessary in the circumstance when a banking entity does not finance,
directly
[[Page 46462]]
or indirectly, the employee's or director's acquisition of a restricted
profit interest in a covered fund organized or offered by the banking
entity. The final rule amends the implementing regulations to limit the
attribution of an employee's or director's restricted profit interest
in a covered fund organized or offered by the banking entity to only
those circumstances in which the banking entity has directly or
indirectly financed the acquisition of the restricted profit interest.
The agencies expect that this amendment will simplify a banking
entity's compliance with the aggregate fund limit and covered fund
deduction provisions of the rule, and more fully recognize that
employees and directors may use their own resources, not provided by
the banking entity, to invest in ownership interests or restricted
profit interests in a covered fund they advise (for example, to align
their personal financial interests with those of other investors in the
covered fund).
The final rule does not adopt the recommendation from commenters
that the agencies should eliminate the per fund limit, aggregate fund
limit, or covered fund deduction requirements. The 2019 amendments
adopted several changes to simplify the covered fund compliance
requirements for banking entities that engage in market making or
underwriting with respect to a third-party covered fund. Specifically,
the 2019 amendments eliminated the aggregate fund limit and capital
deduction requirements for the value of ownership interests in third-
party funds acquired or retained in connection with permissible market
making or underwriting activities (i.e., covered funds that the banking
entity does not advise or organize and offer pursuant to Sec. __.11(a)
or (b) of the implementing regulations). In discussing this change in
the preamble to the 2019 amendments, the agencies noted that the
amendments to the treatment of ownership interests in third-party funds
were intended to better align the compliance requirements for
underwriting and market making involving covered funds with the risks
that those activities entail.\464\ The compliance challenges associated
with underwriting and market making in ownership interests in covered
funds is particularly acute with respect to third-party covered funds.
As discussed in the preamble to the 2019 amendments, ``a banking entity
can more readily determine whether a fund is a covered fund if the
banking entity advises or organizes and offers the fund.'' \465\ While
section 13 of the BHC Act provides the agencies greater flexibility to
adopt changes in the treatment of ownership interests in third-party
funds, it prescribes specific requirements that apply to funds that the
banking entity advises, or organizes and offers. Specifically, section
13 provides that a banking entity must not acquire or retain an
ownership interest in a fund organized and offered by the banking
entity except for a de minimis investment subject to and in compliance
with paragraph (d)(4) of section 13 of the BHC Act.\466\ Therefore, the
final rule does not adopt the change recommended by commenters to
modify the treatment of ownership interests in related covered funds
that are held by a banking entity in connection with market making and
underwriting activities.
---------------------------------------------------------------------------
\464\ See 84 FR 62017.
\465\ Id.
\466\ 12 U.S.C. 1851(d)(1)(G)(iii).
---------------------------------------------------------------------------
F. Parallel Investments
The 2020 proposal included a new rule of construction in Sec.
__.12(b) clarifying that banking entities are not required to treat
investments alongside covered funds as investments in covered funds if
certain conditions are met.\467\ As explained in the 2020 proposal,
this rule of construction was meant to provide clarity in light of a
discrepancy between the preamble to the 2013 rule and the text of the
implementing regulations.
---------------------------------------------------------------------------
\467\ See 85 FR 12149.
---------------------------------------------------------------------------
The implementing regulations require that a banking entity hold no
more than three percent of the total ownership interests of a covered
fund that the banking entity organizes and offers pursuant to Sec.
__.11.\468\ Section __.12(b)(1)(i) of the implementing regulations
requires that, for purposes of this ownership limitation, ``the amount
and value of a banking entity's permitted investment in any single
covered fund shall include any ownership interest held under Sec.
__.12 directly by the banking entity, including any affiliate of the
banking entity.'' \469\ Section __.12(b) also includes several other
rules of construction that address circumstances under which an
investment in a covered fund would be attributed to a banking entity.
---------------------------------------------------------------------------
\468\ See id. at 12148; implementing regulations Sec. __.12.
\469\ See implementing regulations Sec. __.12(b)(1)(i).
---------------------------------------------------------------------------
The 2011 notice of proposed rulemaking included a proposed
provision that would have required attribution of certain direct
investments by a banking entity alongside, or otherwise in parallel
with, a covered fund.\470\ The agencies declined to adopt this
provision in the 2013 rule after considering the language of the
statute as well as commenters' views on that provision.\471\
---------------------------------------------------------------------------
\470\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, 76 FR 68846, 68951-52 (Nov. 7, 2011).
\471\ In declining to adopt this parallel investment provision,
the agencies noted that banking entities rely on a number of
investment authorities and structures to make investments and meet
the needs of their clients. 79 FR 5734.
---------------------------------------------------------------------------
The 2013 rule restricts a banking entity's investment in a covered
fund organized and offered pursuant to Sec. __.11 to three percent of
the total number or value of the outstanding ownership interests of the
fund. That regulatory requirement is consistent with section 13(d)(4)
of the BHC Act, which limits the size of investments by a banking
entity in a hedge fund or private equity fund.\472\ Neither section
13(d)(4) of the BHC Act nor the text of the implementing regulations
requires a banking entity to treat an otherwise permissible investment
the banking entity makes alongside a covered fund as an investment in
the covered fund. The text of the 2013 rule does not impose any
quantitative limits on any investments by banking entities made
alongside, or otherwise in parallel with, covered funds.\473\ However,
in the preamble to the 2013 rule, the agencies discussed the potential
for evasion of the per fund limit and aggregate fund limit and stated
that ``if a banking entity makes investments side by side in
substantially the same positions as the covered fund, then the value of
such investments shall be included for purposes of determining the
value of the banking entity's investment in the covered fund.'' \474\
The agencies also stated that ``a banking entity that sponsors the
covered fund should not itself make any additional side by side co-
investment with the covered fund in a privately negotiated investment
unless the value of such co-investment is less than 3% of the value of
the total amount co-invested by other investors in such investment.''
\475\
---------------------------------------------------------------------------
\472\ 12 U.S.C. 1851(d)(4).
\473\ Any investment by the banking entity would need to comply
with the proprietary trading restrictions in Subpart B of the
implementing regulations.
\474\ 79 FR 5734.
\475\ See id.
---------------------------------------------------------------------------
The 2020 proposal included a new rule of construction to address
investments made by banking entities alongside covered funds. This
proposed rule of construction was intended to clarify in the rule text
that banking
[[Page 46463]]
entities are not required to treat a direct investment by a banking
entity alongside a covered fund as an investment in the covered fund if
certain conditions are met. Specifically, proposed Sec. __.12(b)(5)
provided that:
(1) A banking entity shall not be required to include in the
calculation of the investment limits under Sec. __.12(a)(2) any
investment the banking entity makes alongside a covered fund as long as
the investment is made in compliance with applicable laws and
regulations, including applicable safety and soundness standards.
(2) A banking entity shall not be restricted under Sec. __.12 in
the amount of any investment the banking entity makes alongside a
covered fund as long as the investment is made in compliance with
applicable laws and regulations, including applicable safety and
soundness standards.\476\
---------------------------------------------------------------------------
\476\ See 85 FR 12149.
---------------------------------------------------------------------------
In the preamble to the 2020 proposal, the agencies recognized that
banking entities rely on a number of investment authorities and
structures to make investments and meet the needs of their clients and
shareholders.\477\ The agencies indicated that the proposed rule of
construction would provide clarity to banking entities so that they may
make such investments for the benefit of their clients and
shareholders, provided that those investments comply with applicable
laws and regulations.\478\ The preamble to the 2020 proposal went on to
note several restrictions that may apply to a banking entity's
investment alongside a covered fund. For example, a banking entity may
not engage in prohibited proprietary trading alongside a covered fund.
Likewise, a banking entity must have authority to make any investment
alongside a covered fund under applicable banking and other laws and
regulations and must ensure that the investment complies with
applicable safety and soundness standards. For example, national banks
are restricted in their ability to make direct equity investments under
12 U.S.C. 24 (Seventh) and 12 CFR part 1. In addition, a banking entity
that invests alongside a covered fund that the banking entity organizes
and offers under the asset management exemption in Sec. __.11 would
need to comply with all the conditions of that exemption, which, among
other things, prohibits the banking entity from guaranteeing, assuming,
or otherwise insuring the obligations or performance of the covered
fund. Thus, a banking entity would not be permitted to make a direct
investment alongside a covered fund that the banking entity organizes
and offers for the purpose of artificially maintaining or increasing
the value of the fund's positions. Likewise, the banking entity would
also need to ensure that any direct investment alongside an organized
and offered covered fund does not cause the sponsoring banking entity's
permitted organizing and offering activities to violate the prudential
backstops under Sec. __.15.\479\
---------------------------------------------------------------------------
\477\ Id. See also 79 FR 5734.
\478\ 85 FR 12149.
\479\ See id. In particular, to the extent the investment would
result in a material conflict of interest between the banking entity
and its clients, for example because the banking entity may exit the
position at a different time or on different terms than the covered
fund, the banking entity would be required to provide timely and
effective disclosure in accordance with Sec. __.15(b) prior to
making the investments. Id.
---------------------------------------------------------------------------
Most commenters that addressed the proposed rule of construction
supported adopting the proposed revision.\480\ Commenters stated that
the rule of construction was consistent with section 13 of the BHC Act,
would not increase the types of risks that section 13 of the BHC Act
was meant to address, and would not raise concerns about evading
section 13 of the BHC Act.\481\ Commenters noted that banking entities
would need to hold their investments in a manner consistent with
relevant authorities and the associated risk management and other
prudential and regulatory limits and controls, including stringent
capital requirements, for these types of investments.\482\ Some
commenters also requested that the agencies permit employees and
directors of a banking entity that sponsors a covered fund to invest
directly in that covered fund, regardless of whether the employees or
directors provide services to the covered fund on behalf of their
banking entity employer.\483\ The agencies received one comment
opposing the proposed rule of construction.\484\ This commenter
characterized the proposed rule of construction as permitting
proprietary trading at arm's length but without a limit on the
ownership interest that a banking entity may hold and stated that
parallel investments should be subject to the limitations that would
apply to direct investments in covered funds.\485\
---------------------------------------------------------------------------
\480\ See FSF; SIFMA; BPI; IIB; Goldman Sachs; PNC; and ABA.
\481\ See FSF; SIFMA; and BPI.
\482\ See FSF; SIFMA; and BPI.
\483\ See ABA and PNC.
\484\ See Data Boiler.
\485\ See id.
---------------------------------------------------------------------------
After carefully considering the comments received, the agencies are
adopting the rule of construction in Sec. __.12(b)(5), as
proposed.\486\ As described above and in the 2020 proposal, this rule
of construction is consistent with the text of section 13 of the BHC
Act, which does not prohibit a banking entity from making otherwise
permissible investments directly when doing so alongside a covered
fund. This rule of construction will also reduce compliance burden by
clarifying that a banking entity is not required under Sec. __.12 of
the final rule to attribute to the banking entity direct investments
made alongside a covered fund for purposes of the de minimis investment
limitation. In response to the commenter who opposed the rule of
construction,\487\ the agencies note that the rule of construction is
consistent with section 13 of the BHC Act and each investment by a
banking entity must comply with laws and regulations, including any
applicable safety and soundness standards.
---------------------------------------------------------------------------
\486\ Final rule Sec. __.12(b)(5). These kinds of investments
could be, for example, parallel investments or co-investments. For
these purposes, ``parallel investments'' generally refers to a
series of investments that are made side-by-side with a covered
fund, and ``co-investments'' generally refers to a specific
investment opportunity that is made available to third-parties when
the general partner or investment manager for the covered fund
determines that the covered fund does not have sufficient capital
available to make the entire investment in the target portfolio
company or determines that it would not be suitable for the covered
fund to take the entire available investment.
\487\ See Data Boiler.
---------------------------------------------------------------------------
As discussed in the preamble to the 2020 proposal, the rule of
construction will not prohibit a banking entity from having investment
policies, arrangements or agreements to invest alongside a covered fund
in all or substantially all of the investments made by the covered fund
or to fund all or any portion of the investment opportunities made
available by the covered fund to other investors. Accordingly, a
banking entity could market a covered fund it organizes and offers
pursuant to Sec. __.11 on the basis of the banking entity's
expectation that it would invest in parallel with the covered fund in
some or all of the same investments, or the expectation that the
banking entity would fund one or more co-investment opportunities made
available by the covered fund. However, as discussed in the preamble to
the 2020 proposal, the agencies would expect that any such investment
policies, arrangements or agreements would ensure that the banking
entity has the ability to evaluate each investment on a case-by-case
basis to confirm that the banking entity does not make any investment
unless the investment complies with applicable laws and
[[Page 46464]]
regulations, including any applicable safety and soundness standards.
The agencies believe that this would further ensure that the banking
entity is not exposed to the types of risks that section 13 of the BHC
Act was intended to address.
As discussed earlier and in the preamble to the 2020 proposal, the
agencies recognize that the 2011 proposed rule would have required a
banking entity to apply the per fund limit and aggregate fund limit to
a direct investment alongside a covered fund when, among other things,
a banking entity is contractually obligated to make such investment
alongside a covered fund. The agencies continue to believe that such a
prohibition is not necessary given the agencies' expectation that a
banking entity would retain the ability to evaluate each investment on
a case-by-case basis to confirm that the banking entity does not make
any investment unless the investment complies with applicable laws and
regulations, including any applicable safety and soundness standards.
The 2013 rule imposes certain attribution rules and eligibility
requirements for investments by directors and employees of a banking
entity in covered funds organized and offered by the banking entity.
Specifically, Sec. __.12(b)(1)(iv) of the 2013 rule requires
attribution of an investment by a director or employee of a banking
entity who acquires an ownership interest in his or her personal
capacity in a covered fund sponsored by the banking entity if the
banking entity, directly or indirectly, extends financing for the
purpose of enabling the director or employee to acquire the ownership
interest in the fund and the financing is used to acquire such
ownership interest in the covered fund. Section __.11(a)(7) prohibits
investments by any director or employee of the banking entity (or an
affiliate thereof) in the covered fund, other than any director or
employee who is directly engaged in providing investment advisory,
commodity trading advisory, or other services to the covered fund at
the time the director or employee makes the investment.
As discussed in the preamble to the 2020 proposal, the agencies
recognize that directors and employees of banking entities may
participate in investments alongside a covered fund, for example on an
ad hoc basis or as part of a compensation arrangement. Consistent with
the agencies' rule of construction regarding direct investments by
banking entities alongside a covered fund, the agencies would expect
that any direct investments (whether a series of parallel investments
or a co-investment) by a director or employee of a banking entity (or
an affiliate thereof) made alongside a covered fund in compliance with
applicable laws and regulations would not be treated as an investment
by the director or employee in the covered fund. Accordingly, such a
direct investment would not be attributed to the banking entity as an
investment in the covered fund, regardless of whether the banking
entity arranged the transaction on behalf of the director or employee
or provided financing for the investment.\488\ Similarly, the
requirements under Sec. __.11(a)(7) limiting the directors and
employees that are eligible to invest in a covered fund organized and
offered by the banking entity to those that are directly engaged in
providing specified services to the covered fund would not apply to any
such direct investment.\489\
---------------------------------------------------------------------------
\488\ See 2013 rule Sec. __.12(b)(1)(iv) (requiring attribution
of an investment by a director or employee in a covered fund
organized and offered by the banking entity, where the banking
entity, directly or indirectly, extends financing for the purpose of
enabling the director or employee to acquire the ownership interest
in the covered fund and the financing is used to acquire such
ownership interest in the covered fund) (emphasis added).
\489\ See 2013 rule Sec. __.11(a)(7) (prohibiting investments
by any director or employee of the banking entity (or an affiliate
thereof) in a covered fund organized and offered by the banking
entity, other than any director or employee who is directly engaged
in providing investment advisory, commodity trading advisory, or
other services to the covered fund at the time the director or
employee makes the investment) (emphasis added).
---------------------------------------------------------------------------
With respect to investments in a covered fund, the agencies decline
to permit an employee or director of a banking entity that organizes
and offers a covered fund to make investments in that covered fund if
the director or employee does not provide services to the covered fund
on behalf of the banking entity, as requested by some commenters.\490\
The restriction on these types of director and employee investments is
required by the statute.\491\
---------------------------------------------------------------------------
\490\ See ABA and PNC.
\491\ See 12 U.S.C. 1851(d)(1)(G)(vii).
---------------------------------------------------------------------------
G. Technical Amendments
The agencies proposed five sets of clarifying technical edits to
the implementing regulations. Specifically, the agencies proposed to
(1) amend Sec. __.12(b)(1)(ii) to add a comma after the words ``SEC-
regulated business development companies'' in both places where that
phrase is used; (2) amend Sec. __.12(b)(4)(i) to replace the phrase
``ownership interest of the master fund'' with the phrase ``ownership
interest in the master fund''; (3) amend Sec. __.12(b)(4)(ii) to
replace the phrase ``ownership interest of the fund'' with the phrase
``ownership interest in the fund;'' (4) amend Sec. Sec. __.10(c)(3)(i)
and __.10(c)(10)(i) to replace the word ``comprised'' with the word
``composed;'' and (5) amend Sec. __.10(c)(8)(iv)(A) to replace the
word ``of'' in the phrase ``contractual rights of other assets'' with
the word ``or.''
The agencies did not receive comment on these provisions and are
adopting the technical amendments as proposed.
V. Administrative Law Matters
A. Use of Plain Language
Section 722 of the Gramm-Leach-Bliley Act \492\ requires the
Federal banking agencies to use plain language in all proposed and
final rules published after January 1, 2000. The Federal banking
agencies sought to present the proposed rule in a simple and
straightforward manner and did not receive any comments on plain
language.
---------------------------------------------------------------------------
\492\ Public Law 106-102, section 722, 113 Stat. 1338, 1471
(1999).
---------------------------------------------------------------------------
B. Paperwork Reduction Act
Certain provisions of the final rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act (PRA) of 1995 (44 U.S.C. 3501-3521). In accordance with
the requirements of the PRA, the agencies may not conduct or sponsor,
and a respondent is not required to respond to, an information
collection unless it displays a currently valid Office of Management
and Budget (OMB) control number. The agencies reviewed the final rule
and determined that the final rule creates new recordkeeping
requirements and revises certain disclosure requirements that have been
previously cleared under various OMB control numbers. The agencies did
not receive any specific comments on the PRA. The agencies are
extending for three years, with revision, these information
collections. The information collection requirements contained in this
final rule have been submitted by the OCC and FDIC to OMB for review
and approval under section 3507(d) of the PRA (44 U.S.C. 3507(d)) and
section 1320.11 of the OMB's implementing regulations (5 CFR 1320). The
Board reviewed the final rule under the authority delegated to the
Board by OMB. The Board will submit information collection burden
estimates to OMB, and the submission will include burden for Federal
Reserve-supervised institutions, as well as burden for OCC-, FDIC-,
SEC-, and CFTC-supervised institutions under a holding company. The OCC
and the
[[Page 46465]]
FDIC will take burden for banking entities that are not under a holding
company.
Abstract
Section 13 of the BHC Act generally prohibits any banking entity
from engaging in proprietary trading or from acquiring or retaining an
ownership interest in, sponsoring, or having certain relationships with
a covered fund, subject to certain exemptions. The exemptions allow
certain types of permissible trading and asset management activities.
Current Actions
The final rule contains requirements subject to the PRA, and the
changes relative to the implementing regulations are discussed herein.
The new recordkeeping requirements are found in section
__.10(c)(18)(ii)(C)(1) and the modified disclosure requirements are
found in section __.11(a)(8)(i). The modified information collection
requirements would implement section 13 of the BHC Act. The respondents
are for-profit financial institutions, including small businesses. A
covered entity must retain these records for a period that is no less
than 5 years in a form that allows it to promptly produce such records
to the relevant agency on request.
Recordkeeping Requirements
Section __.10(c)(18)(ii)(C)(1) requires a banking entity relying on
the exclusion from the covered fund definition for customer
facilitation vehicles to maintain documentation outlining how the
banking entity intends to facilitate the customer's exposure to a
transaction, investment strategy, or service. The agencies estimate
that the new recordkeeping requirement will be incurred once a year
with an average hour per response of 10 hours.
Disclosure Requirements
Section __.11(a)(8)(i), which requires banking entities that
organize and offer covered funds to make certain disclosures to
investors in such funds, is being expanded to also apply to banking
entities relying on exclusions for credit funds, venture capital funds,
family wealth management vehicles, or customer facilitation vehicles.
The agencies estimate that the current average hours per response of
0.1 will increase to 0.5.
Revision, With Extension, of the Following Information Collections
Estimated average hours per response:
Reporting
Section __.4(c)(3)(i)--0.25 hours for an average of 20 times per
year.
Section __.12(e)--20 hours (Initial set-up 50 hours) for an average
of 10 times per year.
Section __.20(d)--41 hours (Initial set-up 125 hours) quarterly.
Section __.20(i)--20 hours.
Recordkeeping
Section __.3(d)(3)--1 hour (Initial set-up 3 hours).
Section __.4(b)(3)(i)(A)--2 hours quarterly.
Section __.4(c)(3)(i)--0.25 hours for an average of 40 times per
year.
Section __.5(c)--40 hours (Initial setup 80 hours).
Section __.10(c)(18)(ii)(C)(1)--10 hours.
Section __.11(a)(2)--10 hours.
Section __.20(b)--265 hours (Initial set-up 795 hours).
Section __.20(c)--100 hours (Initial set-up 300 hours).
Section __.20(d)--10 hours.
Section __.20(e)--200 hours.
Section __.20(f)(1)--8 hours.
Section __.20(f)(2)--40 hours (Initial set-up 100 hours).
Disclosure
Section __.11(a)(8)(i)--0.5 hours for an average of 26 times per
year.
OCC
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Restrictions on Proprietary
Trading and Certain Relationships with Hedge Funds and Private Equity
Funds.
Frequency: Annual, quarterly, and event driven.
Affected Public: Businesses or other for-profit.
Respondents: National banks, state member banks, state nonmember
banks, and state and federal savings associations.
OMB control number: 1557-0309.
Estimated number of respondents: 39.
Revisions estimated annual burden: 302 hours.
Estimated annual burden hours: 20,410 hours (3,681 hour for initial
set-up and 16,729 hours for ongoing).
Board
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Regulation VV.
Frequency: Annual, quarterly, and event driven.
Affected Public: Businesses or other for-profit.
Respondents: State member banks, bank holding companies, savings
and loan holding companies, foreign banking organizations, U.S. State
branches or agencies of foreign banks, and other holding companies that
control an insured depository institution and any subsidiary of the
foregoing other than a subsidiary for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory agency. The Board will take burden
for all institutions under a holding company including:
OCC-supervised institutions,
FDIC-supervised institutions,
Banking entities for which the CFTC is the primary
financial regulatory agency, as defined in section 2(12)(C) of the
Dodd-Frank Act, and
Banking entities for which the SEC is the primary
financial regulatory agency, as defined in section 2(12)(B) of the
Dodd-Frank Act.
Legal authorization and confidentiality: This information
collection is authorized by section 13 of the BHC Act (12 U.S.C.
1851(b)(2) and 12 U.S.C. 1851(e)(1)). The information collection is
required in order for covered entities to obtain the benefit of
engaging in certain types of proprietary trading or investing in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund, under the restrictions set forth in section 13 and
the final rule. If a respondent considers the information to be trade
secrets and/or privileged, such information could be withheld from the
public under the authority of the Freedom of Information Act (5 U.S.C.
552(b)(4)). Additionally, to the extent that such information may be
contained in an examination report, such information could also be
withheld from the public (5 U.S.C. 552 (b)(8)).
Agency form number: FR VV.
OMB control number: 7100-0360.
Estimated number of respondents: 255.
Revisions estimated annual burden: 7,880 hours.
Estimated annual burden hours: 36,112 hours (4,381 hour for initial
set-up and 31,731 hours for ongoing).
FDIC
Title of Information Collection: Volcker Rule Restrictions on
Proprietary Trading and Relationships with Hedge Funds and Private
Equity Funds.
Frequency: Annual, quarterly, and event driven.
Affected Public: Businesses or other for-profit.
Respondents: State nonmember banks, state savings associations, and
certain subsidiaries of those entities.
OMB control number: 3064-0184.
Estimated number of respondents: 10.
[[Page 46466]]
Revisions estimated annual burden: 175 hours.
Estimated annual burden hours: 3,288 hours (1,759 hours for initial
set-up and 1,529 hours for ongoing).
C. Regulatory Flexibility Act Analysis
The Regulatory Flexibility Act (RFA) \493\ requires an agency to
either provide a regulatory flexibility analysis with a final rule or
certify that the final rule will not have a significant economic impact
on a substantial number of small entities. The U.S. Small Business
Administration (SBA) establishes size standards that define which
entities are small businesses for purposes of the RFA.\494\ Except as
otherwise specified below, the size standard to be considered a small
business for banking entities subject to the final rule is $600 million
or less in consolidated assets.\495\
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\493\ 5 U.S.C. 601 et seq.
\494\ U.S. SBA, Table of Small Business Size Standards Matched
to North American Industry Classification System Codes, available at
https://www.sba.gov/document/support--table-size-standards.
\495\ See id. Pursuant to SBA regulations, the asset size of a
concern includes the assets of the concern whose size is at issue
and all of its domestic and foreign affiliates. 13 CFR 121.103(6).
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Board
The Board has considered the potential impact of the final rule on
small entities in accordance with section 603 of the RFA. Based on the
Board's analysis, and for the reasons stated below, the Board certifies
that the final rule will not have a significant economic impact on a
substantial of number of small entities.
The Board invited comment on all aspects of its analysis related to
the requirements of the RFA in connection with the 2020 proposal. In
particular, the Board requested that commenters describe the nature of
any impact on small entities and provide empirical data to illustrate
and support the extent of the impact. The Board did not receive any
comments related to this issue.
As discussed in the Supplementary Information, the agencies are
adopting revisions to the regulations implementing section 13 of the
BHC Act in order to improve and streamline the regulations by modifying
and clarifying requirements related to the covered fund
provisions.\496\ Certain of the exclusions from the covered fund
definition included in the final rule contain recordkeeping and
disclosure requirements that would apply to banking entities relying on
the exclusion. For example, the exclusion for customer facilitation
vehicles requires a banking entity relying on the exclusion to maintain
documentation outlining how the banking entity intends to facilitate
the customer's exposure to a transaction, investment strategy, or
service. The final rule is expected to reduce regulatory burden on
banking entities, and the Board does not expect these recordkeeping
requirements to result in a significant economic impact.
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\496\ The agencies are explicitly authorized under section
13(b)(2) of the BHC Act to adopt rules implementing section 13. 12
U.S.C. 1851(b)(2).
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The Board's rule generally applies to state-chartered banks that
are members of the Federal Reserve System, bank holding companies, and
foreign banking organizations and nonbank financial companies
supervised by the Board (collectively, ``Board-regulated entities'').
However, section 203 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act (EGRRCPA),\497\ which was enacted on May 24,
2018, amended section 13 of the BHC Act by narrowing the definition of
banking entity to exclude certain community banks.\498\ The Board is
not aware of any Board-regulated entities that meet the SBA's
definition of ``small entity'' that are subject to section 13 of the
BHC Act and its implementing regulations following the enactment of
EGRRCPA. Furthermore, to the extent that any Board-regulated entities
that meet the definition of ``small entity'' are or become subject to
section 13 of the BHC Act and its implementing regulations, the Board
does not expect the total number of such entities to be substantial.
Accordingly, the Board's final rule is not expected to have a
significant economic impact on a substantial number of small entities.
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\497\ Public Law 115-174 (May 24, 2018).
\498\ Under EGRRCPA, a community bank and its affiliates are
generally excluded from the definition of banking entity, and thus
section 13 of the BHC Act, if the bank and all companies that
control the bank have total consolidated assets equal to $10 billion
or less and trading assets and liabilities equal to five percent or
less of total consolidated assets.
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OCC
The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq.,
requires an agency, in connection with a final rule, to prepare a Final
Regulatory Flexibility Analysis describing the impact of the rule on
small entities (defined by the Small Business Administration (SBA) for
purposes of the RFA to include commercial banks and savings
institutions with total assets of $600 million or less and trust
companies with total assets of $41.5 million or less) or to certify
that the final rule would not have a significant economic impact on a
substantial number of small entities. The OCC currently supervises
approximately 745 small entities.\499\ Under the EGRRCPA, banking
entities with total consolidated assets of $10 billion or less
generally are not ``banking entities'' within the scope of section 13
of the BHC Act if their trading assets and trading liabilities do not
exceed five percent of their total consolidated assets. In addition,
section 13 of the BHC Act generally excludes certain institutions that
function only in a trust or fiduciary capacity from the definition of
``banking entity. As a result, no OCC-supervised small entities are
subject to section 13 of the BHC Act. Thus, the final rule will not
impact any OCC-supervised small entities. Therefore, the OCC certifies
that the final rule will not have a significant impact on a substantial
number of OCC-supervised small entities.
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\499\ The OCC bases its estimate of the number of small entities
on the SBA's size thresholds for commercial banks and savings
institutions, and trust companies, which are $600 million and $41.5
million, respectively. Consistent with the General Principles of
Affiliation, 13 CFR 121.103(a), the OCC counts the assets of
affiliated financial institutions when determining if the OCC should
classify an OCC-supervised institution as a small entity. The OCC
uses December 31, 2019, to determine size because a ``financial
institution's assets are determined by averaging the assets reported
on its four quarterly financial statements for the preceding year.''
See footnote 8 of the SBA's Table of Size Standards.
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FDIC
The RFA generally requires that, in connection with a final
rulemaking, an agency prepare and make available for public comment a
final regulatory flexibility analysis describing the impact of the
final rule on small entities.\500\ However, a regulatory flexibility
analysis is not required if the agency certifies that the final rule
will not have a significant economic impact on a substantial number of
small entities. The SBA has defined ``small entities'' to include
banking organizations with total assets of less than or equal to $600
million that are independently owned and operated or owned by a holding
company with less than or equal to $600 million in total assets.\501\
Generally, the FDIC considers
[[Page 46467]]
a significant effect to be a quantified effect in excess of five
percent of total annual salaries and benefits per institution, or 2.5
percent of total noninterest expenses. The FDIC believes that effects
in excess of these thresholds typically represent significant effects
for FDIC-supervised institutions. For the reasons described below and
under section 605(b) of the RFA, the FDIC certifies that this final
rule will not have a significant economic impact on a substantial
number of small entities.
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\500\ 5 U.S.C. 601 et seq.
\501\ The SBA defines a small banking organization as having
$600 million or less in assets, where an organization's ``assets are
determined by averaging the assets reported on its four quarterly
financial statements for the preceding year.'' See 13 CFR 121.201
(as amended by 84 FR 34261, effective August 19, 2019). In its
determination, the ``SBA counts the receipts, employees, or other
measure of size of the concern whose size is at issue and all of its
domestic and foreign affiliates.'' See 13 CFR 121.103. Following
these regulations, the FDIC uses a covered entity's affiliated and
acquired assets, averaged over the preceding four quarters, to
determine whether the covered entity is ``small'' for the purposes
of RFA.
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As of December 31, 2019, the FDIC supervised 3,344 depository
institutions,\502\ of which 2,581 were considered small entities for
the purposes of RFA.\503\ The Economic Growth, Regulatory Relief, and
Consumer Protection Act excluded entities from the requirements of
section 13 of the BHC Act that do not have and are not controlled by a
company that has total assets of more than $10 billion or trading
assets and liabilities comprising more than five percent of total
consolidated assets.\504\ Only one small, FDIC-supervised institution
is subject to section 13 of the BHC Act, because its trading assets and
liabilities exceed five percent of total consolidated assets.\505\
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\502\ FDIC-supervised institutions are set forth in 12 U.S.C.
1813(q)(2).
\503\ FDIC Call Report data, December 31, 2019.
\504\ Public Law 115-174, May 24, 2018. https://www.congress.gov/bill/115th-congress/senate-bill/ 2155.
\505\ FDIC Call Report data, December 2019.
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Section 13 of the BHC Act generally prohibits any banking entity
from engaging in proprietary trading or from acquiring or retaining an
ownership interest in, sponsoring, or having certain relationships with
a covered fund. As previously discussed, the final rule modifies
existing definitions and exclusions and introduces new exclusions to
the implementing regulations. The final rule permits covered entities
to engage in additional activities with respect to covered funds,
including acquiring or retaining an ownership interest in, sponsoring,
or having certain relationships with covered funds, subject to certain
restrictions.
This final rule excludes certain types of investment funds from the
definition of a ``covered fund'' for the purposes of section 13 of the
BHC Act. Investments in funds that are affected by this final rule
could be reported as deductions from capital on Call Report schedule
RC-R Part 1 Lines 11 or 13 if the investments qualify as ``investments
in the capital of an unconsolidated financial institution'' or as
additional deductions on Lines 17 or 24 of schedule RC-R
otherwise.\506\ The one affected small, FDIC-supervised institution did
not report any such deductions over the past five years.\507\
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\506\ See ``Supervisory Guidance on the Capital Treatment of
Certain Investments in Covered Funds.'' FDIC FIL-50-2015: November
6, 2015. https://www.fdic.gov/news/news/financial/2015/fil15050a.pdf.
\507\ FDIC Call Report data, March 2015-December 2019.
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Based on this supporting information, the FDIC certifies that this
final rule will not have a significant economic impact on a substantial
number of small entities.
SEC
In the 2020 proposal, the SEC certified that, pursuant to 5 U.S.C.
605(b), the 2020 proposal would not, if adopted, have a significant
economic impact on a substantial number of small entities. Although the
SEC solicited written comments regarding this certification, no
commenters responded to this request.
As discussed in the SUPPLEMENTARY INFORMATION, the amendments
clarify and simplify compliance with the implementing regulations,
refine the extraterritorial application of the section 13 of the BHC
Act, and permit additional fund activities that do not present the
risks that section 13 was intended to address.
The amendments will generally apply to banking entities, including
certain SEC-registered entities. These entities include bank-affiliated
SEC-registered investment advisers, broker-dealers, and security-based
swap dealers. Based on information in filings submitted by these
entities, the SEC believes that there are no banking entity registered
investment advisers or broker-dealers that are small entities for
purposes of the RFA. For this reason, the SEC certifies that the
amendments will not have a significant economic impact on a substantial
number of small entities.
CFTC
Pursuant to 5 U.S.C. 605(b), the CFTC hereby certifies that the
final rule will not have a significant economic impact on a substantial
number of small entities for which the CFTC is the primary financial
regulatory agency.
As discussed in this Supplementary Information, the final rule
clarifies and simplifies compliance with the implementing regulations,
refines the extraterritorial application of section 13 of the BHC Act,
and permits additional fund activities that do not present the risks
that section 13 was intended to address. To reduce the extraterritorial
impact of the implementing regulations, the final rule exempts the
activities of certain funds that are organized outside of the United
States and offered to foreign investors from certain restrictions of
the implementing regulations. The final rule also revises several
existing exclusions from the covered fund provisions, to provide
clarity and simplify compliance with the requirements of the
implementing regulations. The final rule adopts several new exclusions
from the covered fund definition in order to more closely align the
regulation with the purpose of the statute. Last, the final rule adopts
revisions to the provisions that govern the relationship between a
banking entity and a fund and the definition of ownership interest.
The final rule will generally apply to banking entities, including
certain CFTC-registered entities. These entities include bank-
affiliated CFTC-registered swap dealers, futures commission merchants,
commodity trading advisors and commodity pool operators.\508\ The CFTC
has previously determined that swap dealers, futures commission
merchants and commodity pool operators are not small entities for
purposes of the RFA and, therefore, the requirements of the RFA do not
apply to those entities.\509\ As for commodity trading advisors, the
CFTC has found it appropriate to consider whether such registrants
should be deemed small entities for purposes of the RFA on a case-by-
case basis, in the context of the particular regulation at issue.\510\
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\508\ The final rule may also apply to other types of CFTC
registrants that are banking entities, such as introducing brokers,
but the CFTC believes it is unlikely that such other registrants
will have significant activities that would implicate the final
rule. See 79 FR 5808, 5813 (Jan. 31, 2014) (CFTC version of 2013
final rule).
\509\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982) (futures commission merchants and
commodity pool operators); Registration of Swap Dealers and Major
Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (swap dealers
and major swap participants).
\510\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18620 (Apr. 30, 1982).
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In the context of the final rule, the CFTC believes it is unlikely
that a substantial number of the commodity trading advisors that are
potentially affected are small entities for purposes of the RFA. In
this regard, the CFTC notes that only commodity trading advisors that
are registered with the CFTC are covered by the implementing
regulations, and generally those that are registered have larger
businesses.
[[Page 46468]]
Similarly, the final rule applies to only those commodity trading
advisors that are affiliated with banks, which the CFTC expects are
larger businesses.
The CFTC requested that commenters address in particular whether
any of these commodity trading advisors, or other CFTC registrants
covered by the proposed revisions, are small entities for purposes of
the RFA. The CFTC did not receive any public comments on this or any
other aspect of the RFA as it relates to the rule.
Because the CFTC believes that there are not a substantial number
of registered, banking entity-affiliated commodity trading advisors
that are small entities for purposes of the RFA, and the other CFTC
registrants that may be affected by the proposed revisions have been
determined not to be small entities, the CFTC believes that the final
rule will not have a significant economic impact on a substantial
number of small entities for which the CFTC is the primary financial
regulatory agency.
D. Riegle Community Development and Regulatory Improvement Act
Section 302(a) of the Riegle Community Development and Regulatory
Improvement Act of 1994 (RCDRIA) \511\ requires that each Federal
banking agency, in determining the effective date and administrative
compliance requirements for new regulations that impose additional
reporting, disclosure, or other requirements on insured depository
institutions, consider, consistent with principles of safety and
soundness and the public interest, any administrative burdens that such
regulations would place on depository institutions, including small
depository institutions, and customers of depository institutions, as
well as the benefits of such regulations. The agencies have considered
comment on these matters in other parts of this SUPPLEMENTARY
INFORMATION.
---------------------------------------------------------------------------
\511\ 12 U.S.C. 4802(a).
---------------------------------------------------------------------------
In addition, under section 302(b) of the RCDRIA, new regulations
that impose additional reporting, disclosures, or other new
requirements on insured depository institutions generally must take
effect on the first day of a calendar quarter that begins on or after
the date on which the regulations are published in final form.\512\
Therefore, the effective date for the Federal banking agencies is
October 1, 2020, the first day of the calendar quarter.\513\
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\512\ 12 U.S.C. 4802(b).
\513\ Additionally, the Administrative Procedure Act generally
requires that the effective date of a rule be no less than 30 days
after publication in the Federal Register. 5 U.S.C. 553(d)(1). The
effective date, October 1, 2020, will be more than 30 days after
publication in the Federal Register.
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E. OCC Unfunded Mandates Reform Act
The OCC has analyzed the final rule under the factors in the
Unfunded Mandates Reform Act of 1995 (UMRA). Under this analysis, the
OCC considered whether the final rule includes a Federal mandate that
may result in the expenditure by state, local, and tribal governments,
in the aggregate, or by the private sector, of $100 million or more in
any one year (adjusted annually for inflation). The UMRA does not apply
to regulations that incorporate requirements specifically set forth in
law.
The final rule does not impose new mandates. Therefore, the OCC
finds that the final rule does not trigger the UMRA cost threshold.
Accordingly, the OCC has not prepared the written statement described
in section 202 of the UMRA.
F. SEC Economic Analysis
1. Broad Economic Considerations
i. Background
As discussed above, section 13 of the Bank Holding Company (BHC)
Act generally prohibits banking entities from acquiring or retaining an
ownership interest in, sponsoring, or having certain relationships
with, a hedge fund or private equity fund (covered funds), subject to
certain exemptions. Section 13(h)(1) of the BHC Act defines the term
``banking entity'' to include (1) any insured depository institution
(as defined by statute), (2) any company that controls an insured
depository institution, (3) any company that is treated as a bank
holding company for purposes of section 8 of the International Banking
Act of 1978, and (4) any affiliate or subsidiary of such an
entity.\514\ In addition, the Economic Growth, Regulatory Relief, and
Consumer Protection Act (EGRRCPA),\515\ enacted on May 24, 2018,
amended section 13 of the BHC Act to exclude from the definition of
``insured depository institution'' any institution that does not have
and is not controlled by a company that has (1) more than $10 billion
in total consolidated assets; and (2) total trading assets and trading
liabilities, as reported on the most recent applicable regulatory
filing filed by the institution, that are more than 5% of total
consolidated assets.\516\
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\514\ See 12 U.S.C. 1851(h)(1).
\515\ See supra note 504.
\516\ These and other aspects of the regulatory baseline against
which the SEC is assessing the economic effects of the final rule
being adopted here on SEC-regulated entities are discussed in the
economic baseline. On July 22, 2019, the agencies adopted a final
rule amending the definition of ``insured depository institution''
in a manner consistent with EGRRCPA. See Revisions to Prohibitions
and Restrictions on Proprietary Trading and Certain Interests in,
and Relationships with, Hedge Funds and Private Equity Funds, 84 FR
35008 (July 22, 2019). In November 2019, the agencies adopted the
2019 amendments, which tailored certain proprietary trading and
covered fund restrictions of the 2013 rule. See supra note 8.
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Certain SEC-regulated entities, such as broker-dealers, security-
based swap dealers (SBSDs), and registered investment advisers (RIAs)
affiliated with an insured depository institution, fall under the
definition of ``banking entity'' and are subject to the prohibitions of
section 13 of the BHC Act.\517\ The SEC's economic analysis is limited
to areas within the scope of the SEC's function as the primary
securities markets regulator in the United States. In particular, the
SEC's economic analysis focuses primarily on the potential effects of
the rule amendments being adopted here (the ``final rule'') on (1) SEC
registrants, in their capacity as such, (2) the functioning and
efficiency of the securities markets, (3) investor protection, and (4)
capital formation. SEC registrants that may be affected by the final
rule include SEC-registered broker-dealers, SBSDs, and RIAs. Thus, the
analysis below does not consider the direct effects of the final rule
on broker-dealers, SBSDs, and registered investment advisers that are
not banking entities, or banking entities that are not SEC registrants.
In addition, potential spillover effects on these and other entities
are reflected in the SEC's analysis of effects on efficiency,
[[Page 46469]]
competition, investor protection, and capital formation in securities
markets. This economic analysis also discusses the impact of the final
rule on private funds,\518\ to the degree that it may flow through to
SEC registrants, such as RIAs, SEC-registered broker-dealers and SBSDs,
and securities markets and investors.
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\517\ Throughout this economic analysis, the terms ``banking
entity'' and ``entity'' generally refer only to banking entities for
which the SEC is the primary financial regulatory agency. While
section 13 of the BHC Act and its associated rules apply to a
broader set of banking entities, this economic analysis is limited
to those banking entities for which the SEC is the primary financial
regulatory agency as defined in section 2(12)(B) of the Dodd-Frank
Act. See 12 U.S.C. 1851(b)(2), 5301(12)(B).
Compliance with SBSD registration requirements is not yet
required and there are currently no registered SBSDs. However, the
SEC has previously estimated that as many as 50 entities may
potentially register as SBSDs and that as many as 16 of these
entities may already be SEC-registered broker-dealers. See Capital,
Margin, and Segregation Requirements for Security-Based Swap Dealers
and Major Security-Based Swap Participants and Capital and
Segregation Requirements for Broker-Dealers, 84 FR 43872 (Aug. 22,
2019) (``Capital, Margin, and Segregation Adopting Release'').
For the purposes of this economic analysis, the term ``dealer''
generally refers to SEC-registered broker-dealers and SBSDs.
\518\ There is significant overlap between the definitions of
``private fund'' and ``covered fund.'' For purposes of this economic
analysis, ``private fund'' means an issuer that would be an
investment company, as defined in section 3 of the Investment
Company Act (15 U.S.C. 80a-3(a)), but for section 3(c)(1) or section
3(c)(7) of that Act (15 U.S.C. 80-3(c)(1) or (7)). See also 15
U.S.C. 80b-2(a)(29). Section 13(h)(2) of the BHC Act defines ``hedge
fund'' and ``private equity fund'' to mean an issuer that would be
an investment company, but for section 3(c)(1) or 3(c)(7) of the
Investment Company Act, or ``such similar funds'' as the agencies
determine by rule (see 12 U.S.C. 1851(h)(2)). In the 2013 rule, the
agencies combined the definitions of ``hedge fund'' and ``private
equity fund'' into a single term ``covered fund'' and defined this
term to include any issuer that would be an investment company as
defined in the Investment Company Act but for section 3(c)(1) or
3(c)(7) of that Act with a number of express exclusions and
additions as determined by the agencies. Implementing regulations
Sec. __.10(b) and (c).
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In implementing section 13 of the BHC Act, the agencies sought to
increase the safety and soundness of banking entities, promote
financial stability, and reduce conflicts of interest between banking
entities and their customers.\519\ The regulatory regime created by the
2013 rule may have enhanced regulatory oversight and compliance with
the substantive prohibitions of section 13 of the BHC Act, but could
also have impacted capital formation and liquidity, as well as the
provision by banking entities of a variety of financial services for
customers.
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\519\ See, e.g., 79 FR 5536, 5541, 5574, 5659, 5666. An
extensive body of research has examined moral hazard arising out of
federal deposit insurance, implicit bailout guarantees, and systemic
risk issues. See, e.g., Andrew G. Atkeson et al., Government
Guarantees and the Valuation of American Banks, 33 NBER
Macroeconomics Ann. 81 (2018). See also Javier Bianchi, Efficient
Bailouts? 106 Amer. Econ. Rev. 3607 (2016); Bryan Kelly, Hanno
Lustig, & Stijn Van Nieuwerburgh, Too-Systematic-to-Fail: What
Option Markets Imply about Sector-Wide Government Guarantees, 106
Amer. Econ. Rev. 1278 (2016); Deniz Anginer, Asli Demirguc-Kunt, &
Min Zhu, How Does Deposit Insurance Affect Bank Risk? Evidence from
the Recent Crisis, 48 J. Banking & Fin. 312 (2014); Andrea Beltratti
& Rene M. Stulz, The Credit Crisis Around the Globe: Why Did Some
Banks Perform Better?, 105 J. Fin. Econ. 1 (2012); Pietro Veronesi &
Luigi Zingales, Paulson's Gift, 97 J. Fin. Econ. 339 (2010). For a
literature review, see, e.g., Sylvain Benoit et al., Where the Risks
Lie: A Survey on Systemic Risk, 21 Rev. Fin. 109 (2017).
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Section 13 of the BHC Act also provides a number of statutory
exemptions to the general prohibitions on proprietary trading and
covered funds activities. For example, the statute exempts certain
covered funds activities, such as organizing and offering covered
funds.\520\ The 2013 rule implemented these exemptions.\521\ Banking
entities engaged in activities and investments covered by section 13 of
the BHC Act and the implementing regulations are required to establish
a compliance program reasonably designed to ensure and monitor
compliance with the implementing regulations.\522\
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\520\ See 12 U.S.C. 1851(d)(1)(G).
\521\ See 2013 rule Sec. Sec. __.4, __.5, __.6, __.11, and
__.13.
\522\ See 2013 rule Sec. __.20. See also 2019 amendments, 84 FR
62021-25, which, among other things, modified these requirements for
banking entities with limited trading assets and liabilities. This
SEC Economic Analysis follows earlier sections by referring to the
regulations implementing section 13 of the BHC Act, as amended
through June 1, 2020 as the ``implementing regulations.'' See supra
note 8.
---------------------------------------------------------------------------
In the 2020 proposal, the SEC solicited comment on all aspects of
the costs and benefits associated with the proposed amendments for SEC
registrants, including spillover effects the proposed amendments may
have on efficiency, competition, and capital formation in securities
markets. The SEC has considered these comments, as discussed in greater
detail in the sections that follow.
ii. Broad Economic Effects
Certain aspects of the implementing regulations may have resulted
in a complex and costly compliance regime that is unduly restrictive
and burdensome on some affected banking entities. Distinguishing
between permissible and prohibited activities may be complex and
costly, resulting in uncertain determinations for some entities.
Moreover, the implementing regulations may include in their scope some
groups of market participants that do not necessarily engage in the
activities or pose the risks that section 13 of the BHC Act intended to
address. For example, definition of the term ``covered fund'' may
include entities that do not engage in the activities contemplated by
section 13 of the BHC Act or may include entities that do not pose the
risks that section 13 is intended to mitigate.
The final rule includes amendments that (1) reduce the scope of
entities that may be treated as covered funds (e.g., credit funds,
venture capital funds, family wealth management vehicles, and customer
facilitation vehicles), (2) modify existing covered fund exclusions
under the implementing regulations (e.g., foreign public funds, public
welfare funds, and small business investment companies), and (3) affect
the types of permitted activities between certain banking entities and
certain covered funds (e.g., restrictions on relationships between
banking entities and covered funds, definition of ``ownership
interest,'' and treatment of loan securitizations). The final rule also
reduces the burden on affected banking entities by codifying an
existing policy statement by the Federal banking agencies that
addresses the potential issues related to a foreign banking entity
controlling a qualifying foreign excluded fund and adopting a rule of
construction to provide clarity regarding a banking entity's
permissible investments alongside a covered fund.
Broadly, to the extent that the final rule directly changes the
scope of permissible covered fund activities, and indirectly reduces
costs to banking entities and covered funds by reducing uncertainty
regarding the scope of permissible activities, the final rule may
enhance the beneficial economic effects of the implementing
regulations.\523\ The SEC's economic analysis continues to recognize
that the overall risk exposure of banking entities generally reflects a
combination of activities, including proprietary trading, market
making, traditional banking, asset management, investment activities,
and the extent to which banking entities engage in hedging and other
risk-mitigating activities. The overall risk exposure is also a
function of the magnitude, structure, and manner in which banking
entities engage in such activities, both within such activities
individually and across all of these activities collectively. As
discussed elsewhere,\524\ the SEC recognizes the complex baseline
effects of section 13 of the BHC Act, as amended by sections 203 and
204 of EGRRCPA, and the implementing regulations (including those made
with respect to sections 203 and 204 of EGRRCPA) on overall levels and
structure of banking entity risk exposures.
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\523\ See, e.g., 2019 amendments, 84 FR 62037-92.
\524\ See id.
---------------------------------------------------------------------------
The final rule may promote the ability of the capital markets to
intermediate between suppliers and users of capital through, for
example, increased ability and willingness of banking entities and
investors in ``covered funds'' to facilitate capital formation through
sponsorship and participation in certain types of funds and to transact
with certain groups of counterparties.\525\ For
[[Page 46470]]
example, exclusions from the ``covered fund'' definition of specific
types of entities may benefit banking entities by providing clarity and
removing certain constraints around potentially profitable business
opportunities and by reducing compliance costs, and may benefit
excluded funds and their banking entity sponsors and advisers by
increasing the spectrum of available counterparties and improving the
quality or cost of financial services available to customers.
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\525\ See, e.g., U.S. Dep't of the Treasury, A Financial System
That Creates Economic Opportunities: Banks and Credit Unions (June
2017), at 77, available at https://www.treasury.gov/press-center/press-releases/Documents/A%20Financial%20System.pdf.
---------------------------------------------------------------------------
The final rule, however, may also facilitate risk mitigation as
well as risk-taking activities of banking entities. The final rule also
may change aspects of the relationships among banking entities and
certain other groups of market participants, including potentially
introducing new conflicts of interest, and increasing or reducing the
potential effects of conflicts of interest. To the degree that some
banking entities react to the final rule by restructuring activities
involving covered funds to take advantage of the exclusions contained
in the final rule, there may be shifts in the structure and levels of
activities of banking entities that would, in turn, decrease or
increase risk exposure. Recognizing these various potential effects,
each of the exclusions includes a number of conditions aimed at
facilitating banking entity compliance while also allowing for customer
oriented financial services provided on arms-length, market terms, and
preventing evasion of the requirements of section 13.
In evaluating these various potential effects, it is important to
acknowledge that the exclusions made available by the final rule, such
as for credit funds and qualifying venture capital funds, allow banking
entities to engage indirectly through fund structures in the same
activities in which they are currently permitted to engage directly
(e.g., extensions of credit or direct ownership stakes). Thus, the type
of exposure permitted by engaging in those activities directly, and
indirectly through covered funds, is the same and the banking entities
may use fund structures to diversify or otherwise mitigate their risk
exposure. Other exclusions permit banking entities to provide
traditional banking and asset management services to customers through
a legal entity structure, with conditions (e.g., limitation on
ownership by the banking entity and prohibition on ``bail outs'')
intended to ensure that the risks that section 13 of the BHC Act was
intended to address are mitigated. Finally, nothing in the final rule
removes or modifies prudential capital, margin, and liquidity
requirements that are applicable to banking entities and that
facilitate the safety and soundness of banking entities and the
financial stability of the United States.
The final rule may also impact competition, allocative efficiency,
and capital formation. To the extent that the implementing regulations
have constrained banking entities in their covered fund activities,
including providing traditional banking and asset management services
to customers through a legal entity structure, the exclusions from the
definition of ``covered fund'' made available by the final rule may
increase competition between banking entities and other entities
providing services to and otherwise transacting with those types of
funds and other entities. Such competition may reduce costs or increase
the quality of certain financial services provided to such funds and
their counterparties.
Finally, the final rule's costs, benefits, and effects on
efficiency, competition, and capital formation will be influenced by a
variety of factors, including the prevailing macroeconomic conditions,
the financial condition of firms seeking to raise capital and of funds
seeking to transact with banking entities, competition between bank and
non-bank providers of capital, and many others. Moreover, these effects
are likely to vary widely among banking entities and funds. The SEC
recognizes that the economic effects of the final rule may be dampened
or magnified in different phases of the macroeconomic cycle, depend on
monetary and fiscal policy developments and other government actions,
and may vary across different types of banking entities.
The SEC also considered the implications of the final rule for
investors. Broadly, the final rule should increase the number of funds
and other entities that will be excluded from the covered fund
definition. This is likely to result in an increase in offerings of
such funds or an increase in the number of banking entities providing
services to customers through entities such as customer facilitation
vehicles and family wealth management vehicles. If the final rule
increases the ability of investors to access public and private markets
through funds and other entities, the final rule may result in the
relaxing of constraints on investors' portfolio optimization and, thus,
enhance the efficiency of portfolio allocations. The ability of
additional investors to access these markets through funds and other
entities may, in addition to providing those investors with greater
choice, benefit the issuers of the securities held by those funds and
other entities by potentially increasing demand for those securities.
Increased demand typically results in increased liquidity which can
benefit investors because it may enable them to enter or exit their
positions in fund instruments, products, and portfolios in a more
timely manner and at a more attractive price.
Moreover, investors who seek access to public capital markets
investments or other investments through foreign public funds may
benefit to the extent the final rule results in banking entities
offering more foreign public funds or offering these funds at a lower
cost. Further, investors that prefer to implement a trading or
investing strategy through a legal entity structure may benefit from
the final rule, which allows banking entities to implement or
facilitate such a trading or investing strategy while providing other
banking and asset management services to the investor.\526\ At the same
time, it is possible that, as a result of banking entities sponsoring
or investing in more funds that are excluded from the definition of
covered fund by the final rule, general market risk could increase and
that risk could adversely affect markets generally, including through
the impact on financial stability. However, due to the mitigation
effects of the various conditions of the exclusions from the definition
of covered fund contained in the final rule as well as expectations
regarding the relative size and mix of the investments in the
aggregate, the SEC believes this risk to be small. For example, the
final rule permits a banking entity to act as a sponsor, investment
adviser, or commodity trading advisor to certain excluded funds (e.g.,
credit funds and qualifying venture capital funds) only to the extent
the banking entity ensures that the activities of the funds are
consistent with safety and soundness standards that are substantially
similar to those that would apply if the banking entity engaged in the
activities directly.
---------------------------------------------------------------------------
\526\ See supra Section IV.B.1. (Foreign Public Funds).
---------------------------------------------------------------------------
iii. Analytical Approach
The SEC's economic analysis is informed by research \527\ on the
effects of section 13 of the BHC Act and the 2013 rule, comments
received by the agencies from a variety of interested parties, and
experience administering the implementing regulations. Throughout this
economic analysis, the SEC discusses how different market
[[Page 46471]]
participants \528\ may respond to various aspects of the final rule.
This analysis also considers the potential effects of the final rule on
activities by banking entities that involve risk, their willingness and
ability to engage in client-facilitation activities, and competition,
market quality, and capital formation.
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\527\ See 2019 amendments, 84 FR 62044-54.
\528\ As discussed above, supra Section V.F.1.i. (Background),
the SEC's economic analysis is focused on the potential effects of
the final rule on (1) SEC registrants, (2) the functioning and
efficiency of the securities markets, (3) investor protection, and
(4) capital formation. Thus, the below analysis does not consider
the direct effects of the final rule on broker-dealers, SBSDs, or
investment advisers that are not banking entities, or banking
entities that are not SEC registrants, in either case for purposes
of section 13 of the BHC Act, beyond the potential spillover effects
on these entities and effects on efficiency, competition, investor
protection, and capital formation in securities markets. See infra
Section V.F.2.i. (Affected Participants).
---------------------------------------------------------------------------
The final rule tailors, removes, or alters the scope of various
covered fund requirements in the implementing regulations. Since
section 13 of the BHC Act and the implementing regulations impose a
number of different requirements, and, as discussed above, the type and
level of risk exposure of a banking entity is the result of a
combination of activities,\529\ it is difficult to attribute the
observed effects to a specific provision or subset of requirements. In
addition, analysis of the effects of the implementation of the 2013
rule is confounded by macroeconomic factors, other policy
interventions, and post-crisis changes to market participants' risk
aversion and return expectations.\530\ Because of the extended timeline
of implementation of section 13 of the BHC Act and the overlap of the
period during which the 2013 rule was in effect with other post-crisis
changes affecting the same group or certain sub-groups of SEC
registrants, the SEC cannot rely on quantitative methods that might
otherwise provide insight into causal attribution and quantification of
the effects of section 13 of the BHC Act and the 2013 rule on measures
of capital formation, liquidity, competition, and informational or
allocative efficiency. Moreover, empirical measures of capital
formation or liquidity are substantially limited by the fact that they
do not provide insight into security issuance and transaction activity
that does not occur (or occurs in a sector of the market for which data
is not readily available) as a result of the implementing regulations.
Accordingly, it is difficult to quantify the primary security issuance
and secondary market liquidity that would have been observed since the
financial crisis absent various provisions of section 13 of the BHC Act
and the implementing regulations.
---------------------------------------------------------------------------
\529\ See, e.g., 2013 rule at 5541.
\530\ With respect to the 2019 amendments, supra note 8,
analysis of the effects is difficult because of the relatively short
time that has passed since they became effective.
---------------------------------------------------------------------------
Importantly, the existing securities markets--including market
participants, their business models, market structure, etc.--differ in
significant ways from the securities markets that existed prior to
enactment of section 13 of the BHC Act and the implementation of the
2013 rule. For example, the role of dealers in intermediating trading
activity has changed in important ways, including the following: (1) In
recent years, on both an absolute and relative basis, bank dealers
generally committed less capital to intermediation activities while
non-bank dealers generally committed more, although not always in the
same manner or on the same terms as bank dealers; (2) the volume and
profitability of certain trading activities after the financial crisis
may have decreased for bank dealers while it may have increased for
other intermediaries, including non-bank entities that provide intraday
liquidity, but generally not overnight liquidity, including in some
sectors of the market through the use of electronic trading algorithms
and high speed access to data and trading venues; and (3) the
introduction of alternative credit markets, including non-bank direct
lending markets, may have contributed to liquidity fragmentation across
markets while potentially increasing access to capital.\531\
---------------------------------------------------------------------------
\531\ See U.S. Sec. & Exch. Comm'n, Access to Capital and Market
Liquidity (Aug. 2017), available at https://www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017.pdf.
---------------------------------------------------------------------------
Where possible, the SEC has attempted to quantify the costs and
benefits it expects to result from the final rule. In many cases,
however, the SEC is unable to quantify these potential economic
effects. Some of the primary economic effects, such as the effect on
incentives that may give rise to conflicts of interest in various
regulated entities and the degree to which the implementing regulations
may be impeding activity of banking entities with respect to certain
investment vehicles, are inherently difficult to quantify. Moreover,
some of the intended benefits of the implementing regulations'
definitions and prohibitions that the agencies are amending include the
potential for more resilient markets during a financial crisis or
during periods of severe market stress. These intended benefits are
less readily observable under periods of strong economic conditions,
periods of significant government credit accommodation, and when
markets have significant liquidity and are less volatile. Even
following an economic shock, identification of these intended benefits
requires a sufficient amount of data covering a relevant sample period.
Moreover, identifying these benefits following an economic shock could
prove difficult if the effects of past regulation are confounded by
other interventions aimed at mitigating the impact of the shock on
financial markets, including regulation, credit accommodation, and
fiscal stimulus. Finally, it is difficult to quantify the net economic
effects of any individual amendment because of overlapping
implementation periods of various post-crisis regulations. Further, it
is difficult to quantify the net economic effects of any individual
amendment because of the fact that many market participants changed
their behavior in anticipation of future changes in regulation.
In some instances, the SEC lacks the information or data necessary
to provide reasonable estimates for the economic effects of the final
rule. For example, the SEC lacks information and data on how market
participants may choose to restructure their relationships with various
types of entities in response to the final rule; the amount of capital
formation in covered funds that does not occur because of current
covered fund provisions, including those concerning the definition of
covered fund, restrictions on relationships with covered funds, the
definition of ownership interest, and the exclusion for loan
securitizations; the volume of loans, guarantees, securities lending,
and derivatives activity dealers may wish to engage in with related
covered funds; as well as the extent of risk reduction associated with
the covered fund provision of the 2013 rule. Where the SEC cannot
quantify the relevant economic effects, they are discussed in
qualitative terms.
2. Economic Baseline
In the context of this economic analysis, the economic costs and
benefits, and the impact of the final rule on efficiency, competition,
and capital formation, are considered relative to a baseline that
includes the implementing regulations (including the 2013 rule and the
2019 amendments), legislative amendments in EGRRCPA, and current
practices aimed at compliance with these regulations.
i. Regulation
The SEC is assessing the economic impact of the final rule against
a baseline that includes the legal and regulatory framework as it
exists at the
[[Page 46472]]
time of this release. Thus, the regulatory baseline for the SEC's
economic analysis includes section 13 of the BHC Act as amended by
EGRRCPA, and the 2013 rule. Further, the baseline accounts for the fact
that since the adoption of the 2013 rule, the agencies have adopted the
2019 amendments, which, among other things, relate to the ability of
banking entities to engage in certain activities, including
underwriting, market-making, and risk-mitigating hedging, with respect
to ownership interests in covered funds, as well as amendments
conforming the 2013 rule to sections 203 and 204 of EGRRCPA. In
addition, the agencies' staffs have provided FAQ responses related to
the regulatory obligations of banking entities, including SEC-regulated
entities that are also banking entities under the 2013 rule, which
likely influenced these entities' decisions about how to comply with
the 2013 rule and may influence these entities' decisions about how to
comply with the 2019 amendments.\532\ The Federal banking agencies also
issued the policy statement in 2017 with respect to foreign excluded
funds, and has since extended the policy statement to 2021.\533\
---------------------------------------------------------------------------
\532\ See supra note 14.
\533\ See supra Section VI.A. (Qualifying Foreign Excluded
Funds) and notes 26 and 28 (discussion of ``the policy statement'').
---------------------------------------------------------------------------
Although the 2013 rule also included restrictions on proprietary
trading and compliance requirements (as modified by the 2019
amendments), the most relevant portion of the 2013 rule for
establishing an economic baseline is that involving covered fund
restrictions.\534\ The features of the regulatory framework under the
2013 rule most relevant to the baseline include the definition of the
term ``covered fund''; restrictions on a banking entity's relationships
with covered funds; and restrictions on parallel investment, co-
investment, and investments in the fund by banking entity employees.
---------------------------------------------------------------------------
\534\ See 84 FR 61974.
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Scope of the Covered Fund Definition
The definition of ``covered fund'' impacts the scope of the
substantive prohibitions on banking entities acquiring or retaining an
ownership interest in, sponsoring, and having certain relationships
with, covered funds. The implementing regulations define covered funds,
in part, as issuers that would be investment companies but for section
3(c)(1) or 3(c)(7) of the Investment Company Act and then excludes
specific types of entities from the definition. The definition also
includes certain commodity pools as well as certain foreign funds.
Funds that rely on the exclusions in sections 3(c)(1) or 3(c)(7) of the
Investment Company Act are covered funds unless an exclusion from the
covered fund definition is available. Funds that rely on any exclusion
or exemption from the definition of ``investment company'' under the
Investment Company Act, other than the exclusion contained in section
3(c)(1) or 3(c)(7), such as real estate and mortgage funds that rely on
the exclusion in section 3(c)(5)(C), are not covered funds under the
implementing regulations. The covered fund provisions of the
implementing regulations may reduce the ability and incentives of
banking entities to bail out affiliated funds to mitigate reputational
risk, limit conflicts of interest with clients, customers, and
counterparties, and reduce the ability of banking entities to engage in
proprietary trading indirectly through funds.
The broad definition of covered funds encompasses many different
types of vehicles, and the implementing regulations exclude some of
them from the definition of a covered fund.\535\ The excluded fund
types relevant to the baseline are funds that are regulated by the SEC
under the Investment Company Act: Registered investment companies
(RICs) and business development companies (BDCs). Seeding vehicles for
these funds are also excluded from the covered fund definition during
their seeding period.\536\
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\535\ The exclusions from the covered fund definition are set
forth in Sec. __.10(c) of the implementing regulations.
\536\ See implementing regulations Sec. Sec. __.10(c)(12)(i)
and __.10(c)(12)(iii).
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Restrictions on Relationships Between Banking Entities and Covered
Funds
Under the baseline, banking entities are limited in the types of
transactions in which they are able to engage with covered funds with
which they have certain relationships. Banking entities that serve,
directly or indirectly, as the investment manager, adviser, or sponsor
to a covered fund are prohibited from engaging in a ``covered
transaction,'' as defined in section 23A of the Federal Reserve Act,
with the covered fund or with any other covered fund that is controlled
by such covered fund.\537\ Similarly, a banking entity that organizes
and offers a covered fund pursuant to Sec. __.11 or that continues to
hold an ownership interest in a covered fund in accordance with Sec.
__.11(b) is prohibited from engaging in such a ``covered transaction.''
This prohibits all ``covered transactions'' that cause the banking
entity to have credit exposure to the affiliated covered fund,
including short-term extensions of credit and various other
transactions required for a banking entity to provide an affiliated
covered fund payment, clearing, and settlement services.
---------------------------------------------------------------------------
\537\ See implementing regulations Sec. __.14(a).
---------------------------------------------------------------------------
Definition of ``Banking Entity''
For foreign banking entities,\538\ certain funds organized under
foreign law and offered to foreign investors (``foreign excluded
funds'') are not ``covered funds'' under the implementing regulations,
but may be subject to the implementing regulations as ``banking
entities'' under certain circumstances. Through the policy statement,
the Federal banking agencies (in consultation with the staffs of the
SEC and the CFTC) have provided temporary relief, that is currently
scheduled to expire on July 21, 2021, for qualifying foreign excluded
funds that may otherwise be subject to the implementing regulations as
banking entities.\539\
---------------------------------------------------------------------------
\538\ For purposes of this analysis, ``foreign banking entity''
has the same meaning as used in the policy statement, supra note 27,
i.e., a banking entity that is not, and is not controlled directly
or indirectly by, a banking entity that is located in or organized
under the laws of the United States or any state.
\539\ See supra note 26 and 28. For purposes of the policy
statement, a ``qualifying foreign excluded fund'' means, with
respect to a foreign banking entity, an entity that (1) is organized
or established outside the United States and the ownership interests
of which are offered and sold solely outside the United States; (2)
would be a covered fund were the entity organized or established in
the United States, or is, or holds itself out as being, an entity or
arrangement that raises money from investors primarily for the
purpose of investing in financial instruments for resale or other
disposition or otherwise trading in financial instruments; (3) would
not otherwise be a banking entity except by virtue of the foreign
banking entity's acquisition or retention of an ownership interest
in, or sponsorship of, the entity; (4) is established and operated
as part of a bona fide asset management business; and (5) is not
operated in a manner that enables the foreign banking entity to
evade the requirements of section 13 or implementing regulations.
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Definition of ``Ownership Interest''
The implementing regulations prohibit a banking entity, as
principal, from directly or indirectly acquiring or retaining an
``ownership interest'' in a covered fund.\540\ The implementing
regulations define an ``ownership interest'' in a covered fund to mean
any equity, partnership, or other similar interest. Under the
implementing regulations, ``other similar interest'' is defined as an
interest that:
---------------------------------------------------------------------------
\540\ Implementing regulations Sec. __.10(a).
---------------------------------------------------------------------------
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees,
[[Page 46473]]
investment manager, investment adviser, or commodity trading advisor of
the covered fund (excluding the rights of a creditor to exercise
remedies upon the occurrence of an event of default or an acceleration
event);
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights above.\541\
---------------------------------------------------------------------------
\541\ Implementing regulations Sec. __.10(d)(6)(i).
---------------------------------------------------------------------------
The implementing regulations permit a banking entity to acquire and
retain an ownership interest in a covered fund that the banking entity
organizes and offers pursuant to Sec. __.11, but limits such ownership
interests to three percent of the total number or value of the
outstanding ownership interests of such fund (the per-fund limit).\542\
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\542\ Implementing regulations Sec. Sec. __.12(a)(1)(ii) and
__.12(a)(2)(ii)(A). The implementing regulations also require that
the aggregate value of all ownership interests of a banking entity
and its affiliates in all covered funds acquired or retained under
Sec. __.12 may not exceed three percent of the tier 1 capital of
the banking entity. Implementing regulations Sec. __.12(a)(2)(iii)
(the aggregate funds limit).
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Loan Securitizations
As discussed above, section 13 of the BHC Act provides a rule of
construction that explicitly allows the sale and securitization of
loans as otherwise permitted by law.\543\ Accordingly, the implementing
regulations exclude from the covered fund definition entities that
issue asset-backed securities if they meet specified conditions,
including that they hold only loans, certain rights and assets, and a
small set of other financial instruments (permissible assets).\544\ In
addition, the baseline includes the FAQs issued by agencies' staff in
June 2014 regarding the servicing asset provision of the loan
securitization exclusion.\545\
---------------------------------------------------------------------------
\543\ 13 U.S.C. 1851(g)(2). See also supra Section IV.B.2 (Loan
Securitizations).
\544\ See implementing regulations Sec. __.10(c)(8). Loan is
further defined as any loan, lease, extension of credit, or secured
or unsecured receivable that is not a security or derivative.
Implementing regulations rule Sec. __.2(t).
\545\ See supra Section IV.B.2 (Loan Securitizations, discussion
of servicing assets).
---------------------------------------------------------------------------
Public Welfare and SBIC Exclusions
Under the implementing regulations, issuers in the business of
making investments that are designed primarily to promote the public
welfare, of the type permitted under paragraph (11) of section 5136 of
the Revised Statutes of the United States (12 U.S.C. 24),\546\ are
excluded from the covered fund definition. Similarly, the implementing
regulations exclude from the covered fund definition small business
investment companies (SBICs) and issuers that have received notice from
the Small Business Administration to proceed to qualify for a license
as a SBIC and for which the notice or license has not been
revoked.\547\
---------------------------------------------------------------------------
\546\ See implementing regulations Sec. __.10(c)(11)(ii).
\547\ See implementing regulations Sec. __.10(c)(11)(i).
---------------------------------------------------------------------------
Attribution of Certain Investments to a Banking Entity
As discussed above, the implementing regulations include a per-fund
limit and aggregate fund limit on a banking entity's ownership of
covered funds that the banking entity organizes and offers.\548\ The
preamble to the 2013 rule stated, ``if a banking entity makes
investments side by side in substantially the same positions as a
covered fund, then the value of such investments shall be included for
purposes of determining the value of the banking entity's investment in
the covered fund.'' \549\ The agencies also stated that a banking
entity that sponsors a covered fund should not make any additional
side-by-side co-investment with the covered fund in a privately
negotiated investment unless the value of such co-investment is less
than 3% of the value of the total amount co-invested by other investors
in such investment.\550\ The 2019 amendments eliminated the aggregate
fund limit and capital deduction requirement under Sec. __.12(d) for
the value of ownership interests held by banking entities in third-
party covered funds (e.g., covered funds that those banking entities do
not organize or offer), acquired or retained as a result of certain
underwriting or market-making activities. However, the 2019 amendments
did not change or amend the application of the per-fund limit or
aggregate funds limit to co-investments alongside a covered fund.
---------------------------------------------------------------------------
\548\ See implementing regulations Sec. __.12(a). See also
supra Section IV.E.2. (Ownership Interest--Fund Limits and Covered
Fund Deduction).
\549\ 79 FR 5734.
\550\ See id.
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For purposes of calculating the aggregate fund limit and the
capital deduction requirement, the implementing regulations require
attribution to a banking entity of restricted profit interests in a
covered fund as ownership interests in the covered fund for which the
banking entity serves as investment manager, investment adviser,
commodity trading advisor, or other service provider.\551\ Under the
implementing regulations, for purposes of calculating a banking
entity's compliance with the aggregate fund limit and the capital
deduction requirement, a banking entity must include any amounts paid
by the banking entity or an employee in connection with obtaining a
restricted profit interest in the covered fund.\552\
---------------------------------------------------------------------------
\551\ Implementing regulations Sec. Sec. __.10(d)(6)(ii) and
__.12(c)(1), (d). See also 12 U.S.C. 1851(d)(1)(G).
\552\ Implementing regulations Sec. Sec. __.12(c)(1), (d).
---------------------------------------------------------------------------
ii. Affected Participants
The SEC-regulated entities directly affected by the final rule
include broker-dealers, security-based swap dealers, and investment
advisers. The implementing regulations impose a range of restrictions
and compliance obligations on banking entities with respect to their
covered fund activities and investments. To the degree that the final
rule reduces or otherwise alters the scope of private funds subject to
covered fund restrictions, SEC-registered banking entities, including
broker-dealers, security-based swap dealers, and investment advisers
may be affected.
Broker-Dealers \553\
---------------------------------------------------------------------------
\553\ This analysis is based on data from Reporting Form FR Y-9C
for domestic holding companies on a consolidated basis and Report of
Condition and Income for banks regulated by the Board, FDIC, and OCC
for the most recent available four-quarter average, as well as data
from S&P Market Intelligence LLC on the estimated amount of global
trading activity of U.S. and non-U.S. bank holding companies.
Broker-dealer bank affiliations were obtained from the Federal
Financial Institutions Examination Council's National Information
Center. Broker-dealer assets and holdings were obtained from FOCUS
Report data for Q4 2019.
---------------------------------------------------------------------------
Under the implementing regulations, some of the largest SEC-
regulated
[[Page 46474]]
broker-dealers are banking entities. Table 1 reports the number, total
assets, and holdings of broker-dealers affiliated with banks and
broker-dealers that are not.
While the 3,487 domestic broker-dealers that are not affiliated
with banks greatly outnumber the 202 banking entity broker-dealers
subject to the implementing regulations, banking entity broker-dealers
dominate non-banking entity broker-dealers in terms of total assets
(72% of total broker-dealer assets) and aggregate holdings (66% of
total broker-dealer holdings).
Table 1--Broker-Dealer Count, Assets, and Holdings by Affiliation
----------------------------------------------------------------------------------------------------------------
Holdings
Broker-dealer affiliation Number Total assets, Holdings, $mln (alternative),
$mln \554\ \555\ $mln \556\
----------------------------------------------------------------------------------------------------------------
Affected bank broker-dealers \557\.............. 202 3,240,045 777,192 607,086
Non-bank broker-dealers \558\................... 3,487 1,258,510 404,754 255,380
---------------------------------------------------------------
Total....................................... 3,689 4,498,556 1,181,946 862,466
----------------------------------------------------------------------------------------------------------------
Security-Based Swap Dealers
The final rule may also affect bank-affiliated SBSDs. As compliance
with SBSD registration requirements is not yet required, there are
currently no registered SBSDs. However, the SEC has previously
estimated that as many as 50 entities may potentially register with the
SEC as security-based swap dealers and that as many as 16 may already
be SEC-registered broker-dealers.\559\ Given the analysis of DTCC
Derivatives Repository Limited Trade Information Warehouse (TIW)
transaction and positions data on single-name credit-default swaps and
consistent with other recent SEC rulemakings, the SEC preliminarily
believes that 41 entities that may register with the SEC as SBSDs are
bank-affiliated firms, including those that are SEC-registered broker-
dealers. Therefore, the SEC preliminarily estimates that, in addition
to the bank-affiliated SBSDs that are already registered as broker-
dealers and included in the discussion above, as many as 25 other bank-
affiliated SBSDs may be affected by the final rule.\560\ Similarly, the
SEC's analysis of TIW data suggests that none of the entities that may
register with the SEC as Major Security-Based Swap Participants are
affected by the final rule.
---------------------------------------------------------------------------
\554\ Broker-dealer total assets are based on FOCUS report data
for ``Total Assets.''
\555\ Broker-dealer holdings are based on FOCUS report data for
securities and spot commodities owned at market value, including
bankers' acceptances, certificates of deposit and commercial paper,
state and municipal government obligations, corporate obligations,
stocks and warrants, options, arbitrage, other securities, U.S. and
Canadian government obligations, and spot commodities.
\556\ This alternative measure excludes U.S. and Canadian
government obligations and spot commodities.
\557\ This category includes all bank-affiliated broker-dealers
except those exempted by section 203 of EGRRCPA.
\558\ This category includes both bank affiliated broker-dealers
subject to section 203 of EGRRCPA and broker-dealers that are not
affiliated with banks or holding companies.
\559\ See Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and
Broker-Dealers, 84 FR 68550, 68607 (Dec. 16, 2019).
\560\ See id.
---------------------------------------------------------------------------
October 6, 2021 is the compliance date for the SEC's registration
rules for SBSDs, as well as several rules applicable to those entities,
including segregation requirements and non-bank capital and margin
requirements, recordkeeping and reporting requirements, business
conduct standards, and risk mitigation techniques.\561\ Accordingly,
the SEC recognizes that in anticipation of the compliance date for
registration, firms may choose to restructure their security-based swap
trading activity into (or out of) an affiliated bank or an affiliated
broker-dealer instead of registering as a standalone SBSD if bank or
broker-dealer capital and other regulatory requirements are less (or
more) costly than those that may be imposed on SBSDs under Title VII.
As a result, the above figures may overestimate or underestimate the
number of SBSDs that are not broker-dealers and that may become SEC-
registered entities affected by the final rule.
---------------------------------------------------------------------------
\561\ See Capital, Margin, and Segregation Adopting Release,
supra note 517, at 43954. See also Rule Amendments and Guidance
Addressing Cross-Border Application of Certain Security-Based Swap
Requirements, 85 FR 6270, 6345-49 (Feb. 4, 2020).
---------------------------------------------------------------------------
Private Funds and Private Fund Advisers \562\
---------------------------------------------------------------------------
\562\ These estimates are calculated from Form ADV data as of
December 31, 2019. An investment adviser is defined as a ``private
fund adviser'' for the purposes of this economic analysis if it
indicates that it is an adviser to any private fund on Form ADV Item
7.B. An investment adviser is defined as a ``banking entity RIA'' if
it indicates on Form ADV Item 6.A.(7) that it is actively engaged in
business as a bank, or it indicates on Form ADV Item 7.A.(8) that it
has a ``related person'' that is a banking or thrift institution.
For purposes of Form ADV, a ``related person'' is any advisory
affiliate and any person that is under common control with the
adviser. The definition of ``control'' for purposes of Form ADV,
which is used in identifying related persons on the form, differs
from the definition of ``control'' under the BHC Act. In addition,
this analysis does not exclude SEC-registered investment advisers
affiliated with banks that have consolidated total assets less than
or equal to $10 billion and trading assets and liabilities less than
or equal to 5% of total assets. Those banks are no longer subject to
the requirements of the 2013 rule following enactment of the
EGRRCPA. Thus, these figures may overestimate or underestimate the
number of banking entity RIAs.
---------------------------------------------------------------------------
This section describes RIAs advising private funds that may be
affected by the final rule. Using Form ADV data, Table 2 reports the
number of RIAs advising private funds by fund type as defined in Form
ADV.\563\ Private funds rely on either section 3(c)(1) or 3(c)(7) of
the Investment Company Act and so meet the implementing regulations'
definition of ``covered fund.'' Table 3
---------------------------------------------------------------------------
\563\ RIAs may also advise foreign public funds that are
excluded from the covered fund definition in the implementing
regulations, are the subject of the final rule discussed below, and
are not reported on Form ADV.
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[[Page 46475]]
reports the number and gross assets of private funds advised by RIAs
and separately reports these statistics for banking entity RIAs. As can
be seen from Table 2, the two largest categories of private funds
advised by RIAs are hedge funds and private equity funds.\564\
Banking entity RIAs advise a total of 4,387 private funds with
approximately $2.089 trillion in gross assets. From Form ADV data,
banking entity RIAs' gross private fund assets under management are
concentrated in hedge funds and private equity funds. The SEC estimates
on the basis of this data that banking entity RIAs advise 890 hedge
funds with approximately $606 billion in gross assets and 1,518 private
equity funds with approximately $466 billion in assets.
Table 2--SEC-Registered Investment Advisers Advising Private Funds by
Fund Type \565\
------------------------------------------------------------------------
Banking entity
Fund type All RIA RIA
------------------------------------------------------------------------
Hedge Funds............................. 2,620 151
Private Equity Funds.................... 1,738 96
Real Estate Funds....................... 551 51
Securitized Asset Funds................. 233 44
Venture Capital Funds................... 223 8
Liquidity Funds......................... 44 16
Other Private Funds..................... 1,060 140
-------------------------------
Total Private Fund Advisers......... 4,781 282
------------------------------------------------------------------------
Table 3--The Number and Gross Assets of Private Funds Advised by SEC-Registered Investment Advisers \566\
----------------------------------------------------------------------------------------------------------------
Number of private funds Gross assets, $bln
---------------------------------------------------------------
Fund type Banking entity Banking entity
All RIA RIA All RIA RIA
----------------------------------------------------------------------------------------------------------------
Hedge Funds..................................... 10,445 890 8,048 606
Private Equity Funds............................ 16,217 1,518 4,119 466
Real Estate Funds............................... 3,699 320 732 94
Securitized Asset Funds......................... 2,000 380 767 145
Venture Capital Funds........................... 1,387 44 174 3
Liquidity Funds................................. 76 30 304 231
Other Private Funds............................. 4,757 1,206 1,543 542
---------------------------------------------------------------
Total Private Funds......................... 38,581 4,387 15,685 2,089
----------------------------------------------------------------------------------------------------------------
In addition, the SEC's economic analysis is informed by private
fund statistics submitted by certain RIAs of private funds through Form
PF as summarized in quarterly ``Private Fund Statistics.'' \567\
---------------------------------------------------------------------------
\564\ For purposes of Form ADV, ``private equity fund'' is
defined as ``any private fund that is not a hedge fund, liquidity
fund, real estate fund, securitized asset fund, or venture capital
fund and does not provide investors with redemption rights in the
ordinary course.'' See Form ADV: Instructions for Part 1A,
Instruction 6. For purposes of Form ADV, ``hedge fund'' is defined
as ``any private fund (other than a securitized asset fund): (a)
With respect to which one or more investment advisers (or related
persons of investment advisers) may be paid a performance fee or
allocation calculated by taking into account unrealized gains (other
than a fee or allocation the calculation of which may take into
account unrealized gains solely for the purpose of reducing such fee
or allocation to reflect net unrealized losses); (b) that may borrow
an amount in excess of one-half of its net asset value (including
any committed capital) or may have gross notional exposure in excess
of twice its net asset value (including any committed capital); or
(c) that may sell securities or other assets short or enter into
similar transactions (other than for the purpose of hedging currency
exposure or managing duration).
\565\ This table includes only the advisers that list private
funds on section 7.B.(1) of Form ADV. The number of advisers in the
``Total Private Fund Advisers'' row is not the sum of the rows that
precede it since an adviser may advise multiple types of private
funds. Each listed private fund type (e.g., real estate funds and
liquidity funds) is defined in Form ADV, and those definitions are
the same for purposes of the SEC's Form PF.
\566\ Gross assets include uncalled capital commitments on Form
ADV. The large decrease in Gross assets for Liquidity Funds from
that reported in the proposing release is due, in part, to the
removal of certain Form ADV data from one filer that contained an
erroneous value for gross assets.
\567\ See U.S. Sec. and Exchange Comm'n, Div. of Inv. Mgmt.
Analytics Office, Private Fund Statistics, Third Calendar Quarter
2019 (May 14, 2020), available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2019-q3-accessible.pdf. Statistics for preceding quarters are available
at https://www.sec.gov/divisions/investment/private-funds-statistics.shtml.
---------------------------------------------------------------------------
Registered Investment Companies and Business Development Companies
The baseline also reflects the potential that a RIC or a BDC would
be treated as a banking entity where the RIC or BDC's sponsor is a
banking entity that holds 25% or more of the RIC or BDC's voting
securities after a seeding period.\568\ On the basis of SEC filings and
public data, the SEC estimates that, as of December 2019, there were
approximately 15,300 RICs \569\ and 101 BDCs. Although RICs and BDCs
are generally not themselves banking entities subject to the
implementing regulations, they may be indirectly affected by the
implementing regulations and the final rule, for example, if their
sponsors or advisers are banking entities. For instance, bank-
affiliated RIAs or their affiliates may reduce their level of
investment in the RICs or BDCs they advise, or potentially close those
funds, to eliminate the risk of those funds becoming banking entities
themselves.
---------------------------------------------------------------------------
\568\ See, e.g., 2019 amendments, 84 FR 61979.
\569\ This estimate includes open-end companies, exchange-traded
funds, closed-end funds, and non-insurance unit investment trusts
and does not include fund of funds. The inclusion of fund of funds
increases this estimate to approximately 16,800.
---------------------------------------------------------------------------
Small Business Investment Companies
Small business investment companies are generally ``privately owned
and managed investment funds, licensed and regulated by the Small
Business Administration (SBA), that use their own capital plus funds
borrowed with
[[Page 46476]]
an SBA guarantee to make equity and debt investments in qualifying
small businesses.'' \570\ The final rule provides relief with respect
to banking entity investments in SBICs during the wind-down process by
excluding from the definition of ``covered fund'' those SBICs.\571\
While the SEC does not have data to quantify the number of SBICs
undergoing wind-down, trends in the number of SBIC licenses can be
indicative of the turnover in the total number of SBIC licensees. For
example, according to SBA data, there were 295 SBIC licensees as of
March 31, 2020 \572\ and 299 SBIC licensees as of December 31,
2019.\573\ By contrast, as of September 30, 2017, there were 315 SBICs
licensed by the SBA.\574\
---------------------------------------------------------------------------
\570\ See U.S. Small Bus. Admin., SBIC Program Overview,
available at https://www.sba.gov/content/sbic-program-overview.
For purposes of the Advisers Act, an SBIC is (other than an
entity that has elected to be regulated or is regulated as a
business development company pursuant to section 54 of the
Investment Company Act of 1940): (A) A small business investment
company that is licensed under the Small Business Investment Act of
1958, (B) an entity that has received from the Small Business
Administration notice to proceed to qualify for a license as a small
business investment company under the Small Business Investment Act
of 1958, which notice or license has not been revoked, or (C) an
applicant that is affiliated with 1 or more licensed small business
investment companies described in subparagraph (A) and that has
applied for another license under the Small Business Investment Act
of 1958, which application remains pending. 15 U.S.C. 80b-3(b)(7).
\571\ Specifically, the final rule excludes from the definition
of ``covered fund'' any SBIC that has voluntarily surrendered its
license to operate as an SBIC in accordance with 13 CFR 107.1900 and
does not make any new investments (with some exceptions) after such
voluntary surrender. See Sec. __.10(c)(11)(i).
\572\ See U.S. Small Bus. Admin., SBIC Program Overview as of
March 31, 2020, available at: https://www.sba.gov/sites/default/files/2020-05/SBIC%20Quarterly%20Report%20as%20of%
20March_31_2020%20Amended%205.14.2020.pdf.
\573\ See U.S. Small Bus. Admin., SBIC Program Overview as of
December 31, 2019, available at https://www.sba.gov/sites/default/files/2020-02/SBIC%20Quarterly%20Report%20as%20of%20December_31_2019.pdf.
\574\ See id.
---------------------------------------------------------------------------
The final rule includes an exclusion for rural business investment
companies (RBICs) from the implementing regulations similar to that
provided to SBICs.\575\ As the SEC has discussed elsewhere,\576\ an
RBIC is defined in section 384A of the Consolidated Farm and Rural
Development Act as a company that is approved by the Secretary of
Agriculture and that has entered into a participation agreement with
the Secretary.\577\ Because SBICs and RBICs share the common purpose of
promoting capital formation in their respective sectors, advisers to
SBICs and RBICs are treated similarly under the Advisers Act in that
they have the opportunity to take advantage of expanded exemptions from
investment adviser registration.\578\ As of August 2019, there were 5
RBICs who were licensed by the USDA managing approximately $352 million
in assets.\579\
---------------------------------------------------------------------------
\575\ Under the implementing regulations, an SBIC is excluded
from the ``covered fund'' definition. See implementing regulations
Sec. __.10(c)(11)(i).
\576\ See Exemptions from Investment Adviser Registration for
Advisers to Certain Rural Business Investment Companies, 85 FR 13734
(Mar. 10, 2020) (``RBIC Investment Adviser Adopting Release'').
\577\ See the RBIC Advisers Relief Act of 2018, Public Law 115-
417, 132 Stat. 5438 (2019) (the ``RBIC Advisers Relief Act''). To be
eligible to participate as an RBIC, the company must be a newly
formed for-profit entity or a newly formed for-profit subsidiary of
such an entity, have a management team with experience in community
development financing or relevant venture capital financing, and
invest in enterprises that will create wealth and job opportunities
in rural areas, with an emphasis on smaller enterprises. See 7
U.S.C. 2009cc-3(a).
\578\ Following enactment of the RBIC Advisers Relief Act, supra
note 577, advisers to solely RBICs and advisers to solely SBICs are
exempt from investment adviser registration pursuant to Advisers Act
sections 203(b)(8) and 203(b)(7), respectively. The venture capital
fund adviser exemption deems RBICs and SBICs to be venture capital
funds for purposes of the registration exemption 15 U.S.C. 80b-3(l).
Accordingly, the exclusion for certain venture capital funds
discussed below (see infra text accompanying notes 672 and 673)
which require that a fund be a venture capital fund as defined in
the SEC regulations implementing the registration exemption, could
include RBICs and SBICs to the extent that they satisfy the other
elements of the exclusion.
\579\ See RBIC Investment Adviser Adopting Release, supra note
576.
---------------------------------------------------------------------------
The Tax Cuts and Jobs Act established the ``opportunity zone''
program to provide tax incentives for long-term investing in designated
economically distressed communities.\580\ The program allows taxpayers
to defer and reduce taxes on capital gains by reinvesting gains in
``qualified opportunity funds'' (QOFs) that are required to have at
least 90 percent of their assets in designated low-income zones.\581\
In this regard, QOFs are similar to SBICs and public welfare companies.
The final rule provides relief to QOFs from the implementing
regulations that is similar to the relief provided to SBICs.\582\ SEC
staff is not aware of an official source for data regarding QOFs that
are available for investment, but some private firms collect and report
such data. One such firm reports that, as of April 2020, there were 406
QOFs that report raising $10.09 billion in equity, and have a
fundraising goal of $31.89 billion.\583\
---------------------------------------------------------------------------
\580\ Tax Cuts and Jobs Act of 2017, Public Law 115-97, 131
Stat. 2054 (2017).
\581\ See U.S. Sec. and Exchange Comm'n & NASAA, Staff Statement
on Opportunity Zones: Federal and State Securities Laws
Considerations, available at https://www.sec.gov/2019_Opportunity-Zones_FINAL_508v2.pdf (``Opportunity Zone Statement'').
\582\ See supra note 575.
\583\ As reported by Novogradac, a national professional
services organization that collects and reports information on QOFs.
See https://www.novoco.com/resource-centers/opportunity-zone-resource-center/opportunity-funds-listing.
---------------------------------------------------------------------------
3. Costs and Benefits
Section 13 of the BHC Act generally prohibits banking entities from
acquiring or retaining an ownership interest in, sponsoring, or having
certain relationships with covered funds, subject to certain
exemptions.\584\ The SEC's economic analysis concerns the potential
costs, benefits, and effects on efficiency, competition, and capital
formation of the final rule for five groups of market participants.
First, the final rule may impact SEC-registered investment advisers
that are banking entities, including those that sponsor or advise
covered funds and those that do not, as well as SEC-registered
investment advisers that are not banking entities that sponsor or
advise covered funds and compete with banking entity RIAs. Second, the
final rule permits dealers greater flexibility in providing services to
more types of funds since dealers can provide a broader array of
services to funds that would be excluded from the covered fund
definition. Third, banking entities that are broker-dealers or RIAs may
enjoy reduced uncertainty and greater flexibility in making direct
investments alongside covered funds. Fourth, the final rule may impact
private funds and other vehicles, including those entities scoped in or
out of the covered fund provisions of the implementing regulations, as
well as private funds competing with such funds. One such impact may be
seen to the extent that the final rule permits banking entities to
provide a full range of traditional customer-facing banking and asset
management services to certain entities, such as customer facilitation
vehicles and family wealth management vehicles. Fifth, to the extent
that the final rule impacts efficiency, competition, and capital
formation in covered funds or underlying securities, investors in, and
sponsors of, covered funds and underlying securities and issuers may be
affected as well.
---------------------------------------------------------------------------
\584\ See 12 U.S.C. 1851.
---------------------------------------------------------------------------
As discussed below, the agencies carefully considered the competing
effects that could potentially result from the final rule and
alternatives. For example, the final rule could result in enhanced
competition among, and capital formation driven by, entities that would
be treated as covered funds under the implementing regulations.
[[Page 46477]]
The final rule could also potentially increase (or decrease) financial
and other risks posed by the ability to make investments in covered
funds in addition to or in lieu of direct investments; however, the
agencies have sought to mitigate the potential for increased risk and
other concerns by imposing various conditions on the exclusions
designed to address such risks.
In addition, to the extent that the covered fund provisions of the
implementing regulations limit fund formation, the final rule could
provide a greater ability for banking entities to organize funds and
attract capital from third party investors. This could increase
revenues for banking entities while reducing long-term compliance
costs; increase the availability of venture, credit, and other
financing, including for small businesses and start-ups; and, as a
result, increase capital formation. The SEC is not currently aware of
any information or data that would allow a quantification of the extent
to which the covered fund provisions of the implementing regulations
are inhibiting capital formation via funds. Therefore, the bulk of the
analysis below is necessarily qualitative. To the extent that the
covered fund provisions of the implementing regulations limit alignment
of interests between banking entities and their clients, customers, or
counterparties, and to the extent the final rule alters the alignment
of interests, the final rule could have a positive or negative effect
on conflict of interest concerns.
The final rule creates new recordkeeping requirements and revise
certain disclosure requirements. Specifically, a banking entity may
only rely on the exclusion for customer facilitation vehicles if the
banking entity and its affiliates maintain documentation outlining how
the banking entity intends to facilitate the customer's exposure to a
transaction, investment strategy or service provided by the banking
entity. As discussed above in Section V.B. (Paperwork Reduction Act)
\585\ and discussed further below, these new recordkeeping burdens may
impose an initial burden of $1,078,650 \586\ and an ongoing annual
burden of $1,078,650.\587\ In addition, under certain circumstances, a
banking entity must make certain disclosures with respect to an
excluded credit fund, venture capital fund, family wealth vehicle, or
customer facilitation vehicle, as if the entity were a covered fund. As
discussed above in Section V.B, these disclosure requirements may
impose an initial burden of $53,933 \588\ and an ongoing burden of
$1,402,245.\589\
---------------------------------------------------------------------------
\585\ For the purposes of the burden estimates in this release,
we are assuming the cost of $423 per hour for an attorney, from
SIFMA's Management and Professional Earnings in the Securities
Industry 2013 (available at https://www.sifma.org/resources/research/management-and-professional-earnings-in-the-securities-industry-2013/), modified to account for an 1800-hour work year and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead, and adjusted for inflation.
\586\ In the 2019 amendments, amendments that sought, among
other things, to provide greater clarity and certainty about what
activities were prohibited by the 2013 rule--in particular, under
the prohibition on proprietary trading--and to better tailor the
compliance requirements to the risk of a banking entity's
activities, banking entity PRA-related burdens were apportioned to
SEC-regulated entities on the basis of the average weight of broker-
dealer assets in holding company assets. See 2019 amendments, 84 FR
62074. The SEC believes that such an approach would be inappropriate
for the PRA-related burdens associated with the final rule because
we do not have a comparable proxy for an investment adviser's
significance within the holding company. Since we do not have
sufficient information to determine the extent to which the costs
associated with any of the new recordkeeping and disclosure
requirements would be borne by SEC registrants specifically, we
report the entire burden estimated based on information in supra
Section V.B (Paperwork Reduction Act).
Initial recordkeeping burdens: (10 hours) x (255 entities) x
(Attorney at $423 per hour) = $1,078,650.
\587\ Annual recordkeeping burdens: (10 hours) x (255 entities)
x (Attorney at $423 per hour) = $1,078,650.
\588\ Initial recordkeeping burdens: (0.5 hours) x (255
entities) x (Attorney at $423 per hour) = $53,933.
\589\ Annual recordkeeping burdens: (0.5 hours) x (255 entities)
x (26 disclosures per year) x (Attorney at $423 per hour) =
$1,402,245.
---------------------------------------------------------------------------
The sections that follow discuss how each of the amendments in the
final rule change the implementing regulations, and the anticipated
costs and benefits of the amendments, subject to the caveat that not
all anticipated costs and benefits can be meaningfully quantified.\590\
---------------------------------------------------------------------------
\590\ See supra Section V.F.1.iii. (SEC Economic Analysis--
Analytical Approach).
---------------------------------------------------------------------------
i. Amendments Related to Specific Types of Funds
As discussed above, the final rule modifies a number of the
provisions of the implementing regulations related to the treatment of
certain types of funds (e.g., credit funds, family wealth management
vehicles, small business investment companies, qualifying venture
capital funds, customer facilitation vehicles, foreign excluded funds,
foreign public funds, and loan securitizations).\591\
---------------------------------------------------------------------------
\591\ See supra Section IV. (Summary of the Final Rule).
---------------------------------------------------------------------------
Broadly, such modifications reduce the number and types of funds
that are within the scope of the implementing regulations, impacting
the economic effects of section 13 of the BHC Act and the implementing
regulations.\592\
---------------------------------------------------------------------------
\592\ See, e.g., 2019 amendments, 84 FR 62037-92.
---------------------------------------------------------------------------
Form ADV data is not sufficiently granular to allow the SEC to
estimate the number of funds and fund advisers affected by the
exclusions from the covered fund definition added or modified by the
final rule and other relief addressed by the final rule. However, Table
2 and Table 3 in the economic baseline quantify the number and asset
size of private funds advised by banking entity RIAs by the type of
private fund they advise, as those fund types are defined in Form
ADV.\593\
---------------------------------------------------------------------------
\593\ These fund types include hedge funds, private equity
funds, real estate funds, securitized asset funds, venture capital
funds, liquidity, and other private funds. See supra note 564.
---------------------------------------------------------------------------
Using Form ADV data, the SEC estimates that approximately 151
banking entity RIAs advise hedge funds and 96 banking entity RIAs
advise private equity funds (as those terms are defined in Form
ADV).\594\ As can be seen from Table 2 in the economic baseline, 44
banking entity RIAs advise securitized asset funds. Table 3 shows that
banking entity RIAs advise 380 securitized asset funds with $145
billion in gross assets. Another 51 banking entity RIAs advise real
estate funds, and banking entity RIAs advise 320 real estate funds with
$94 billion in gross assets. Venture capital funds are advised by only
8 banking entity RIAs, and all 44 venture capital funds advised by
banking entity RIAs have in aggregate approximately $3 billion in gross
assets.
---------------------------------------------------------------------------
\594\ As noted in the economic baseline, a single RIA may advise
multiple types of funds. See supra note 565.
---------------------------------------------------------------------------
As noted elsewhere, the covered fund provisions of the implementing
regulations may limit the ability of banking entities to use covered
funds to circumvent the proprietary trading prohibition, reduce bank
incentives to bail out their covered funds, and mitigate conflicts of
interest between banking entities and their clients, customers, or
counterparties. As discussed in the 2020 proposal, the implementing
regulations may limit the ability of banking entities to conduct
traditional asset management activities and reduce the availability of
capital by imposing significant costs on some banking entities without
providing commensurate benefits.\595\ Moreover, the 2013 rule's
limitations on banking entities' investment in covered funds may be
more significant for certain covered funds that are typically small in
size such as many venture capital funds, with potentially more negative
spillover
[[Page 46478]]
effects on capital formation in the types of underlying securities in
which these types of funds invest.\596\
---------------------------------------------------------------------------
\595\ See 85 FR 12164.
\596\ See id.
---------------------------------------------------------------------------
The final rule could reduce the scope of funds that need to be
analyzed for covered fund status or could simplify this analysis and
enable banking entities to own, sponsor, and have relationships with
the types of entities that the final rule excludes from the covered
fund definition. Accordingly, the final rule may reduce costs of
banking entity ownership in, sponsorship of, and transactions with
certain funds; may promote greater capital formation in, and
competition among such funds; and may improve access to capital for
issuers of the underlying debt or equity that those funds may purchase.
The final rule may also benefit banking entity dealers through
higher profits or greater demand for derivatives, margin, payment,
clearing, and settlement services. Reducing restrictions on banking
entities by further tailoring the covered fund definition may encourage
more launches of funds that are excluded from the definition, capital
formation and, possibly, competition in those types of funds. If
competition increases the quality of funds available to investors or
reduces the fees funds charge, investors in funds may benefit.
Moreover, to the degree that the final rule may increase the spectrum
of funds available to investors, the final rule may relax constraints
around investor portfolio optimization and increase the efficiency of
capital allocation.
The SEC received comments from a diverse set of commenters.
Comments from banking entities and financial services industry trade
groups were generally supportive of the proposal, although many
recommended additional modifications.\597\ There were also several
organizations and individuals that were generally opposed to the 2020
proposal.\598\ The sections that follow further discuss the economic
costs, benefits, and effects on competition, efficiency, and capital
formation with respect to specific types of funds and specific
amendments in the final rule.
---------------------------------------------------------------------------
\597\ See supra Section IV. (Summary of the Final Rule) for
discussion of comments and recommendations for each of the proposed
amendments.
\598\ See id.
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Foreign Excluded Funds
Under the baseline, foreign excluded funds are excluded from the
covered fund definition, but could be considered banking entities if a
foreign banking entity controls the foreign fund in certain
circumstances.\599\ As discussed above, the policy statement released
by Federal banking agencies provides that the Federal banking agencies
would not propose to take action (1) against a foreign banking entity
based on attribution of the activities and investments of a qualifying
foreign excluded fund to the foreign banking entity \600\ or (2)
against a qualifying foreign excluded fund as a banking entity, in each
case where the foreign banking entity's acquisition or retention of any
ownership interest in, or sponsorship of, the qualifying foreign
excluded fund would meet the requirements for permitted covered fund
activities and investments solely outside the United States, as
provided in section 13(d)(1)(I) of the BHC Act and Sec. __.13(b) of
the implementing regulations, as if the qualifying foreign excluded
fund were a covered fund.\601\ As in the 2020 proposal, the final rule
provides a permanent exemption from the proprietary trading and covered
fund prohibitions for certain foreign excluded funds that is
substantively similar to the relief currently provided to qualifying
foreign excluded funds by the policy statement.\602\
---------------------------------------------------------------------------
\599\ See supra Section IV.A. (Qualifying Foreign Excluded
Funds).
\600\ Foreign banking entity was defined for purposes of the
policy statement to mean a banking entity that is not, and is not
controlled directly or indirectly by, a banking entity that is
located in or organized under the laws of the United States or any
State.
\601\ See supra note 26. The policy statement was subsequently
extended for a two-year period ending on July 21, 2021. See also
supra Section IV.A. (Qualifying Foreign Excluded Funds) and note 28.
\602\ See final rule Sec. Sec. __.6(f) and __.13(d).
---------------------------------------------------------------------------
Commenters were generally supportive of the proposal to exempt
qualifying foreign excluded funds from certain requirements of the
rule.\603\ Two commenters expressed opposition to the proposed
exemption.\604\
---------------------------------------------------------------------------
\603\ SIFMA; BPI; BVI; AIC; ABA; EFAMA; SAF; IIB; JBA; CBA; and
Credit Suisse. See also supra Section IV.A. (Qualifying Foreign
Excluded Funds) for a discussion of individual comments.
\604\ See Occupy and Data Boiler.
---------------------------------------------------------------------------
The SEC recognizes that failing to exclude such funds from the
definition of ``banking entity'' in the implementing regulations
imposed proprietary trading restrictions, covered fund prohibitions,
and compliance obligations on qualifying foreign excluded funds that
may be more burdensome than the requirements that would apply under the
implementing regulations to covered funds.
The SEC believes that, absent the qualifying foreign excluded fund
exemption and upon expiry of the policy statement, the implementing
regulations may have significant adverse effects on foreign banking
entities' ability to organize and offer certain private funds for
foreign investments, disrupting foreign asset management activities.
The SEC recognizes that the exemption of qualifying foreign excluded
funds from the proprietary trading and covered fund prohibitions that
apply to ``banking entities'' may result in increased activity by
foreign banking entities in organizing and offering such funds, and
that such activity may involve risk for those banking entities. At the
same time, the SEC recognizes a statutory purpose of certain portions
of section 13 of the BHC Act is to limit the extraterritorial impact on
foreign banking entities.\605\ Accordingly, the final rule may benefit
foreign banking entities and their foreign counterparties seeking to
transact with and through such funds.
---------------------------------------------------------------------------
\605\ See 85 FR 12123-26.
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The agencies received comments on the 2020 proposal that expressed
concern that although qualifying foreign excluded funds would be
exempted from the proprietary trading and covered funds restrictions of
the implementing regulations, these funds would still be required to
put in place compliance programs.\606\ However, since these qualifying
foreign excluded funds are exempted from the proprietary trading
requirements of Sec. __.3(a) and covered fund restrictions of Sec.
__.10(a), the agencies believe that requiring compliance programs to be
established for the qualifying foreign excluded fund itself would be
overly burdensome and unnecessary. Therefore, under the final rule, in
addition to the proposed exemptions from the proprietary trading and
covered fund prohibitions, qualifying foreign excluded funds will also
not be required to have compliance programs under Sec. __.20. However,
any banking entity that owns or sponsors a qualifying foreign excluded
fund will still be required to have in place the appropriate compliance
programs as required by Sec. __.20.
---------------------------------------------------------------------------
\606\ See IIB; JBA; CBA; EBF; and Credit Suisse.
---------------------------------------------------------------------------
The exemption is also expected to promote capital formation in the
United States. While qualifying foreign excluded funds have a limited
nexus to the United States, such funds are permitted to invest in U.S.
companies. Therefore, to the extent that these funds have any direct
impact on capital formation and U.S. financial stability, the exemption
would promote U.S. financial stability by providing additional capital
and liquidity to U.S. capital markets without a concomitant increase in
risk borne by U.S. banking entities.
[[Page 46479]]
The final rule may increase the incentive for some foreign banking
entities seeking to organize and offer qualifying foreign excluded
funds to reorganize their activities so that these funds' activities
qualify for the exemptions. The costs and feasibility of such
reorganization will depend on the complexity and existing compliance
structures for banking entities, the degree to which there is unmet
demand for investment funds that may be organized as qualifying foreign
excluded funds, and the profitability of such banking activities.
Importantly, the principal risk of foreign banking entities' activities
related to foreign excluded funds generally resides outside the United
States. As discussed above,\607\ because the exemption requires that
the foreign banking entity's acquisition of an ownership interest in or
sponsorship of the fund meets the requirements in Sec. __.13(b) of the
final rule, the exemption will help to ensure that the risks of the
investments made by these foreign funds would be booked to foreign
entities in foreign jurisdictions. The agencies believe that exempting
the activities of qualifying foreign excluded funds promotes and
protects the safety and soundness of banking entities and U.S.
financial stability,\608\ and relatedly the SEC believes the exemption
is unlikely to impact negatively SEC registrants.
---------------------------------------------------------------------------
\607\ See supra Section IV.A. (Qualifying Foreign Excluded
Funds).
\608\ See id.
---------------------------------------------------------------------------
Foreign Public Funds
The implementing regulations exclude from the covered fund
definition any foreign public fund that satisfies three sets of
conditions. First, the issuer must be organized or established outside
of the United States, be authorized to offer and sell ownership
interests to retail investors in the issuer's home jurisdiction (the
``home jurisdiction'' requirement), and sell ownership interests
predominantly through one or more public offerings outside of the
United States. The agencies stated in the preamble to the 2013 rule
that they generally expect that an offering is made predominantly
outside of the United States if 85 percent or more of the fund's
interests are sold to investors that are not residents of the United
States.\609\ Second, for funds that are sponsored by a U.S. banking
entity, or by a banking entity controlled by a U.S. banking entity, the
ownership interests in the issuer must be sold ``predominantly'' to
persons other than the sponsoring banking entity, the issuer, their
affiliates, directors of such entities, or employees of such entities
(the sales limitation). The agencies stated in the preamble to the 2013
rule that, consistent with the agencies' view concerning whether a
foreign public fund has been sold predominantly outside of the United
States, the agencies generally expect that a foreign public fund would
satisfy this additional condition if 85 percent or more of the fund's
interests are sold to persons other than the sponsoring U.S. banking
entity and the specified persons connected to that banking entity.\610\
Third, such public offerings must occur outside the United States, must
comply with applicable jurisdictional requirements (the compliance
obligation), may not restrict availability to investors having a
minimum level of net worth or net investment assets, and must have
publicly available offering disclosure documents filed or submitted
with the relevant jurisdiction.
---------------------------------------------------------------------------
\609\ 79 FR 5678.
\610\ Id.
---------------------------------------------------------------------------
The final rule makes several changes to the foreign public fund
exclusion. First, the final rule removes the home jurisdiction
requirement.\611\ Second, the final rule makes the exclusion available
with respect to issuers authorized to offer and sell ownership
interests through one or more public offerings, removing the
requirement that the issuer sells ownership interests ``predominantly''
through such public offerings.\612\ Third, the agencies are also
modifying the definition of ``public offering'' from the implementing
regulations to add a new requirement that the distribution is subject
to substantive disclosure and retail investor protection laws or
regulations in one or more jurisdictions where ownership interests are
sold.\613\ Fourth, the final rule applies the compliance obligation
only in instances in which the banking entity serves as the investment
manager, investment adviser, commodity trading advisor, commodity pool
operator, or sponsor.\614\ Finally, the final rule narrows the sales
limitation to the sponsoring banking entity, the issuer, affiliates,
and directors and senior executive officers of such entities, and
requires more than 75 percent of the fund's interest to be sold to such
entities and persons.\615\
---------------------------------------------------------------------------
\611\ See final rule Sec. __.10(c)(1)(i)(B).
\612\ See final rule Sec. __.10(c)(1)(i)(B).
\613\ See final rule Sec. __.10(c)(1)(iii)(A).
\614\ See final rule Sec. __.10(c)(1)(iii)(B).
\615\ See final rule Sec. __.10(c)(1)(ii).
---------------------------------------------------------------------------
As discussed in the 2020 proposal, the SEC has received comments
indicating that the foreign public fund exclusion under the
implementing regulations is impractical, overly narrow, and
prescriptive, and results in competitive disparities between foreign
public funds and RICs.\616\ The SEC also received comment that the home
jurisdiction requirement under the implementing regulations is narrow
and fails to recognize the prevalence of non-U.S. retail funds
organized in one jurisdiction and authorized to sell interests in other
jurisdictions.\617\
---------------------------------------------------------------------------
\616\ See 85 FR 12166.
\617\ Such funds could be organized in a particular jurisdiction
for reasons including tax treatment, investment strategy, or
flexibility to distribute into multiple markets (for instance, in
the European Union), even though such funds are authorized to sell
interests in other jurisdictions. See also id.
---------------------------------------------------------------------------
As adopted in the final rule, the elimination of the home
jurisdiction requirement may benefit such foreign public funds and may
facilitate greater capital formation through such funds, with the
potential to create more capital allocation choices for investors. To
the degree that the implementing regulations have disadvantaged foreign
public funds relative to otherwise comparable RICs, the elimination of
the home jurisdiction requirement may dampen such competitive
disparities.
As also discussed in the 2020 proposal, the SEC has received
comment that the requirement that ownership interests be sold
``predominantly'' through one or more public offerings outside of the
United States has been burdensome and poses significant compliance
burdens.\618\ For example, banking entities may not fully observe and
predict both historical and potential future distributions of funds
that are sponsored by third parties, listed on exchanges, or sold
through third-party intermediaries or distributors.\619\ In response to
the 2020 proposal, commenters supported the elimination of the home
jurisdiction requirement and the requirement that the fund be sold
predominantly through one or more public offerings.\620\
---------------------------------------------------------------------------
\618\ See 85 FR 12166.
\619\ See id.
\620\ IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; and CBA.
See also supra Section IV.B.1. (Foreign Public Funds).
---------------------------------------------------------------------------
To the degree that some banking entities restrict their activities
because they are unable to quantify the volumes of distributions
through foreign public offerings relative to, for instance, foreign
private placements, the final rule may enable greater activity by
banking entities relating to foreign public funds. Similar to the above
discussion, this aspect of the final rule also treats foreign public
funds in a manner more similar to RICs (which are not required to
[[Page 46480]]
monitor or assess distributions), with corresponding competitive
effects.
Commenters on the 2020 proposal also supported the proposed change
to the ``public offering'' definition to include a requirement that the
distribution be subject to substantive disclosure and retail investor
protection laws or regulations.\621\ The final rule adopts that change,
as proposed. Accordingly, the final rule tailors the scope of
disclosure and compliance obligations for those jurisdictions where
ownership interests are sold in recognition of the prevalence of
foreign retail fund sales across jurisdictions. Similarly, the final
rule limits the compliance obligation to settings in which the banking
entity serves as the investment manager, investment adviser, commodity
trading advisor, commodity pool operator, or sponsor--settings that may
involve greater conflicts of interest between banking entities and fund
investors than when the banking entity is only an investor in the fund.
---------------------------------------------------------------------------
\621\ IIB; EFAMA; FSF; ICI; and BVI.
---------------------------------------------------------------------------
The final rule also replaces the employee sales limitation with a
limitation on sales to senior executive officers.\622\ As discussed in
the 2020 proposal, the SEC has received comment that banking entities
may face significant costs and logistical and interpretive challenges
monitoring investments by their employees, including those who transact
in fund shares through unaffiliated brokers or through independent
exchange trading.\623\ The SEC has also received comment that the
employee sales limitation serves no discernible anti-evasion
purpose.\624\ In addition, commenters noted that employee ownership
interest can be a meaningful mechanism of promoting incentive
alignment.\625\ The final rule replaces the employee sales limitation
with a corresponding sales limitation with respect only to senior
executive officers. This change may reduce these reported compliance
challenges and burdens while preserving, in part, the original anti-
evasion purpose of the limitations on employee ownership.
---------------------------------------------------------------------------
\622\ Final rule Sec. __.10(c)(1)(ii)(D).
\623\ See 85 FR 12166.
\624\ See id.
\625\ See id.
---------------------------------------------------------------------------
The SEC received comments to the 2020 proposal that recommended the
agencies modify their expectation of the level of ownership of a
foreign public fund that would satisfy the requirement that a fund be
``predominantly'' sold to persons other than its U.S. banking entity
sponsor and associated parties,\626\ which the preamble to the 2013
rule stated was 85 percent or more (which would permit the U.S. banking
entity sponsor and associated parties to own the remaining 15 percent).
These commenters asserted that the relevant ownership threshold for
U.S. registered investment companies is 25 percent, and that, for
foreign public funds, the threshold should be the same. The agencies
agree that the permitted ownership level of a foreign public fund by a
U.S. banking entity sponsor and associated parties should be aligned
with the functionally equivalent threshold for banking entity
investments in U.S. registered investment companies, which is 24.9
percent.\627\ Accordingly, the agencies have amended this provision in
the final rule to require that more than 75 percent of a foreign public
fund's interests must be sold to persons other than the U.S. banking
entity sponsor and associated parties.\628\
---------------------------------------------------------------------------
\626\ BPI; FSF; ICI; and CCMC. See also supra Section IV.B.1.
(Foreign Public Funds).
\627\ Although the implementing regulations do not explicitly
prohibit a banking entity from acquiring 25 percent or more of a
U.S. registered investment company, a U.S. registered investment
company would become a banking entity if it is affiliated with
another banking entity (other than as described in Sec.
__.12(b)(1)(ii) of the implementing regulations). See 79 FR 5732
(``[F]or purposes of section 13 of the BHC Act and the final rule, a
registered investment company . . . will not be considered to be an
affiliate of the banking entity if the banking entity owns,
controls, or holds with the power to vote less than 25 percent of
the voting shares of the company or fund, and provides investment
advisory, commodity trading advisory, administrative, and other
services to the company or fund only in a manner that complies with
other limitations under applicable regulation, order, or other
authority.'').
\628\ See supra note 69.
---------------------------------------------------------------------------
Commenters on the 2020 proposal generally supported the proposed
changes to the foreign public funds exclusion; \629\ however, as
discussed in this section and above, the agencies are making certain
targeted adjustments in response to comments received.\630\ One
commenter stated that the proposed changes were less than ideal for
maximum control but acceptable from a practical implementation
standpoint to balance compliance costs and benefits.\631\
---------------------------------------------------------------------------
\629\ IIB; SIFMA; BPI; ABA; EBF; EFAMA; FSF; ICI; BVI; CBA;
CCMR; Data Boiler; GS; IAA; JBA; SAF; and CCMC.
\630\ See supra Section IV.B.1. (Foreign Public Funds).
\631\ See Data Boiler.
---------------------------------------------------------------------------
As discussed above, the SEC believes that the foreign public fund
provisions of the final rule may facilitate greater capital formation
through such funds, with the potential to create more capital
allocation choices for investors. In particular, to the degree that
some banking entities restrict their activities relating to foreign
public funds because they are unable to quantify the distributions
through public offerings or determine the holdings of their employees,
the final rule may enable greater activity by banking entities relating
to foreign public funds. The final rule also limits the compliance
obligation to settings in which the banking entity serves as the
investment manager, investment adviser, commodity trading advisor,
commodity pool operator, or sponsor--settings that may involve greater
conflicts of interest between banking entities and fund investors than
when the banking entity is only an investor in the fund.
The agencies could have adopted a variety of alternatives offering
more or less relief with respect to foreign public funds. For example,
the agencies could have eliminated altogether the limit on sales to
affiliated entities, directors and employees, which would have provided
an even greater alignment of treatment between foreign public funds and
RICs.\632\ Alternatives providing greater relief with respect to
foreign public funds may have facilitated greater banking entity
activity and intermediation of such funds on the one hand, but they may
also have strengthened the competitive positioning of foreign public
funds relative to U.S. registered funds. Moreover, providing greater
relief with respect to foreign public funds may have allowed banking
entities greater flexibility in the formation and operation of foreign
public funds, but may also have increased the risk that banking
entities would be able to use foreign public funds to engage in
activities that the restrictions on covered funds were intended to
prohibit, thereby reducing the magnitude of the expected economic
benefits of section 13 of the BHC Act and the implementing regulations.
Similarly, relative to the final rule, alternatives providing less
relief with respect to foreign public funds may have strengthened the
competitive positioning of U.S. RICs relative to foreign public funds
and posed lower compliance or evasion risks, but may also have reduced
the benefits of the relief for capital formation in foreign public
funds and their investors.
---------------------------------------------------------------------------
\632\ See 2020 proposal at 12166.
---------------------------------------------------------------------------
Loan Securitizations
The 2013 rule excludes from the definition of covered fund any loan
securitization that issues asset-backed securities, holds only loans,
certain
[[Page 46481]]
rights and assets that arise from the structure of the loan
securitization or from the loans supporting a loan securitization, and
a small set of other financial instruments (permissible assets), and
meets other criteria.\633\ As discussed in the 2020 proposal, the SEC
received comment that, as a result of the 2013 rule, some banking
entities may have divested or restructured their interests in loan
securitizations due to the narrowly-drawn conditions of the exclusion,
and that a limited holding of non-loan assets may enable banking
entities to provide traditional securitization products and services
demanded by customers, clients, and counterparties.\634\
---------------------------------------------------------------------------
\633\ See 2013 rule Sec. __.10(c)(8). Loan is further defined
as any loan, lease, extension of credit, or secured or unsecured
receivable that is not a security or derivative. See also 2013 rule
Sec. __.2(t).
\634\ See 85 FR 12173.
---------------------------------------------------------------------------
The implementing regulations permit loan securitizations to hold
rights or other assets (servicing assets) that arise from the structure
of the loan securitization or from the loans supporting a loan
securitization.\635\ In response to questions regarding the scope of
the provisions permitting servicing assets and a separate provision
limiting the types of permitted securities, the staffs of the agencies
released the Loan Securitization Servicing FAQ.\636\ The final rule
codifies the staff-level approach to the loan securitization exclusion
in the Loan Securitization Servicing FAQ.\637\ To the degree that
market participants may have restructured their activities consistent
with the Loan Securitization Servicing FAQ, an effect of the final rule
may be to reduce uncertainty. However, the economic effects of the
codification of the Loan Securitization Servicing FAQ with respect to
enabling greater capital formation through loan securitizations on the
one hand, and increasing potential risks related to such activities on
the other, may be limited.
---------------------------------------------------------------------------
\635\ Implementing regulations Sec. Sec. __.2(s);
__.10(c)(8)(i)(D), (v).
\636\ See supra note 14 (links to the staff-level FAQs) and 78
and referencing paragraph (discussion of Loan Securitization
Servicing FAQ).
\637\ Sec. __.10(c)(8)(i)(B).
---------------------------------------------------------------------------
In the preamble to the 2013 rule, the agencies declined to permit
loan securitizations to hold a certain amount of non-loan assets.\638\
Several commenters on the 2018 proposal disagreed with the agencies'
views and supported expanding the range of permissible assets in an
excluded loan securitization.\639\ The 2020 proposal would have allowed
a loan securitization vehicle to hold up to five percent of the fund's
total assets in any non-loan assets.
---------------------------------------------------------------------------
\638\ 2013 rule at 5687-88.
\639\ See 85 FR 12129.
---------------------------------------------------------------------------
Commenters were generally supportive of allowing loan
securitizations to hold a limited amount of non-loan assets.\640\ These
commenters indicated that the requirements under the implementing
regulations for the loan securitization exclusion have been too
restrictive, excessively limited use of the exclusion, and prevented
issuers from responding to investor demand. Further, commenters
suggested that a limited bucket of non-loan assets would not
fundamentally alter the characteristics and risks of securitizations or
otherwise increase risks in banking entities or the financial
system.\641\
---------------------------------------------------------------------------
\640\ See, e.g., SIFMA; CCMC; ABA; Credit Suisse; MFA; Goldman
Sachs; LSTA; BPI; and SFA.
\641\ See, e.g., LSTA and Goldman Sachs.
---------------------------------------------------------------------------
In the final rule, the agencies are revising the loan
securitization exclusion to permit a loan securitization to hold a
limited amount of debt securities.\642\ To minimize the potential for
banking entities to use this exclusion to engage in impermissible
activities or take on excessive risk, the final rule permits a loan
securitization to hold debt securities (excluding asset-backed
securities and convertible securities), as opposed to any non-loan
asset, as the 2020 proposal would have allowed.\643\
---------------------------------------------------------------------------
\642\ Final rule Sec. __.10(c)(8)(i)(E).
\643\ The implementing regulations also allow an excluded loan
securitization to hold certain interest rate and foreign exchange
derivatives for risk management purposes. The final rule makes no
change to this provision.
---------------------------------------------------------------------------
The SEC believes that non-loan assets with materially different
risk characteristics from loans could change the character and
complexity of an issuer and raise the type of concerns that section 13
of the BHC Act was intended to address. Moreover, as described further
below, limiting the assets to those with risk characteristics that are
similar to loans may allow for a simpler and more transparent
calculation of the five percent limit than would have been necessary if
loan securitizations could invest in any non-loan asset, which will
facilitate banking entities' compliance with the exclusion.
Alternatively, the agencies could have expanded the range of
permissible assets in an excluded loan securitization to include any
non-loan asset with or without limitations (e.g., the holding of asset-
backed securities could have been permitted). Permitting loan
securitizations to hold small amounts of non-loan assets may have
enabled loan securitizations to respond to investor demand and may have
reduced compliance costs associated with ensuring that a loan
securitization holds only assets permitted under the exclusion.
However, permitting excluded loan securitizations to hold a broader
range of non-loan assets could have increased the risk that the
character and complexity of excluded loan securitizations would have
changed in a manner that raised the type of concerns that section 13 of
the BHC Act was intended to address.
However, the SEC recognizes that the loan securitization industry
may have evolved since the issuance of the 2013 rule. As a result, the
SEC believes that, even if the scope of non-loan assets permitted to be
held were expanded beyond debt securities, loan securitizations may
continue to have excluded non-loan assets. Further, permitting loan
securitizations to hold a small amount of debt securities will not
affect the applicable prudential requirements aimed at the safety and
soundness of banking entities. Banking entities currently take on a
variety of risks arising out of a broad range of permissible
activities, including the core traditional banking activity related to
the extension of credit and direct and indirect extension of credit by
banking entities flows through to the real economy in the form of
greater access to capital.
In the 2020 proposal, the agencies also requested comment on the
methodology for calculating the limit on non-loan assets. Several
commenters suggested using as a method for calculating the limit on
non-loan assets: The par value of assets on the day they are
acquired.\644\ These commenters suggested that relying on par value is
accepted practice in the loan securitization industry and would obviate
concerns related to tracking amortization or prepayment of loans in a
securitization portfolio.\645\ Another commenter indicated that the
limit should be calculated as the lower of the purchase price and par
value of the non-qualifying assets over the issuer's aggregate capital
commitments plus its subscription based credit facility.\646\
---------------------------------------------------------------------------
\644\ SIFMA; BPI; ABA; and LSTA.
\645\ SIFMA and BPI.
\646\ Goldman Sachs.
---------------------------------------------------------------------------
In response to these comments, the agencies are clarifying the
methodology for calculating the five percent limit on non-loan
assets.\647\ As suggested by several commenters, the final rule
specifies that the limit on debt securities must be calculated at the
most recent
[[Page 46482]]
time of acquisition of such assets.\648\ Specifically, the aggregate
value of debt securities may not exceed five percent of the aggregate
value of loans, cash and cash equivalents, and debt securities, where
the value of the loans, cash and cash equivalents, and debt securities
is calculated using par value at the most recent time any such debt
security is purchased.\649\
---------------------------------------------------------------------------
\647\ Final rule Sec. __.10(c)(8)(i)(E).
\648\ This limit applies to the debt securities that a loan
securitization may hold pursuant to final rule Sec.
__.10(c)(8)(i)(E).
\649\ Id.
---------------------------------------------------------------------------
The agencies have determined a calculation methodology that is
intended to reduce compliance costs while ensuring that the investment
pool of a loan securitization is composed of loans. The agencies have
chosen the most recent time any such debt security is acquired as the
moment of calculation to simplify the manner in which the five percent
limit applies. This would permit an issuer that, at some point in its
life, held debt securities in excess of five percent of its assets to
continue to qualify for the exclusion if it came into compliance with
the five percent limit prior to the next acquisition of a debt security
that is subject to the five percent limit. The SEC believes that this
approach balances the cost of calculation with the benefits of
addressing the potential for evasion. The SEC believes that the
alternative of a continuous monitoring obligation (i.e., requiring an
excluded loan securitization to ensure that it held debt securities
below or at the five percent limit at all times, regardless of any
change in value of the securitization's assets) would have imposed
significant burdens on banking entities and could have caused an issuer
to be disqualified from the loan securitization exclusion based on
market events not under its control.
In the final rule, this calculation is based only on the value of
the loans and debt securities held under Sec. Sec. __.10(c)(8)(i)(A)
and (E) and the cash and cash equivalents held under Sec.
__.10(c)(8)(iii)(A) rather than the aggregate value of all of the
issuing entity's assets. The purpose of the five percent limit is to
ensure the investment pool of a loan securitization is composed of
loans. Therefore, the calculation takes into account the assets that
should make up the issuing entity's investment pool and excludes the
value of other rights or incidental assets, as well as derivatives held
for risk management. This further simplifies the calculation
methodology by excluding assets that may be more complex to value and
that are ancillary to the loan securitization's investment activities.
This straightforward calculation methodology will ensure that the loan
securitization exclusion remains easy to use and will facilitate
banking entities' compliance with the exclusion.
The agencies recognize that a loan securitization's transaction
agreements may require that some categories of loans, cash equivalents,
or debt securities be valued at fair market value for certain purposes.
To accommodate such situations, the exclusion provides that the value
of any loan, cash equivalent, or permissible debt security may be based
on its fair market value if (1) the issuing entity is required to use
the fair market value of such loan or debt security for purposes of
calculating compliance with concentration limitations or other similar
calculations under its transaction agreements and (2) the issuing
entity's valuation methodology values similarly situated assets, for
example non-performing loans, consistently. This provision is intended
to provide issuers with the flexibility to leverage existing
calculation methodologies while preventing issuers from using
inconsistent methodologies in a manner to evade the requirements of the
exclusion.
Credit Funds
Under the baseline, funds that raise capital to engage in loan
originations or extensions of credit or purchase and hold debt
instruments that a banking entity would be permitted to acquire
directly may be ``covered funds'' under the implementing regulations.
As a result, prior to the final rule, banking entities faced
limitations on sponsoring or investing in credit funds that engage in
traditional banking activities--activities that banking entities are
able to engage in directly outside of the fund structure. The SEC
received several comments to the 2018 proposal supporting an exclusion
for credit funds. For example, some commenters suggested that a fund or
partnership structure enables banking entities to engage in permissible
activities more efficiently.\650\ Specifically, one commenter indicated
that credit funds facilitate investments by third parties, leading to
the creation of a broader and deeper pool of capital, which may allow
for more diversification in banking entities' lending portfolios, the
pooling of expertise of groups of market participants, and otherwise
reduce the risk for banking entities and the financial system.\651\ In
addition, some commenters stated that to the degree that credit funds
require pre-commitments of capital, they may dampen cyclical
fluctuations in loan originations and may facilitate ongoing extensions
of credit during times of market stress.\652\
---------------------------------------------------------------------------
\650\ See 85 FR 12167.
\651\ See id.
\652\ See id.
---------------------------------------------------------------------------
The agencies included in the 2020 proposal a specific exclusion for
credit funds. Under the 2020 proposal, a credit fund would have been an
issuer whose assets consist solely of: Loans, debt instruments, related
rights and other assets that are related or incidental to acquiring,
holding, servicing, or selling loans, or debt instruments; and certain
interest rate or foreign exchange derivatives.\653\ The proposed
exclusion would have been subject to certain additional requirements to
reduce evasion concerns and ensure that banking entities invest in,
sponsor, or advise credit funds in a safe and sound manner. For
example, the proposed exclusion would have imposed (1) certain activity
requirements on the credit fund, including a prohibition on proprietary
trading; \654\ (2) disclosure and safety and soundness requirements on
banking entities that sponsor or serve as an advisor for a credit fund;
\655\ (3) safety and soundness requirements on all banking entities
that invest in or have certain relationships with a credit fund; \656\
and (4) restrictions on the banking entity's investment in, and
relationship with, a credit fund.\657\ The proposed exclusion also
would have permitted a credit fund to receive and hold a limited amount
of equity securities (or rights to acquire equity securities) that were
received on customary terms in connection with the credit fund's loans
or debt instruments.\658\
---------------------------------------------------------------------------
\653\ 2020 proposal Sec. __.10(c)(15)(i).
\654\ 2020 proposal Sec. __.10(c)(15)(ii).
\655\ 2020 proposal Sec. __.10(c)(15)(iii).
\656\ 2020 proposal Sec. __.10(c)(15)(iv).
\657\ 2020 proposal Sec. __.10(c)(15)(v).
\658\ 2020 proposal Sec. __.10(c)(15)(i)(C)(1)(iii).
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Commenters on the 2020 proposal were generally supportive of
adopting an exclusion for credit funds.\659\ After consideration of the
comments, the agencies are adopting the credit fund exclusion largely
as proposed. The final rule creates a separate exclusion from the
covered fund definition for credit funds that meet certain conditions,
including several conditions that are similar to certain conditions of
the loan securitization exclusion, but that reflect
[[Page 46483]]
the structure and operation of credit funds.
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\659\ See, e.g., CCMC; AIC; SIFMA; FSF; ABA; Arnold & Porter;
and Goldman Sachs. See also supra Section IV.C.1.ii. (Credit Funds--
Comments) for a more detailed discussion of comments received.
---------------------------------------------------------------------------
The final rule permits banking entities to extend credit through a
fund structure but also contains provisions to prevent a banking entity
from taking the types of risks that the covered fund provisions of
section 13 were meant to address. First, the credit fund exclusion
specifies the types of activities in which these funds may engage.
Excluded credit funds can transact in or hold only loans, debt
instruments that would be permissible for the banking entity relying on
the exception to hold directly, certain rights or assets that are
related or incidental to the loans or debt instruments, and certain
interest rate and foreign exchange derivatives. The final rule requires
that the credit fund not engage in activities that would constitute
proprietary trading. Finally, the restrictions on guarantees and other
limitations should eliminate the ability and incentive for either the
banking entity sponsoring a credit fund or any affiliate to provide
additional support beyond the ownership interest retained by the
sponsor.
Credit funds are likely to carry similar returns and risks as
direct extensions of credit and loan origination outside of the fund
structure, including the possibility of losses or gains related to
changes in interest rates, borrower default or delinquent payments,
fluctuations in foreign currencies, and overall market conditions.
While the presence of a fund structure may introduce certain common
risks associated with pooled investments, e.g., those related to
governance of the fund and those related to relying on third-party
investors providing capital to the fund, the SEC believes those risks
to banking entities to be limited. Moreover, fund structures also
entail certain common risk mitigating features (such as diversification
across a larger number of borrowers) as well as significant cost
efficiencies for banking entities.
The SEC believes that the credit fund exclusion may allow banking
entities to engage, indirectly, in more loan origination and
traditional extension of credit relative to the current baseline. To
the degree that banking entities are currently constrained in their
ability to engage in extensions of credit through credit funds because
of the implementing regulations, the exclusion may increase the volume
of intermediation of credit by banking entities and make intermediation
more efficient and less costly. In addition, permitting banking
entities to extend financing to businesses through credit funds could
allow banking entities to compete more effectively with non-banking
entities that are not subject to the same prudential regulation or
supervision as banking entities subject to section 13 of the BHC Act
and thereby likely result in an increase in lending activity in banking
entity-sponsored credit funds without negatively affecting capital
formation or the availability of financing. In this respect, the final
rule could result in greater competition between bank and non-bank
provision of credit with both expected lower costs that typically
result from increased competition and a larger volume of permissible
banking and financial activities to occur in the regulated banking
system. In addition, since cost reductions and increased efficiencies
are commonly passed along to customers, the exclusion may also benefit
banking entities' borrowers and facilitate the extension of credit in
the real economy.
The SEC continues to recognize that banking entities already engage
in a variety of permissible activities involving risk, including
extensions of credit, underwriting, and market-making. To the degree
that credit funds may enable greater formation of capital by banking
entities through various debt instruments, this may influence the risks
and returns of banking entities individually and of banking entities as
a whole. However, the SEC recognizes that the activities of credit
funds largely replicate permissible and traditional activities of
banking entities and undertaking similar activities largely results in
the same risk exposures. Moreover, banking entities subject to the
implementing regulations may also be subject to multiple prudential,
capital, margin, and liquidity requirements that facilitate the safety
and soundness of banking entities and promote the financial stability
of the United States. These requirements would necessarily limit the
risk that banks could take on by lending through a credit fund
structure in a similar manner that would apply if the banking entity
were to undertake similar lending activities directly. In addition, the
final rule includes a set of conditions on the credit fund exclusion,
including limitations on banking entities' guarantees, assumption or
other insurance of the obligations or performance of the fund,\660\ and
compliance with applicable safety and soundness standards.\661\
---------------------------------------------------------------------------
\660\ Final rule Sec. __.10(c)(15)(iv)(A).
\661\ Final rule Sec. __.10(c)(15)(v)(B).
---------------------------------------------------------------------------
Several provisions of the exclusion are similar to and modeled on
conditions in the existing loan securitization exclusion to ease
compliance burdens. For example, any derivatives held by the credit
fund must relate to loans, permissible debt instruments, or other
rights or assets held and reduce the interest rate and/or foreign
exchange risks related to these holdings.\662\ In addition, any related
rights or other assets held that are securities must be cash
equivalents, securities received in lieu of debts previously contracted
with respect to loans or debt instruments held or, unique to the credit
fund exclusion, equity securities (or rights to acquire equity
securities) received on customary terms in connection with the credit
fund's loans or debt instruments.\663\ Establishing an exclusion for
credit funds based on the framework provided by the loan securitization
exclusion will allow banking entities to provide traditional extensions
of credit regardless of the specific form, whether directly via a loan
made by a banking entity, or indirectly through an investment in or
relationship with a credit fund that transacts primarily in loans and
certain debt instruments.
---------------------------------------------------------------------------
\662\ Final rule Sec. __.10(c)(15)(i)(D).
\663\ Final rule Sec. __.10(c)(15)(i)(C).
---------------------------------------------------------------------------
In the 2020 proposal, the agencies requested comment on whether to
impose a limit on the amount of equity securities (or rights to acquire
equity securities) that may be held by an excluded credit fund.\664\
After a review of the comments and further deliberation, the agencies
are not adopting a quantitative limit on the amount of equity
securities (or rights to acquire equity securities) that may be held by
an excluded credit fund. Any such equity securities or rights are
limited by the requirements that they be (1) received on customary
terms in connection with the fund's loans or debt instruments and (2)
related or incidental to acquiring, holding, servicing, or selling
those loans or debt instruments. The agencies generally expect that the
equity securities or rights satisfying those criteria in connection
with an investment in loans or debt instruments of a borrower (or
affiliated borrowers) would not exceed five percent of the value of the
fund's total investment in the borrower (or affiliated borrowers) at
the time the investment is made.
---------------------------------------------------------------------------
\664\ 85 FR 12133.
---------------------------------------------------------------------------
The agencies could have imposed a quantitative limit on the amount
of equity securities (or rights to acquire equity securities) held by
the fund. However, the value of those equity securities or other rights
may change over time for a variety of reasons, including as a result of
market
[[Page 46484]]
conditions and business performance, as well as more fundamental
changes in the business and the credit fund's corresponding management
of the investment (e.g., exchanges of debt instruments for equity in
connection with mergers and restructurings or a disposition of all
portion of the credit investment without a corresponding disposition of
the equity securities or rights due to differences in market conditions
or other factors). Accordingly, the agencies can foresee various
circumstances where the relative value of such equity securities or
rights in a borrower (or affiliated borrowers) would over the life of
the investment exceed five percent on a basis consistent with the
requirements. Therefore, a quantitative limit on the amount of equity
securities held by the fund could have imposed compliance, opportunity,
and performance costs on a fund without a substantial reduction in risk
to the fund. Nonetheless, the agencies expect that the fund's exposure
to equity securities (or other rights), individually and collectively
and when viewed over time, would be managed on a basis consistent with
the fund's overall purpose.
The credit fund exclusion prevents a banking entity from relying on
the exclusion unless any debt instruments and equity securities (or
rights to acquire an equity security) held by the credit fund and
received on customary terms in connection with the credit fund's loans
or debt instruments are permissible for the banking entity to acquire
and hold directly. A banking entity that acts as sponsor, investment
adviser or commodity trading advisor of a credit fund must ensure that
the activities of the credit fund are consistent with certain safety
and soundness standards.\665\ In addition, a banking entity's
investment in, and relationship with, a credit fund must be conducted
in compliance with, and subject to, applicable banking laws and
regulations, including applicable safety and soundness standards.\666\
Combined with the prohibition on proprietary trading by a credit
fund,\667\ these limitations are expected to prevent evasion of section
13 of the BHC Act.
---------------------------------------------------------------------------
\665\ Final rule Sec. Sec. __.10(c)(15)(iv)(B), (iii)(B).
\666\ Final rule Sec. Sec. __.10(c)(15)(v)(B).
\667\ Final rule Sec. __.10(c)(15)(ii)(A).
---------------------------------------------------------------------------
The final rule does not separately permit credit funds to hold
derivatives under the provision allowing related rights and other
assets. The preamble to the 2020 proposal made clear that ``any
derivatives held by the credit fund must relate to loans, permissible
debt instruments, or other rights or assets held, and reduce the
interest rate and/or foreign exchange risks related to these
holdings.'' \668\ The agencies suggested then and currently believe
that allowing a credit fund to hold derivatives not related to interest
rate or foreign exchange hedging would not be necessary to facilitate
the indirect extensions of credit by banking entities that are the goal
of the exclusion and may pose the very risks that section 13 of the BHC
Act was intended to reach. To help ensure that the credit fund
exclusion does not inadvertently allow the holding of certain
derivatives unrelated to hedging interest rate and/or foreign exchange
risks, the final rule explicitly excludes derivatives from permissible
related rights and other assets.\669\
---------------------------------------------------------------------------
\668\ See 85 FR 12132.
\669\ Final rule Sec. __.10(c)(15)(i)(C)(2).
---------------------------------------------------------------------------
Importantly, extensions of credit and loan origination by banking
entities, whether directly or indirectly, are influenced by a wide
variety of factors, including the prevailing macroeconomic conditions,
the creditworthiness of borrowers and potential borrowers, competition
between bank and non-bank credit providers, and many others. Moreover,
the efficiencies of credit funds relative to direct extensions of
credit described above are likely to vary considerably among banking
entities and funds. The SEC recognizes that the potential effects
described above of the credit fund exclusion may be dampened or
magnified in different phases of the macroeconomic cycle and across
various types of banking entities.
Investors in a credit fund that a banking entity sponsors or for
which the banking entity serves as an investment adviser or commodity
trading advisor may have expectations related to the performance of the
credit fund that raise bailout concerns. To ensure that these investors
are adequately informed of the banking entity's role in the credit
fund, the final rule requires a banking entity that acts as a sponsor,
investment adviser, or commodity trading advisor to an excluded credit
fund to provide prospective and actual investors the disclosures
specified in Sec. __.11(a)(8) of the implementing regulations as if
the credit fund were a covered fund.\670\ In addition, a banking entity
that acts as a sponsor, investment adviser, or commodity trading
advisor must ensure that the activities of the credit fund are
consistent with safety and soundness standards that are substantially
similar to those that would apply if the banking entity engaged in the
activities directly.\671\
---------------------------------------------------------------------------
\670\ Final rule Sec. __.10(c)(15)(iii)(A).
\671\ Final rule Sec. __.10(c)(15)(iii)(B).
---------------------------------------------------------------------------
As an alternative, the agencies could have adopted a credit fund
exclusion that restricted permissible assets to only loans or debt
instruments and not equity. The SEC recognizes that many banking
entities are permitted to take as consideration for a loan to a
borrower a warrant or option issued by the borrower that may result in
an equity holding. The SEC recognizes that if banking entities are to
be allowed to provide credit through a fund structure that they would
otherwise be allowed to provide outside of a fund structure, an
allowance for equity holdings is necessary. However, allowing a credit
fund to hold an unlimited amount of equity in connection with an
extension of credit could turn the exclusion for credit funds into an
exclusion for the type of funds that section 13 of the BHC Act was
intended to address. Accordingly, the agencies indicate above that they
generally expect that the equity securities or other rights acquired by
a credit fund would not exceed five percent of the value of the fund's
total investment in a borrower at the time the investment is made.
Venture Capital Funds
As discussed above, the agencies are adopting amendments in the
final rule to exclude certain venture capital funds from the definition
of ``covered fund,'' which allow banking entities to acquire or retain
an ownership interest in, or sponsor, those venture capital funds to
the extent the banking entity is otherwise permitted to engage in such
activities under applicable law.\672\ The exclusion is available with
respect to qualifying venture capital funds, which includes an issuer
that meets the definition of ``venture capital fund'' in 17 CFR
275.203(l)-1 and that meets several additional criteria.\673\
---------------------------------------------------------------------------
\672\ Final rule Sec. __.10(c)(16).
\673\ See supra Section IV.C.2. (Venture Capital Funds).
---------------------------------------------------------------------------
A qualifying venture capital fund is an issuer that, among other
criteria, is a venture capital fund as defined in 17 CFR 275.203(l)-
1.\674\ In the preamble to the regulations adopting this definition of
venture capital fund, the SEC explained that the definition's criteria
distinguish venture capital funds from other types of funds, including
private
[[Page 46485]]
equity funds and hedge funds.\675\ Moreover, the SEC explained that
these criteria reflect the Congressional understanding that venture
capital funds are less connected with the public markets and therefore
may have less potential for systemic risk.\676\ The SEC further
explained that the restriction on the amount of borrowing, debt
obligations, guarantees or other incurrence of leverage are appropriate
to differentiate venture capital funds from other types of private
funds that may engage in trading strategies that use financial leverage
and may contribute to systemic risk.\677\ The SEC believes that its
definition includes criteria reflecting the characteristics of venture
capital funds that may pose less potential risk to a banking entity
sponsoring or investing in venture capital funds and to the financial
system--specifically, the smaller role of leverage financing and a
lesser degree of interconnectedness with public markets.
---------------------------------------------------------------------------
\674\ See id. for a discussion of the SEC's definition of
``venture capital fund'' in 17 CFR 275.203(l)-1. Following enactment
of the RBIC Advisers Relief Act, supra note 577, the SEC's
definition of ``venture capital fund'' includes any RBIC and any
SBIC. See 15 U.S.C. 80b-3(l).
\675\ See, e.g., Exemptions for Advisers to Venture Capital
Funds, Private Fund Advisers With Less Than $150 Million in Assets
Under Management, and Foreign Private Advisers, 76 FR 39645, 39652
(July 6, 2011).
\676\ See id. at 39648 (``[T]he proposed definition of venture
capital fund was designed to . . . address concerns expressed by
Congress regarding the potential for systemic risk.''); and at 39656
(``Congressional testimony asserted that these funds may be less
connected with the public markets and may involve less potential for
systemic risk. This appears to be a key consideration by Congress
that led to the enactment of the venture capital exemption. As we
discussed in the Proposing Release, the rule we proposed sought to
incorporate this Congressional understanding of the nature of
investments of a venture capital fund, and these principles guided
our consideration of the proposed venture capital fund
definition.'').
\677\ See id. at 39661-62. See also id. at 39657 (``We proposed
these elements of the qualifying portfolio company definition
because of the focus on leverage in the Dodd-Frank Act as a
potential contributor to systemic risk as discussed by the Senate
Committee report, and the testimony before Congress that stressed
the lack of leverage in venture capital investing.'').
---------------------------------------------------------------------------
As discussed in the 2020 proposal, the SEC has received comments
supporting an exclusion for venture capital funds and stating that
venture capital funds do not commonly engage in short-term, high-risk
activities, and that, by their nature, venture capital funds make long-
term investments in private firms.\678\ Moreover, the SEC received
comment that venture capital funds promote economic growth and
competitiveness of the United States more effectively than investments
in expressly permissible vehicles, such as small business investment
companies.\679\ The SEC has also received comment that, by virtue of
their investment strategy, long-term investment horizon, and
intermediation between companies in need of capital and institutional
investors seeking to deploy capital in efficient ways, venture capital
funds may play a significant role in capital formation, economic
growth, and efficient market function.\680\
---------------------------------------------------------------------------
\678\ See 85 FR 12168.
\679\ See id.
\680\ See id.
---------------------------------------------------------------------------
In response to the 2020 proposal, the agencies received comments
supporting the proposed definition of ``qualifying venture capital
fund.'' \681\ At the same time, two commenters expressed opposition to
the 2020 proposal.\682\
---------------------------------------------------------------------------
\681\ See supra note 244.
\682\ See supra note 270.
---------------------------------------------------------------------------
The final rule largely adopts the exclusion as proposed.\683\ As
adopted, the exclusion for qualifying venture capital funds is
available to an issuer that is a venture capital fund as defined in 17
CFR 275.203(l)-1 and does not engage in any activity that would
constitute proprietary trading, under Sec. __.3(b)(1)(i), as if it
were a banking entity.\684\ With respect to any banking entity that
acts as sponsor, investment adviser, or commodity trading advisor to
the issuer, the banking entity is required (1) to provide in writing to
any prospective and actual investor the disclosures required under
Sec. __.11(a)(8), as if the issuer were a covered fund, (2) to ensure
that the activities of the issuer are consistent with the safety and
soundness standards that are substantially similar to those that would
apply if the banking entity engaged in the activities directly, and (3)
to comply with the restrictions in Sec. __.14 (except the banking
entity may acquire and retain any ownership interest in the issuer), as
if the issuer were a covered fund.\685\
---------------------------------------------------------------------------
\683\ The one change from the proposal is moving the requirement
that the banking entity must comply with Sec. Sec. __.14 to
__.10(c)(16)(ii). This change clarifies that this requirement
applies to a banking entity that acts as sponsor, investment
adviser, or commodity trading advisor to the qualifying venture
capital fund and does not apply to a banking entity that merely
invests in a qualifying venture capital fund.
\684\ Final rule Sec. __.10(c)(16)(i).
\685\ Final rule Sec. __.10(c)(16)(ii).
---------------------------------------------------------------------------
As in the 2020 proposal, a banking entity that relies on the
exclusion may not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of the issuer.\686\
Finally, the banking entity's ownership interest in or relationship
with a qualifying venture capital fund must comply with the limitations
imposed in Sec. __.15 of the implementing regulations (regarding,
among other subjects, material conflicts of interest and high-risk
investments), as if the issuer were a covered fund; and must be
conducted in compliance with and subject to, applicable banking laws
and regulations, including applicable safety and soundness
standards.\687\
---------------------------------------------------------------------------
\686\ Final rule Sec. __.10(c)(16)(iii).
\687\ Final rule Sec. __.10(c)(16)(iv).
---------------------------------------------------------------------------
The qualifying venture capital fund exclusion being adopted may
provide banking entities with greater flexibility in their investments
in private firms generally and in private firms with a broader range of
financing sources, in each case to the extent that those investments
are made through a fund structure. In addition, it is widely noted that
the availability of venture capital and other financing from funds is
not uniform throughout the United States and is generally available on
a competitive basis for companies with a significant presence in
certain geographic regions (e.g., the New York metropolitan area, the
Boston metropolitan area, and ``Silicon Valley'' and surrounding
areas).\688\ This view was shared by several commenters on the 2020
proposal, who indicated that an exclusion for venture capital funds
would benefit underserved regions where venture capital funding is not
readily available currently.\689\ In this respect, the qualifying
venture capital fund exclusion could allow banking entities with a
presence in and knowledge of the areas where venture capital and other
types of financing are less readily available to businesses to provide
this type of financing in those areas, further promoting capital
formation.
---------------------------------------------------------------------------
\688\ See, e.g., Richard Florida, Venture Capital Remains Highly
Concentrated in Just a Few Cities, CITYLAB (Oct. 3, 2017), available
at https://www.citylab.com/life/2017/10/venture-capital-concentration/539775/; PRICEWATERHOUSECOOPERS & CB INSIGHTS,
MoneyTree Report (Q3 2019), available at https://www.pwc.com/us/en/moneytree-report/assets/moneytree-report-q3-2019.pdf.
\689\ See FSF; SIFMA; CCMC; and NVCA.
---------------------------------------------------------------------------
The SEC remains cognizant of the fact that the overall level and
structure of activities of banking entities that involve risk stems
from a variety of permissible sources, including traditional capital
provision, underwriting, and market-making. To the degree that
qualifying venture capital funds may enable greater formation of
capital by banking entities, this may influence the risks and returns
of such funds individually and of banking entities as a whole. However,
the exclusion has a number of conditions, including a prohibition on
direct or indirect guarantees by the banking entity, disclosures to
investors, and compliance with applicable safety and soundness
standards.
The SEC recognizes that venture capital funds commonly invest in
[[Page 46486]]
illiquid private firms with few sources of market price information,
with corresponding risks and returns. To the degree that the exclusion
for qualifying venture capital funds facilitates banking entity
activities related to venture capital funds, this exclusion could
increase the volume and alter the structure of banking entities'
activities, affecting the risks associated with those activities. At
the same time, as discussed elsewhere,\690\ many other traditional and
permissible activities of banking entities involve risk, and the
provision of capital to private firms is an important function of
banking entities within the financial system and securities markets
that benefits the real economy.
---------------------------------------------------------------------------
\690\ See 2019 amendments, 84 FR 62037-92.
---------------------------------------------------------------------------
As an alternative, the agencies considered an additional
restriction for which they are requested specific comment as part of
the 2020 proposal. Under this additional restriction, and
notwithstanding 17 CFR 275.203(1)-1(a)(2), the venture capital fund
exclusion would be limited to funds that do not invest in companies
that, at the time of the investment, have more than a limited dollar
amount of total annual revenue. The agencies considered several
alternative thresholds that could have been appropriate in this regard
to further differentiate qualifying venture capital funds from other
types of private funds. The potential benefit of including a revenue or
other similar test is that it could have been more difficult for
banking entities to use the exclusion to make investments through the
fund that the agencies may not have intended to be permissible.
However, any such anti-evasion benefits of this alternative could have
been offset by the extent to which anti-evasion concerns are already
addressed by the other conditions of the exclusion. In addition, such a
revenue test or other similar test could have facilitated the indirect
investment by banking entities in smaller companies that may have been
particularly risky or would have required qualifying venture capital
funds to pass up investment opportunities that would otherwise be
considered typical venture capital-type investments.
Such an additional restriction as contemplated in the alternative
would have made it more difficult for banking entities to sponsor and
invest in qualifying venture capital funds by limiting the pool of
possible investments in which those funds could invest. This difficulty
may have been particularly pronounced for banking entities that would
use the qualifying venture capital fund exclusion to make investments
in third-party funds, which may not have been willing to restrict--and
could have been prohibited from restricting under other applicable
laws--the fund's investments in companies that met any such revenue or
other similar test. As a result, such an additional condition could
have diminished the benefits discussed above, both by limiting the
utility of the exclusion for banking entities to make permissible
investments and potentially reducing the availability of financing for
businesses, including small businesses and start-ups in areas outside
of certain major metropolitan areas.
Small Business Investment Companies
The implementing regulations exclude from the covered fund
definition small business investment companies. The implementing
regulations include within the scope of the exclusion SBICs and issuers
that have received notice to proceed to qualify for a license as an
SBIC and which have not received a revocation of the notice or license.
The final rule expands the exclusion to incorporate SBICs that have
voluntarily surrendered their licenses to operate and do not make new
investments (other than investments in cash equivalents) after such
voluntary surrender.\691\
---------------------------------------------------------------------------
\691\ Final rule Sec. __.10(c)(11)(i).
---------------------------------------------------------------------------
Clarifying that SBICs that have voluntarily surrendered their
licenses and are winding-down remain excluded from the covered fund
definition reduces regulatory uncertainty for banking entities. Under
the implementing regulations, because it is unclear whether an SBIC
that has voluntarily surrendered its license is still excluded from the
definition of ``covered fund,'' banking entities must make a
determination whether or not the SBIC that is winding-down is a covered
fund. If the banking entity determines that when the SBIC that is
winding-down and has voluntarily surrendered its license no longer
qualifies for the exclusion from the covered fund definition, then the
implementing regulations apply and the banking entity's existing
investment in, and relationship with, the SBIC is prohibited. This
potential result may discourage banking entities from making
investments in SBICs.
The 2020 proposal discussed comments the SEC had received
indicating that the 2013 rule had limited banking entity activities in
SBICs that may spur economic growth, and that banking entities faced
significant regulatory burdens that are not commensurate with the risk
of the underlying activities.\692\ Another commenter indicated that, in
the ordinary course of business, SBIC fund managers often relinquish or
voluntarily surrender a license during the wind-down of the fund while
liquidating assets in the dissolution process (since the license is no
longer necessary or an efficient use of partnership funds).\693\
---------------------------------------------------------------------------
\692\ See 85 FR 12169.
\693\ See id.
---------------------------------------------------------------------------
The agencies proposed revising the exclusion for SBICs to clarify
how the exclusion would apply to SBICs that voluntarily surrender their
licenses during wind-down phases.\694\ Specifically, the agencies
proposed revising the exclusion for SBICs to apply explicitly to an
issuer that has voluntarily surrendered its license to operate as an
SBIC and does not make new investments (other than investments in cash
equivalents) after such voluntary surrender.\695\
---------------------------------------------------------------------------
\694\ See 85 FR 12131.
\695\ See id.
---------------------------------------------------------------------------
Most commenters that directly addressed the 2020 proposal's
revisions concerning SBICs supported the proposed revisions, stating
that the proposed revisions would provide greater certainty to banking
entities wishing to invest in SBICs and would increase investment in
small businesses.\696\ The final rule adopts the 2020 proposal's
revisions concerning SBICs without modification.
---------------------------------------------------------------------------
\696\ See SIFMA; BPI; ABA; PNC; and SBIA.
---------------------------------------------------------------------------
SBICs are an important mechanism for capital allocation by banking
entities and one important channel of capital raising for issuers. The
final rule clarifies that banking entities are able to continue to
participate in SBIC-related activities during the dissolution of such
funds, as long as certain conditions are met. To the degree that
banking entities have been reluctant to invest in SBICs to avoid the
risk of an SBIC being treated as a covered fund during SBIC
dissolution, the final rule may increase the willingness of some
banking entities to participate in SBICs. The final rule requires that
SBICs that have voluntarily surrendered their license may not make new
investments during the wind-down process. This aspect of the final rule
seeks to address the possibility of banking entities becoming exposed
to greater risk as part of their participation in SBICs during their
wind-down process, even though such exposure may not be common in an
SBIC's ordinary course of business. In any case, both the risks and the
returns arising out of a banking entity's investment in a SBIC at all
stages of its lifecycle are
[[Page 46487]]
likely to flow through to the banking entity's shareholders. Moreover,
banking entities participating in SBICs remain subject to applicable
safety and soundness regulations and requirements.
Public Welfare Funds
The implementing regulations exclude from the definition of
``covered fund'' issuers that make investments that are designed
primarily to promote the public welfare, of the type permitted under
paragraph 11 of section 5136 of the Revised Statutes of the United
States (12 U.S.C. 24), including the welfare of low- and moderate-
income communities or families (such as providing housing, services, or
jobs) (public welfare investment exclusion).\697\
---------------------------------------------------------------------------
\697\ Implementing regulations Sec. __.10(c)(11)(ii)(A).
---------------------------------------------------------------------------
As discussed in the 2020 proposal, the SEC has received comment
that the implementing regulations' exclusion for public welfare funds
may not capture community development investments made through
investment vehicles and comment supporting an exclusion of investments
that qualify for Community Reinvestment Act (CRA) credit, including
direct and indirect investments in a community development fund, SBIC,
or similar fund.\698\
---------------------------------------------------------------------------
\698\ See 85 FR 12169.
---------------------------------------------------------------------------
The 2020 proposal posed a number of questions related to the scope
of the public welfare investment exclusion. For example, the 2020
proposal asked whether investments that would receive consideration as
qualified investments under the regulations implementing the CRA should
be excluded from the definition of covered fund, either by
incorporating these investments into the public welfare investment
exclusion or by establishing a new exclusion for CRA-qualifying
investments.\699\ In addition, the 2020 proposal requested comment on
whether RBICs are typically excluded from the definition of ``covered
fund'' because of the public welfare investment exclusion or another
exclusion and on whether the agencies should expressly exclude RBICs
from the definition of covered fund.\700\ Finally, the 2020 proposal
requested comment on whether many or all QOFs would meet the terms of
the public welfare investment exclusion and on whether the agencies
should expressly exclude QOFs from the definition of covered fund.\701\
---------------------------------------------------------------------------
\699\ See id.
\700\ See id.
\701\ See id.
---------------------------------------------------------------------------
The final rule revises the public welfare investment exclusion of
the implementing regulations to incorporate issuers explicitly, the
business of which is to make investments that qualify for consideration
under the regulations implementing the CRA.\702\
---------------------------------------------------------------------------
\702\ See Final rule Sec. __.10(c)(11)(ii)(A).
---------------------------------------------------------------------------
To the degree that some banking entities have faced uncertainty
about their ability to make CRA-qualified investments and qualify for
the exclusion, the explicit exclusion for such funds may increase the
willingness of banking entities to intermediate such community
development investments. At the same time, to the degree that banking
entities have financed community development projects eligible for the
CRA through other fund structures and have relied on corresponding
exemptions, the economic effects of the explicit exclusion for CRA-
qualified investments may be limited to the difference in compliance
burdens between the new explicit exclusion and any existing covered
fund exclusions.
Commenters on the 2020 proposal generally favored explicitly
excluding RBICs from the definition of ``covered fund,'' either by
adopting a new exclusion, or by further clarifying the scope of the
public welfare investment exclusion.\703\ The final rule provides a
separate specific exclusion for RBICs, similar to the separate,
specific exclusion for SBICs.\704\ As discussed elsewhere,\705\ RBICs
are intended to promote economic development and the creation of wealth
and job opportunities in rural areas and among individuals living in
such areas,\706\ and their purpose is similar to the purpose of SBICs
and public welfare companies.\707\ Because SBICs and RBICs share the
common purpose of promoting capital formation in their respective
sectors, advisers to SBICs and RBICs are treated similarly under the
Advisers Act (in that they have the opportunity to take advantage of
exemptions from investment adviser registration).\708\ The final rule's
specific exclusion for RBICs should expand the economic effects of the
SBIC exclusion discussed above and may facilitate capital formation by
banking entities in growth stage businesses.
---------------------------------------------------------------------------
\703\ See SIFMA; FSF; and SBIA.
\704\ See supra note 575.
\705\ See supra note 576.
\706\ See U.S. Dep't of Agriculture, Rural Business Investment
Program Overview, available at http://www.rd.usda.gov/programs-services/rural-business-investment-program.
\707\ SBICs are intended to increase access to capital for
growth stage businesses. See U.S. Small Bus. Admin., SBIC Program
Overview, available at https://www.sba.gov/partners/sbics.
\708\ See supra note 578. The private fund adviser exemption
excludes the assets of RBICs and SBICs from counting towards the
$150 million threshold. 15 U.S.C. 80b-3(m).
---------------------------------------------------------------------------
The SEC understands that RBICs may already have been excluded from
the definition of covered fund under the implementing regulations.\709\
For example, RBICs may qualify for the public welfare exclusion under
the implementing regulations or may not be a covered fund by virtue of
relying on an exclusion from the definition of ``investment company''
under the Investment Company Act other than section 3(c)(1) or 3(c)(7).
An express exclusion for RBICs nevertheless should reduce compliance
costs for banking entities, which may otherwise have been required to
conduct a case-by-case analysis of each RBIC to determine whether it
qualifies for an exclusion or exemption under the implementing
regulations.
---------------------------------------------------------------------------
\709\ In addition, RBICs may be excluded from the definition of
``covered fund'' under the qualifying venture capital fund exclusion
in the final rule. See supra note 578.
---------------------------------------------------------------------------
In response to a request for comment in the 2020 proposal,
commenters generally favored explicitly excluding QOFs from the
definition of ``covered fund.'' \710\ The final rule provides a
specific exclusion for QOFs similar to that provided to RBICs.\711\ As
discussed above, the QOF program allows taxpayers to defer and reduce
taxes on capital gains by reinvesting gains in QOFs that are required
to have at least 90 percent of their assets in designated low-income
zones. In this regard, QOFs are similar to SBICs and public welfare
companies. The QOF exclusion should expand the economic effects of the
SBIC exclusion and public welfare exclusion discussed above, and may
facilitate capital formation by banking entities.
---------------------------------------------------------------------------
\710\ See SIFMA; FSF; and ABA.
\711\ Final rule Sec. __.10(c)(11)(iv).
---------------------------------------------------------------------------
QOFs already may have been excluded from the definition of covered
fund under the implementing regulations. For example, QOFs may qualify
for the public welfare exclusion under the implementing regulations or
may not be covered funds by virtue of relying on an exclusion from the
definition of ``investment company'' under the Investment Company Act
other than section 3(c)(1) or 3(c)(7), such as section 3(c)(5)(C).\712\
In addition, depending on the facts and circumstances, an issuer that
holds securities issued by a QOF may not meet the definition of
``investment company'' under section 3(a)(1) of the Investment Company
Act, may be excluded under Rule 3a-1 thereunder, or may qualify for the
exclusion under
[[Page 46488]]
section 3(c)(6) of the Investment Company Act.\713\ The express
exclusion for QOFs, similar to the express exclusion for RBICs, should
reduce compliance costs for banking entities, which may otherwise be
required to conduct a case-by-case analysis of each QOF to determine
whether it qualifies for an exclusion or exemption under the
implementing regulations.
---------------------------------------------------------------------------
\712\ See Opportunity Zone Statement, supra note 581.
\713\ See id.
---------------------------------------------------------------------------
Family Wealth Management Vehicles
As discussed in the 2020 proposal, family wealth management
vehicles commonly engage in asset management activities, as well as
estate planning and other related activities.\714\ The SEC understands
that some banking entities may have been constrained in providing
traditional banking and asset management services, including, for
example, investment advice, brokerage execution, financing, clearing,
and settlement services, to family wealth management vehicles due to
the implementing regulations.\715\ In addition, the SEC understands
that certain family wealth management vehicles that are structured as
trusts may prefer to appoint banking entities as trustees acting in a
fiduciary capacity.\716\
---------------------------------------------------------------------------
\714\ See 85 FR 12170.
\715\ See id.
\716\ See id.
---------------------------------------------------------------------------
In the 2020 proposal, the agencies requested comment on whether to
exclude family wealth management vehicles from the definition of
``covered fund.'' \717\ Several commenters supported this exclusion,
stating generally that it would reduce uncertainty for banking entities
about the permissibility of providing traditional banking, investment
management, and trust and estate planning services to family wealth
management vehicle clients.\718\
---------------------------------------------------------------------------
\717\ See 85 FR 12170.
\718\ See, e.g., Goldman Sachs; FSF; CCMR; IAA; ABA; BPI; PNC;
and SIFMA.
---------------------------------------------------------------------------
As discussed above, the agencies are adopting an exclusion from the
definition of ``covered fund'' for any entity that acts as a ``family
wealth management vehicle.'' By specifically excluding family wealth
management vehicles, the final rule may benefit such banking entities
and their family customers by permitting the banking entities to offer
services to and engage in transactions with family wealth management
vehicle customers.
Importantly, the final rule may benefit family wealth management
vehicles and their investment advisers by increasing the number of
banking entity counterparties willing to provide traditional client-
oriented financial and asset management services. Thus, the final rule
may enhance competition among banking and non-banking entities
providing financial services to family wealth management vehicles and
may lead to more efficient capital allocation of family wealth
management vehicles' funds. To the degree banking entities pass
compliance costs on to customers, family wealth vehicles may experience
costs savings from the final rule as well.
Some commenters on the 2020 proposal opposed the exclusion for
family wealth management vehicles. One commenter stated that rather
than providing an exclusion for family wealth management vehicles
through an agency rulemaking, the agencies should instead provide no-
action relief to such vehicles on a case-by-case basis.\719\ The SEC
believes that such an approach would be unnecessarily burdensome and
difficult to administer. The compliance costs of such an approach could
impact the willingness of banking entities to provide traditional
client-oriented financial and asset management services to their family
customers. This approach would also unnecessarily deviate from the
agencies' treatment of other excluded entities under the implementing
regulations and hinder transparency and consistency.
---------------------------------------------------------------------------
\719\ See Data Boiler.
---------------------------------------------------------------------------
The SEC recognizes that some banking entities may respond to the
exclusion by seeking to structure other entities as family wealth
management vehicles. However, as discussed in detail above, the
exclusion is only available under a number of conditions.\720\
Specifically, if the entity is a trust, the grantor(s) of the entity
must all be family customers; if the entity is not a trust, a majority
of the voting interests in the entity must be owned (directly or
indirectly) by family customers, a majority of the interests in the
entity must be owned by family customers, and the entity must be owned
only by family customers and up to five closely related persons of the
family customers.\721\ Moreover, up to an aggregate 0.5 percent of the
family wealth management vehicle's outstanding ownership interests may
be acquired or retained by one or more entities that are not family
customers or closely related persons for the purpose of and to the
extent necessary for establishing corporate separateness or addressing
bankruptcy, insolvency, or similar concerns.\722\ In addition, banking
entities may rely on this exclusion only if they: (1) Provide bona fide
trust, fiduciary, investment advisory, or commodity trading advisory
services to the entity; \723\ (2) do not, directly or indirectly,
guarantee, assume, or otherwise insure the obligations or performance
of such entity; \724\ (3) comply with the disclosure obligations under
Sec. __.11(a)(8), as if such entity were a covered fund, provided that
the content may be modified to prevent the disclosure from being
misleading and the manner of disclosure may be modified to accommodate
the specific circumstances of the entity; \725\ (4) comply with the
requirements of Sec. Sec. __.14(b) and __.15, as if such entity were a
covered fund; \726\ and (5) except for riskless principal transactions
as defined in Sec. __.10(d)(11), comply with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the entity were an affiliate thereof.\727\
---------------------------------------------------------------------------
\720\ See supra Section IV.C.3. (Family Wealth Management
Vehicles).
\721\ See final rule Sec. __.10(c)(17)(i).
\722\ See final rule Sec. __.10(c)(17)(i)(C).
\723\ See final rule Sec. __.10(c)(17)(ii)(A).
\724\ See final rule Sec. __.10(c)(17)(ii)(B).
\725\ The disclosure content may be modified to prevent the
disclosure from being misleading, and the manner of disclosure may
be modified to accommodate the specific circumstances of the entity.
See final rule Sec. __.10(c)(17)(ii)(C).
\726\ See final rule Sec. __.10(c)(17)(ii)(E).
\727\ See final rule Sec. __.10(c)(17)(ii)(F).
---------------------------------------------------------------------------
The definition of ``family customer'' includes any ``family
client'' as defined in Rule 202(a)(11)(G)-1(d)(4) of the Investment
Advisers Act of 1940, and any natural person who is a father-in-law,
mother-in-law, brother-in-law, sister-in-law, son-in-law or daughter-
in-law of a family client, or a spouse or a spousal equivalent of any
of the foregoing.\728\ The SEC believes that the conditions for the
exclusion and the definition of ``family customer'' will result in
family wealth management vehicles being used as vehicles for providing
customer-oriented financial services on arms-length, market terms,
which the SEC believes will reduce the risk that banking entities'
involvement in these vehicles will give rise to the types of risks that
the covered funds provisions are meant to mitigate.
---------------------------------------------------------------------------
\728\ See final rule Sec. __.10(c)(17)(iii)(B).
---------------------------------------------------------------------------
In the 2020 proposal, the agencies proposed to permit up to three
closely related persons to hold ownership interests in a family wealth
management vehicle. Several commenters supported allowing a finite
number of closely related persons to hold ownership interests, but
suggested that the proposed limit of three did not reflect the typical
manner in which family
[[Page 46489]]
wealth management vehicles are constituted and would unnecessarily
constrain the availability of the exclusion.\729\
---------------------------------------------------------------------------
\729\ See, e.g., BPI; SIFMA; ABA; and PNC.
---------------------------------------------------------------------------
The final rule allows for five closely related persons to hold
ownership interests in a family wealth management vehicle. The agencies
understand that many family wealth management vehicles currently
include more than three closely related persons.\730\ The agencies
believe that the final rule will more closely align the exclusion with
the current composition of family wealth management vehicles, thereby
increasing the utility of the exclusion without allowing such a large
number of non-family customer owners to suggest the entity is in
reality a hedge fund or private equity fund.
---------------------------------------------------------------------------
\730\ See, e.g., BPI; ABA; and PNC.
---------------------------------------------------------------------------
In the 2020 proposal, a banking entity could rely on the family
wealth management vehicle exclusion only if the banking entity and its
affiliates did not acquire or retain, as principal, an ownership
interest in the entity, other than up to 0.5 percent of the entity's
outstanding ownership interests. In addition, such de minimis interest
could be held only for the purpose of and to the extent necessary for
establishing corporate separateness or addressing bankruptcy,
insolvency, or similar concerns.\731\ Some commenters requested that
unaffiliated third parties--such as third-party trustees or similar
service providers--be permitted to hold the de minimis interest.\732\
---------------------------------------------------------------------------
\731\ See 85 FR 12139.
\732\ See, e.g., SIFMA and BPI.
---------------------------------------------------------------------------
As adopted, the final rule allows up to an aggregate 0.5 percent of
the vehicle's outstanding ownership interests to be acquired or
retained by third parties (that is, entities other than family
customers or closely related persons). The SEC believes that permitting
de minimis ownership by these third parties reflects a common structure
of family wealth management vehicles. The SEC recognizes that without
this modification, family wealth management vehicles may be forced to
engage in less effective and/or efficient means of structuring and
organization because the exclusion could limit the vehicle's access to
some customary service providers that have traditionally taken small
ownership interests for structuring purposes. To the extent that a
family customer prefers a particular person or entity to act as a
service provider, allowing third-party service providers to acquire the
de minimis ownership interest may enable the family customer to choose
to establish a family wealth management vehicle. Whether the de minimis
amount is held by a banking entity or some other third party is not
likely to raise any concerns that are not sufficiently addressed by the
aggregate ownership limit and the narrow circumstances in which such de
minimis ownership interest may be held. At the same time, when
circumstances require that a de minimis ownership interest be held
(e.g., for establishing corporate separateness), if the de minimis
ownership interest is held by a third party and not a banking entity,
then no banking entity will be exposed to any risk associated with
holding the interest, however minimal that risk may be.
In the 2020 proposal, banking entities could rely on the family
wealth management vehicle exclusion only if the banking entity complied
with the disclosure obligations under Sec. __.11(a)(8), as if such
vehicle were a covered fund. Commenters on the 2020 proposal requested
that the agencies clarify that the disclosures could be modified (1) to
reflect the specific circumstances of the banking entity's relationship
with, and the particular structure of, its family wealth management
vehicle clients; and (2) to allow the banking entity to satisfy the
written disclosure requirement by means other than including such
disclosures in the governing document(s) of the family wealth
management vehicle(s).
The final rule provides such clarity and change the disclosure
requirement to permit banking entities and their affiliates (1) to
modify the content of such disclosures to prevent them from being
misleading and (2) to modify the manner of disclosure to accommodate
the specific circumstances of the vehicle. The SEC believes that these
disclosures will provide important information to the customers for
whom these vehicles will be established. Because the final rule permits
modification of the disclosures for certain reasons, the SEC expects
that the disclosures provided to any particular family customer will be
more accurate and better tailored to the particular circumstances of
the family wealth management vehicle than the disclosures might have
been under the 2020 proposal. These disclosures may result in the
family customers being better able to understand the information
included in these disclosures and being better able to weigh that
information in determining whether to establish a family wealth
management vehicle. To the extent that these tailored disclosures
assist family customers in determining whether or how to structure a
family wealth management vehicle, they may assist family customers in
deciding how best to receive services from or otherwise interact with
banking entities. The SEC expects that these benefits will justify any
costs incurred by banking entities in tailoring the disclosures of
Sec. __.11(a)(8) or in providing them to customers (either by
including them in existing documents or preparing a new disclosure
document).
The agencies are adopting, with modifications, the condition
requiring a banking entity relying on the exclusion for family wealth
management vehicles to comply with the requirements of 12 CFR
223.15(a), as if such banking entity were a member bank and the vehicle
were an affiliate thereof.\733\ This condition prohibits banking entity
purchases of low-quality assets from these vehicles and is intended to
prevent banking entities from ``bailing out'' family wealth management
vehicles. Several commenters on the 2020 proposal stated that the
agencies should clarify that the exclusion permits banking entities to
engage in riskless principal transactions to purchase assets--including
low quality assets for purposes of section 223.15 of Regulation W--from
family wealth management vehicles.\734\ According to these commenters,
allowing a banking entity to engage in such riskless principal
transactions would facilitate the family customer's sale of
assets,\735\ while posing minimal market or credit risk to the banking
entity because the banking entity would purchase and sell the same
asset contemporaneously.\736\ Furthermore, commenters stated that
absent clarity on the permissiveness of riskless principal
transactions, a family wealth management vehicle would be forced to
obtain the services of a third party service provider to sell low
quality assets, which in turn would increase the vehicle's costs and
operational complexity without providing a meaningful benefit to
furthering the aims of section 13 of the BHC or the implementing
regulations.\737\
---------------------------------------------------------------------------
\733\ See final rule Sec. __.10(c)(17)(ii)(F). 12 CFR 223.15(a)
provides that a member bank may not purchase a low-quality asset
from an affiliate unless, pursuant to an independent credit
evaluation, the member bank had committed itself to purchase the
asset before the time the asset was acquired by the affiliate. 12
CFR 223.15(a).
\734\ See, e.g., BPI and SIFMA.
\735\ See, e.g., SIFMA.
\736\ See, e.g., SIFMA and BPI.
\737\ See, e.g., SIFMA.
---------------------------------------------------------------------------
The SEC believes that permitting a banking entity to engage in
riskless principal transactions that involve the purchase of low-
quality assets from a
[[Page 46490]]
family wealth management vehicle is unlikely to pose a substantive risk
of evading section 13 of the BHC Act. Accordingly, in a change from the
2020 proposal and in response to the concerns raised by commenters, the
condition will explicitly exclude from the requirements of 12 CFR
223.15(a) transactions that meet the definition of riskless principal
transactions as defined in Sec. __.10(d)(11). The SEC expects that,
together, the adopted criteria for the family wealth management vehicle
exclusion will prevent a banking entity from being able to bail out
such vehicles in periods of financial stress or otherwise expose the
banking entity to the types of risks that the covered fund provisions
of section 13 were intended to address.
Alternative forms of relief with respect to family wealth
management vehicles--for example, alternatives that define ``family
customers'' more broadly or narrowly, or that remove some of the
conditions for the exclusion--would have increased or reduced the
availability of the exclusion relative to the final rule.
Alternatively, the agencies could have amended the limitations on
relationships with a covered fund to permit banking entity transactions
with family wealth management vehicles that would otherwise be
considered covered transactions (e.g., ordinary extensions of credit)
without subjecting them to 12 CFR 223.15(a) or section 23B of the
Federal Reserve Act, as if such banking entity were a member bank and
such family wealth management vehicle were an affiliate thereof.
Broader (narrower) alternative forms of relief may have increased
(decreased) the magnitude of the economic benefits for capital
formation, allocative efficiency, and the ability of banking entities
to provide traditional customer oriented services to family wealth
management vehicles. At the same time, such broader relief may have
increased the risk that some banking entities would have responded to
such relief by attempting to evade the intent of the rule, increasing
the volume of their activities with family wealth management vehicles.
Such risks of the alternatives, as compared to the exclusion contained
in the final rule, may have been mitigated by the fact that banking
entities would have remained subject to the full scope of broker-dealer
and prudential capital, margin, and other rules aimed at facilitating
safety and soundness. Nonetheless, by providing relief that is narrower
than the broader alternative, the final rule should reduce those
possible risks even further. Moreover, as discussed above, the SEC
believes that traditional banking and asset management services
involving family wealth management vehicles in general do not involve
the types of risks that section 13 of the BHC Act was designed to
address.\738\ Accordingly, any narrower relief than that provided by
the final rule with respect to family wealth management vehicles may
have constrained the economic benefits of the final rule (including
with respect to capital formation and allocative efficiency)
unnecessarily.
---------------------------------------------------------------------------
\738\ See supra Section IV.C.3. (Customer Facilitation
Vehicles).
---------------------------------------------------------------------------
Customer Facilitation Vehicles
As discussed in the 2020 proposal, the SEC has received comments
that, because of the implementing regulations' covered fund
restrictions, some banking entities have been unable to engage in
traditional banking and asset management services with respect to
vehicles provided for customers, even though banking entities are
otherwise able to provide such exposures and services to customers
directly (outside of the fund structure).\739\ The SEC has also
received comment that some clients, particularly clients in markets
such as Brazil, Germany, Hong Kong, and Japan, prefer to transact with
or through such vehicles rather than banking entities directly because
of a variety of legal, counterparty risk management, and accounting
factors.\740\ Moreover, the SEC is aware that limitations of the
implementing regulations on the activities of such vehicles may have
disrupted client relationships, reducing the efficiency of customer-
facing financial services, and raising compliance costs of banking
entities.\741\
---------------------------------------------------------------------------
\739\ See 85 FR 12171.
\740\ See id.
\741\ See id.
---------------------------------------------------------------------------
The final rule establishes an exclusion from the definition of
``covered fund'' for any issuer that acts as a ``customer facilitation
vehicle.'' The customer facilitation vehicle exclusion will, as
proposed, be available for any issuer that is formed by or at the
request of a customer of the banking entity for the purpose of
providing such customer (which may include one or more affiliates of
such customer) with exposure to a transaction, investment strategy, or
other service provided by the banking entity.\742\
---------------------------------------------------------------------------
\742\ See final rule Sec. __.10(c)(18)(i).
---------------------------------------------------------------------------
A banking entity may only rely on the exclusion with respect to an
issuer provided that: (1) All of the ownership interests of the issuer
are owned by the customer (which may include one or more of its
affiliates) for whom the issuer was created; \743\ and (2) the banking
entity and its affiliates: (i) Maintain documentation outlining how the
banking entity intends to facilitate the customer's exposure to such
transaction, investment strategy, or service; (ii) do not, directly or
indirectly, guarantee, assume, or otherwise insure the obligations or
performance of such issuer; (iii) comply with the disclosure
obligations under Sec. __.11(a)(8), as if such issuer were a covered
fund, provided that the content may be modified to prevent the
disclosure from being misleading and the manner of disclosure may be
modified to accommodate the specific circumstances of the issuer; (iv)
do not acquire or retain, as principal, an ownership interest in the
issuer, other than up to an aggregate 0.5 percent of the issuer's
outstanding ownership interests for the purpose of and to the extent
necessary for establishing corporate separateness or addressing
bankruptcy, insolvency, or similar concerns; (v) comply with the
requirements of Sec. Sec. __.14(b) and __.15, as if such issuer were a
covered fund; and (vi) except for riskless principal transactions as
defined in Sec. __.10(d)(11), comply with the requirements of 12 CFR
223.15(a), as if such banking entity and its affiliates were a member
bank and the entity were an affiliate thereof.
---------------------------------------------------------------------------
\743\ Notwithstanding this condition, up to an aggregate 0.5
percent of the issuer's outstanding ownership interests may be
acquired or retained by one or more entities that are not customers
if the ownership interest is acquired or retained by such parties
for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or
similar concerns. See Sec. __.10(c)(18)(ii)(B).
---------------------------------------------------------------------------
The exclusion in the final rule should reduce or eliminate the
costs imposed by the implementing regulations that limit the services
that banking entities can provide to customer facilitation vehicles,
which in turn may limit the activities of these vehicles. These costs
include those associated with the disruption of client relationships
and the reduction in the efficiency of customer-facing financial
services. The final rule should reduce these baseline costs and
inefficiencies by allowing banking entities to provide customer-
oriented financial services through vehicles, the purpose of which is
to provide such customers with exposure to a transaction, investment
strategy, or other service. As a result, banking entities may become
better able to engage in the full range of customer facilitation
activities through special
[[Page 46491]]
purpose vehicles and fund structures, which could benefit banking
entities, their customers, and securities markets more broadly.
Most commenters on the 2020 proposal that addressed this exclusion
were supportive,\744\ stating that it would provide banking entities
with greater flexibility to meet client needs and objectives.\745\ Some
commenters found the exclusion's conditions to be reasonable and
sufficient.\746\ However, two commenters recommended that the agencies
impose additional limitations on the exclusion.\747\ One of these
commenters argued that the exclusion would permit, and possibly
encourage, banking entities to increase their risk exposures through
the use of customer facilitation vehicles, and the agencies should
minimize such risk exposures and promote risk monitoring and
management.\748\
---------------------------------------------------------------------------
\744\ See, e.g., SIFMA; BPI; ABA; Credit Suisse; FSF; Goldman
Sachs; and IAA.
\745\ See, e.g., SIFMA; BPI; ABA; and Goldman Sachs.
\746\ See, e.g., SIFMA; FSF; and SAF.
\747\ See Better Markets and Data Boiler.
\748\ See Better Markets.
---------------------------------------------------------------------------
In the 2020 proposal, banking entities could rely on the customer
facilitation vehicle exclusion only if the banking entity complied with
the disclosure obligations under Sec. __.11(a)(8), as if such vehicle
were a covered fund. Commenters on the 2020 proposal requested that the
agencies provide clarification in the context of family wealth
management vehicles that the content of the disclosure may be modified
to prevent the disclosure from being misleading and the manner of
disclosure may be modified to accommodate the specific circumstances of
the issuer.
As with family wealth management vehicles, the final rule includes
a modification to the proposed exclusion clarifying that the content of
the disclosure may be modified to accommodate the specific
circumstances of the issuer.\749\ The SEC believes that these
disclosures will provide important information to the customers for
whom these vehicles will be used to provide services--whether they are
family customers under the family wealth management vehicle exclusion
or other customers under this exclusion. As discussed above with
respect to family wealth management vehicles, the SEC believes that the
clarification in the final rule regarding permissible modifications of
the disclosures required by Sec. __.11(a)(8) will provide benefits
that will justify any costs from tailoring and providing the
disclosures.
---------------------------------------------------------------------------
\749\ See final rule Sec. __.10(c)(18)(ii)(C)(3).
---------------------------------------------------------------------------
In the 2020 proposal, as with family wealth management vehicles, a
banking entity could rely on the customer facilitation vehicle
exclusion only if the banking entity and its affiliates did not acquire
or retain, as principal, an ownership interest in the entity, other
than up to 0.5 percent of the entity's outstanding ownership interests.
In addition, such de minimis interest could be held only for the
purpose of and to the extent necessary for establishing corporate
separateness or addressing bankruptcy, insolvency, or similar
concerns.\750\ As with family wealth management vehicles, commenters
suggested that the agencies specifically allow any party that is
unaffiliated with the customer, rather than only the banking entity and
its affiliates, to own this de minimis interest.\751\
---------------------------------------------------------------------------
\750\ See 85 FR 12139.
\751\ See SIFMA; BPI; and FSF.
---------------------------------------------------------------------------
As adopted, the final rule allows up to an aggregate 0.5 percent of
the vehicle's outstanding ownership interests to be acquired or
retained by third parties (that is, entities other than the customer)
if the ownership interest is acquired or retained by such parties for
the purpose of and to the extent necessary for establishing corporate
separateness or addressing bankruptcy, insolvency, or similar
concerns.\752\ The SEC recognize that without this modification,
customer facilitation vehicles may be forced to engage in less
effective and/or efficient means of structuring and organization
because the exclusion could limit the vehicle's access to some
customary service providers that have traditionally taken or may
otherwise take small ownership interests for structuring purposes. To
the extent that a customer prefers a particular person or entity to act
as a service provider, allowing third-party service providers to
acquire the de minimis ownership interest may make the customer more
willing to establish a customer facilitation vehicle. Whether the de
minimis amount is held by a banking entity or some other third party is
not likely to raise any concerns that are not sufficiently addressed by
the aggregate ownership limit and the narrow circumstances in which the
de minimis ownership interest may be held.
---------------------------------------------------------------------------
\752\ See final rule Sec. __.10(c)(18)(ii)(B).
---------------------------------------------------------------------------
The SEC recognizes that the provision of financial services related
to customer facilitation vehicles may involve market risk, and the
exclusion in the final rule may enable banking entities to provide a
greater array of financial services to, and otherwise transact with,
such vehicles. The SEC believes that such risks may be mitigated by at
least two of the conditions of the exclusion. First, similar to the
family wealth management vehicle discussed above, other than the de
minimis ownership interest, a banking entity and its affiliates may not
acquire or retain, as principal, any ownership in interest in the
issuer.\753\ Second, a banking entity and its affiliates may not
directly or indirectly guarantee, assume, or otherwise insure the
obligations or performance of the vehicle.\754\ These conditions, among
the other conditions of the exclusion, may mitigate risks that may be
borne by individual banking entities and by banking entities as a whole
as a result of the exclusion, and may facilitate banking entities'
ongoing compliance with section 13 of the BHC Act and the final rule.
Moreover, the SEC continues to believe that the provision of customer-
oriented financial services by banking entities may benefit customers,
counterparties, and securities markets.
---------------------------------------------------------------------------
\753\ Final rule Sec. __.10(c)(18)(ii)(B)(4).
\754\ Final rule Sec. __.10(c)(18)(ii)(B)(2).
---------------------------------------------------------------------------
The final rule creates new recordkeeping requirements for a banking
entity that relies on the exclusion for customer facilitation
vehicles.\755\ Specifically, the banking entity and its affiliates must
maintain documentation outlining how the banking entity intends to
facilitate the customer's exposure to a transaction, investment
strategy or service offered by the banking entity. As discussed in
Section V.B \756\ and above, these recordkeeping burdens may impose a
total initial burden of $1,078,650 \757\ and a total ongoing annual
burden of 1,0798,650.\758\
---------------------------------------------------------------------------
\755\ Final rule Sec. __.10(c)(18)(ii)(B)(1).
\756\ See supra note 585.
\757\ See supra note 586.
\758\ See supra note 587.
---------------------------------------------------------------------------
The agencies are adopting, with modifications, the condition
requiring a banking entity relying on the exclusion for customer
facilitation vehicles to comply with the requirements of 12 CFR
223.15(a), as if such banking entity were a member bank and the vehicle
were an affiliate thereof.\759\ The purpose of the proposed requirement
that a customer facilitation vehicle must comply with 12 CFR 223.15(a)
was the same for both the family wealth management vehicle and the
customer facilitation vehicle
[[Page 46492]]
exclusions--to help ensure that the exclusions do not allow banking
entities to ``bail out'' either vehicle.\760\ For the same reasons
discussed above with respect to family wealth management vehicles, the
agencies have modified the requirement to exclude from the requirements
of 12 CFR 223.15(a) any transactions that meet the definition of
riskless principal transactions as defined in Sec. __.10(d)(11).
---------------------------------------------------------------------------
\759\ See final rule Sec. __.10(c)(18)(ii)(C)(6). 12 CFR
223.15(a) provides that a member bank may not purchase a low-quality
asset from an affiliate unless, pursuant to an independent credit
evaluation, the member bank had committed itself to purchase the
asset before the time the asset was acquired by the affiliate. 12
CFR 223.15(a).
\760\ See 85 FR 12140.
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As with the discussion of family wealth management vehicles above,
the SEC believes that the ability of a banking entity to engage in
riskless principal transactions with a customer facilitation vehicle
will lower costs for the vehicle by allowing it to avoid finding a
third party to intermediate trades for low quality assets. At the same
time, allowing these riskless principal transactions should not pose
the type of risk to the banking entity that section 13 of the BHC Act
was intended to prevent. The SEC expects that the conditions for the
customer facilitation vehicle exclusion will prevent a banking entity
from being able to bail out such vehicles in periods of financial
stress or otherwise expose the banking entity to the types of risks
that the covered fund provisions of section 13 were intended to
address.
The agencies considered alternative forms of relief with respect to
customer facilitation vehicles. For example, the agencies could have
adopted a higher third party ownership limit (of, for example, 5% or
10%). Alternatively, the agencies could have adopted a 0.5% ownership
interest limit, but without specifying a list of purposes for which
such interest may be held, leading to banking entities accumulating
greater ownership interests in such vehicles. As another example, the
agencies could have adopted an exclusion for customer facilitation
vehicles without subjecting the banking entity relying on the exclusion
to 12 CFR 223.15(a) or section 23B of the Federal Reserve Act, as if
such banking entity were a member bank and such customer facilitation
vehicles were an affiliate thereof. Such alternatives would have
removed or loosened the conditions of the exclusion, which may have
increased the risk that customer facilitation vehicles could be used
for evasion purposes or could have exposed banking entities to
additional risk, but could also have further reduced compliance burdens
and provided greater flexibility to banking entities and their
customers.
ii. Limitations on Relationships Between Banking Entities and Covered
Funds
As discussed above, under the implementing regulations, banking
entities that either: (1) Serve, directly or indirectly, as a sponsor,
investment adviser, commodity trading advisor, or investment manager to
a covered fund; (2) organize and offer a covered fund under Sec.
__.11; or (3) hold an ownership interest under Sec. __.11(b) have been
unable to engage in any covered transactions with such funds.\761\ This
prohibition may have limited the services that such banking entities
and their affiliates have been able to provide to certain entities that
are covered funds under the implementing regulations. For example, as
noted above, banking entities have been significantly limited in their
ability to both organize and offer a covered fund, as well as to
provide custody or other services to the fund.
---------------------------------------------------------------------------
\761\ See 12 U.S.C. 1851(f)(1).
---------------------------------------------------------------------------
The final rule permits a banking entity to engage in certain
covered transactions with a related covered fund that would be exempt
from the quantitative limits, collateral requirements, and low-quality
asset prohibition under section 23A of the Federal Reserve Act,
including certain transactions that would be exempt pursuant to section
223.42 of the Board's Regulation W.\762\ In addition, the final rule
authorizes banking entities to engage in certain transactions, such as
extensions of intraday credit for purchases of assets from covered
funds in connection with payment, clearing, and settlement
services.\763\ Finally, in a modification from the 2020 proposal, the
final rule expressly permits banking entities to enter into certain
riskless principal transactions with a related covered fund, including
in circumstances where the covered fund is not a ``securities
affiliate.'' \764\
---------------------------------------------------------------------------
\762\ See final rule Sec. __.14(a)(2)(iii).
\763\ See final rule Sec. __.14(a)(2)(v).
\764\ See final rule Sec. __.14(a)(2)(iv).
---------------------------------------------------------------------------
As discussed in the 2020 proposal, the SEC received comment
suggesting that section 13(f)(1) of the BHC Act should be interpreted
to include the exemptions provided under section 23A of the Federal
Reserve Act, and that banking entities should be permitted to engage in
a limited amount of covered transactions with related covered
funds.\765\ The SEC recognizes that outsourcing such activities to
third parties may have adversely affected customer relationships,
increasing costs and decreasing operational efficiency for banking
entities and covered funds. The final rule provides banking entities
greater flexibility to provide these and other services directly to
covered funds. If being able to provide custody, clearing, and other
services to related covered funds reduces the costs of these services
and risks of operational failure of fund custodians, then fund advisers
and, indirectly, fund investors, may benefit from the final rule. Many
direct benefits are likely to accrue to banking entity advisers to
covered funds that have been relying on third-party service providers
as a result of the requirements of the implementing regulations.
---------------------------------------------------------------------------
\765\ See 85 FR 12144.
---------------------------------------------------------------------------
The final rule includes a standalone provision that permits banking
entities to enter into riskless principal transactions with a related
covered fund, including in circumstances where the covered fund is not
a ``securities affiliate.'' The 2020 proposal would have permitted a
banking entity to enter into a riskless principal transaction with a
covered fund provided it met the criteria in Regulation W. The SEC
believes that providing a standalone exception will provide clarity and
certainty to banking entities about the extent to which they are able
to enter into riskless principal transactions with related covered
funds. In addition, by permitting more riskless principal transactions
than would have been the case under the 2020 proposal (i.e., those that
do not or may not meet the criteria of Regulation W), the final rule
may facilitate banking entities entering into more of these
transactions than they would have, reducing the likelihood that the
covered fund would incur additional costs in buying or selling
securities.\766\ As described above, in a riskless principal
transaction, the riskless principal (the banking entity) buys and sells
the same security contemporaneously, and the asset risk passes promptly
from the affiliate (the related covered fund) through the riskless
principal to a third party. Accordingly, the SEC does not believe that
an increase in riskless principal transactions overall will increase
the risks borne by any particular banking entity or banking entities in
general.
---------------------------------------------------------------------------
\766\ As discussed above, the final rule includes a definition
of riskless principal transaction that is similar to the definition
adopted in Regulation W. To the extent these definitions are
sufficiently similar, the SEC expects that compliance costs will be
low for banking entities seeking to enter into riskless principal
transactions with related covered funds.
---------------------------------------------------------------------------
The final rule increases banking entities' ability to engage in
custody, clearing, and other transactions with related covered funds
and will benefit banking entities that have been unable
[[Page 46493]]
to engage in otherwise profitable or efficient activities with related
covered funds. Moreover, this may enhance operational efficiency and
reduce operational risks and costs incurred by covered funds, which
have been unable to rely on banking entities with which they have
certain relationships for custody, clearing, and other transactions. As
discussed above, reducing operational risk as well as the
interconnectedness between financial firms that would result from such
services being provided by the banking entities and their affiliates,
would promote the financial stability of the U.S. financial
system.\767\
---------------------------------------------------------------------------
\767\ See supra Section IV.D. (Limitations on Relationships with
a Covered Fund).
---------------------------------------------------------------------------
In the 2020 proposal, the SEC discussed a prior comment that
opposed incorporating the Federal Reserve Act section 23A exemptions or
quantitative limits.\768\ To the extent that the final rule may
increase transactions between banking entities and related covered
funds, banking entities could incur risks associated with these
transactions. However, as discussed above, the final rule imposes a
number of conditions aimed at reducing overall risks to banking
entities, the ability of banking entities to lever up related covered
funds, and the incentive of banking entities to bail out related
covered funds, while enhancing their ability to provide ordinary-course
banking, custody, and asset management services, and to facilitate
capital formation in covered funds.
---------------------------------------------------------------------------
\768\ See 85 FR 12172.
---------------------------------------------------------------------------
The agencies could have adopted broader or narrower forms of
relief. For example, in addition to the relief under the final rule,
the agencies could have permitted banking entities to engage in
additional covered transactions in connection with payment, clearing,
and settlement services beyond extensions of credit and purchases of
assets. Further, under the final rule, each extension of credit must be
repaid, sold, or terminated by the end of five business days.\769\ As
another alternative, the agencies could have allowed extensions of
credit in connection with payment transactions, clearing, or settlement
services for periods that are longer than five business days. However,
the five business day criteria is consistent with the federal banking
agencies' capital rule and generally requires banking entities to rely
on transactions with normal settlement periods, which have lower risk
of delayed settlement or failure, when providing short-term extensions
of credit.\770\ In addition, the agencies could have imposed
quantitative limits on the newly permitted covered transactions tied to
bank capital or fund size. Relative to the final rule, alternatives
providing greater relief with respect to covered transactions with
covered funds could have magnified the cost savings and operational
risk benefits described above, but may also have increased risk to
banking entities or the incentives for banking entities to bail out
related covered funds. Similarly, narrower alternative forms of relief
may have dampened the economic effects of the final rule discussed
above.
---------------------------------------------------------------------------
\769\ See final rule Sec. __.14(a)(2)(iv)(B).
\770\ See supra note 435.
---------------------------------------------------------------------------
iii. Definition of Ownership Interest
As discussed above, the implementing regulations define ``ownership
interest'' in a covered fund to mean any equity, partnership, or
``other similar interest.'' This definition focuses on the attributes
of the interest and whether it provides a banking entity with voting
rights or economic exposure to the profits and losses of the covered
fund, rather than its form. ``Other similar interest'' is defined, in
part, as an interest that:
``Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors
or trustees, investment manager, investment adviser, or commodity
trading advisor of the covered fund (excluding the rights of a
creditor to exercise remedies upon the occurrence of an event of
default or an acceleration event).'' \771\
---------------------------------------------------------------------------
\771\ See implementing regulations Sec. __.10(d)(6)(i)(A). See
also supra Section IV.E.1. (Ownership Interest).
As discussed in the 2020 proposal, the SEC has received comment
that the implementing regulations' definition of ownership interest has
captured instruments that do not have equity-like features and
constrained banking entity investments in debt securitizations and
client facilitation services.\772\ For example, one commenter indicated
that analyzing the ownership interest definition in the context of
securitizations had resulted in added time and costs of executing
transactions, as well as impeded securitization transactions.\773\
Moreover, the commenter indicated that the ``other similar interest''
prong of the definition precluded some banking entities from investing
in collateralized loan obligation (CLO) senior debt instruments, which
affects lending to CLOs, and that banking entities with pre-existing
CLO exposures have had to waive credit-enhancing remedies to avoid
triggering the ownership interest restrictions.\774\ In addition, the
SEC received comment that the ownership interest definition in the
implementing regulations may have required an extensive legal analysis
and documentation review and that, as a result, some banking entities
may have defaulted to treating interests without controlling positions
or equity-like features as ownership interests.\775\
---------------------------------------------------------------------------
\772\ See 85 FR 12173.
\773\ See id.
\774\ See id.
\775\ See id.
---------------------------------------------------------------------------
The final rule modifies the definition of ownership interest in
several ways. First, the final rule moves the existing exclusion from
the definition of ``other similar interest'' in Sec. __.10(d)(6)(A)
(``for the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event'') from the
parenthetical to its own provision.\776\ The final rule also creates a
new exclusion, for ``the right to participate in the removal of an
investment manager for ''cause'' or participate in the selection of a
replacement manager upon an investment manager's resignation or
removal.'' \777\
---------------------------------------------------------------------------
\776\ See final rule Sec. __.10(d)(6)(i)(A)(1).
\777\ See final rule Sec. __.10(d)(6)(i)(A)(2).
---------------------------------------------------------------------------
Commenters on the 2020 proposal asserted that creditors' rights are
also provided to debt holders in circumstances other than an event of
default or acceleration. These commenters therefore recommended the
proposed exclusion be expanded to include additional for cause events
that are independent of an event of default or acceleration, such as
the insolvency of the investment manager or breach of the investment
management or collateral management agreement.\778\ The final rule
reflects those comments and provide clarity about the types of creditor
rights that may attach to an interest without that interest being
deemed an ownership interest. In particular, under Sec.
__.10(d)(6)(A)(2), the definition of ownership interest does not
include rights of an interest that allows a creditor to participate in
the removal of an investment manager for ``cause.'' The final rule
defines ``cause'' for removal to mean one or more of the following
events:
---------------------------------------------------------------------------
\778\ See SIFMA.
---------------------------------------------------------------------------
(1) The bankruptcy, insolvency, conservatorship or receivership of
the investment manager;
(2) The breach by the investment manager of any material provision
of the covered fund's transaction agreements applicable to the
investment manager;
(3) The breach by the investment manager of material
representations or warranties;
[[Page 46494]]
(4) The occurrence of an act that constitutes fraud or criminal
activity in the performance of the investment manager's obligations
under the covered fund's transaction agreements;
(5) The indictment of the investment manager for a criminal
offense, or the indictment of any officer, member, partner or other
principal of the investment manager for a criminal offense materially
related to his or her investment management activities;
(6) A change in control with respect to the investment manager;
(7) The loss, separation or incapacitation of an individual
critical to the operation of the investment manager or primarily
responsible for the management of the covered fund's assets; or
(8) Other similar events that constitute ``cause'' for removal of
an investment manager, provided that such events are not solely related
to the performance of the covered fund or to the investment manager's
exercise of investment discretion under the covered fund's transaction
agreements.
The final rule also modifies the definition of ownership interest
to add to the list of interests that are excluded from the definition
of ownership interest. Specifically, the final rule provides a safe
harbor excluding any senior loan or senior debt interest that has
specific characteristics.\779\ Those characteristics are: (1) Under the
terms of the interest, the holders do not have the right to receive a
share of the income, gains, or profits of the covered fund, but are
entitled to receive only certain interest and fees, and repayment of a
fixed principal amount on or before a maturity date in a contractually-
determined manner (which may include prepayment premiums intended
solely to reflect, and compensate holders of the interest for, forgone
income resulting from an early prepayment); (2) the entitlement to
payments is absolute and cannot be reduced because of the losses
arising from the covered fund's underlying assets; and (3) the holders
of the interest are not entitled to receive the underlying assets of
the covered fund after all other interests have been redeemed or paid
in full (excluding the rights of a creditor to exercise remedies upon
the occurrence of an event of default or an acceleration event).\780\
---------------------------------------------------------------------------
\779\ See final rule Sec. __.10(d)(6)(ii)(B).
\780\ See id. See also, supra Section IV.E.1. (Ownership
Interest).
---------------------------------------------------------------------------
The final rule should simplify the analysis banking entities must
perform to determine whether they have an ownership interest under
section 13 of the BHC Act and the final rule. Moreover, to the degree
that banking entities may have responded to the ownership interest
definition in the implementing regulations by reducing their
investments in certain debt instruments, the final rule may result in
greater banking entity investments in covered funds and a greater
ability of covered funds to allocate capital to the underlying assets.
The SEC recognizes that such debt instrument investments carry
risk,\781\ and that the risks and returns of such investments flow
through to banking entities' shareholders. While the final rule's
ownership interest definition may permit banking entities to increase
exposures to certain debt instruments, three key considerations may
mitigate the risks associated with such activities. First, the final
rule does not change any of the applicable prudential capital, margin,
or liquidity requirements intended to ensure safety and soundness of
banking entities. Second, to the degree that the ownership interest
definition has actually discouraged banking entities from obtaining
credit enhancements to avoid triggering the ownership interest
restrictions, the final rule may result in banking entities receiving
credit enhancements that reduce the risk of the debt instrument or loan
and are therefore stronger than what banking entities may have received
in the absence of the final rule. Finally, the final rule includes a
number of conditions and restrictions aimed at reducing the risk to
banking entities while facilitating traditional lending activity.
---------------------------------------------------------------------------
\781\ See Occupy.
---------------------------------------------------------------------------
The agencies could have adopted broader relief by limiting the
particular forms of a banking entity's interest (e.g., equity or
partnership shares) that would qualify as an ownership interest or by
limiting the definition of ownership interest to ``voting securities''
as defined by the Board's Regulation Y. By providing broader relief
relative to the final rule, such an alternative may have produced
greater reductions in uncertainty and compliance burdens, and a greater
willingness of banking entities to become involved in certain debt
transactions. However, such greater involvement in certain debt
transactions may also have given rise to greater risks being borne by
banking entities. The final rule is intended to provide sufficient
safeguards and limitations to prevent banking entities from acquiring
interests in covered funds that run counter to the intentions of the
implementing regulations and limit a banking entity's exposure to the
economic risks of covered funds and their underlying assets, while
reducing compliance uncertainty and increasing the willingness of
banking entities to participate in covered funds.
iv. Parallel Investments
As discussed above, the preamble to the 2013 rule stated that if a
banking entity makes investments side by side in substantially the same
positions as a covered fund, then the value of such investments would
be included for the purposes of determining the value of the banking
entity's investment in the covered fund.\782\ The agencies also stated
that a banking entity that sponsors a covered fund should not make any
additional side-by-side co-investment with the covered fund in a
privately negotiated investment unless the value of such co-investment
is less than three percent of the value of the total amount co-invested
by other investors in such investment.\783\
---------------------------------------------------------------------------
\782\ See supra Section IV.F. (Parallel Investments) and
references therein.
\783\ See id.
---------------------------------------------------------------------------
As discussed in the 2020 proposal, the SEC has received comment
that argued the implementing regulations should not impose a limit on
parallel investments and noted that such a restriction is not reflected
in the text of the 2013 rule.\784\ The final rule includes a rule of
construction that (1) a banking entity will not be required to include
in the calculation of the investment limits under Sec. __.12(a)(2) any
investment the banking entity makes alongside a covered fund, as long
as the investment is made in compliance with applicable laws and
regulations, and (2) a banking entity shall not be restricted in the
amount of any investment the banking entity makes alongside a covered
fund as long as the investment is made in compliance with applicable
laws and regulations, including applicable safety and soundness
standards.\785\
---------------------------------------------------------------------------
\784\ See 85 FR 12174.
\785\ See final rule Sec. __.12(b)(5)(i).
---------------------------------------------------------------------------
The SEC recognizes that this rule of construction may increase the
incentive for banking entities to make parallel investments alongside a
covered fund that is organized and offered by the banking entity for
the purposes of artificially maintaining or increasing the value of the
fund's positions. Supporting a fund with a direct investment in such a
manner would increase these banking entities' exposures to the covered
fund's assets and, as discussed above, could be inconsistent with the
final rule's restriction on a banking entity guaranteeing, assuming, or
otherwise
[[Page 46495]]
insuring the obligations or performance of such covered fund.\786\
---------------------------------------------------------------------------
\786\ Id.
---------------------------------------------------------------------------
Further, as stated above, the agencies would expect that any
investments made alongside a covered fund by a director or employee of
a banking entity or its affiliate, if made in compliance with
applicable laws and regulations, would not be treated as an investment
by the director or employee in the covered fund. Accordingly, such an
investment would not be attributed to the banking entity as an
investment in the covered fund, regardless of whether the banking
entity arranged the transaction on behalf of the director or employee
or provided financing for the investment.
The SEC recognizes that the rule of construction may remove a
restriction on investments made alongside a covered fund that may have
interfered with banking entities' ability to make otherwise permissible
investments directly on their balance sheets.\787\ In particular, the
rule of construction may allow banking entities to make parallel
investments alongside their covered funds without including the value
of those parallel investments within the ownership limits imposed on a
banking entity. Similarly, the rule of construction may provide clarity
to banking entities such that they will not be prevented from making
investments alongside their covered funds, as long as those investments
are otherwise permissible under applicable laws and regulations.\788\
In addition to removing impediments for banking entities' otherwise
permissible investments, the rule of construction in the final rule may
enable banking entities to make investments alongside a covered fund
that will credibly signal the banking entity's view of the quality of
the investment(s) to investors in the fund, and may also help align the
incentives of banking entities, and their directors and employees, with
those of the covered funds and their investors.
---------------------------------------------------------------------------
\787\ See supra note 784.
\788\ See id.
---------------------------------------------------------------------------
4. Efficiency, Competition, and Capital Formation
As discussed above, the final rule excludes certain groups of
private funds and other entities from the scope of the covered fund
definition and modifies other covered fund restrictions applicable to
banking entities subject to the final rule. Moreover, the final rule
reduces compliance obligations of banking entities subject to the final
rule. The SEC believes that the final rule may impact competition,
capital formation, and allocative efficiency.
The final rule may have three groups of competitive effects. First,
the final rule may make it easier for bank affiliated broker-dealers,
SBSDs, and RIAs to compete with bank unaffiliated broker-dealers,
SBSDs, and RIAs in their activities with certain groups of private
funds and other entities. Second, the final rule may reduce competitive
disparities between banking entities subject to the final rule and
affected by the final rule, and banking entities that are not. Third,
certain aspects of the final rule (such as those related to foreign
excluded funds and foreign public funds) may reduce competitive
disparities between U.S. banking entities and foreign banking entities
in their covered fund activities. Because competition may reduce costs
or increase quality, and because some affected banking entities may
face economies of scale or scope in the provision of services to
certain private funds, these competitive effects may flow through to
customers, clients, and investors in the form of reduced transaction
costs and greater quality of private fund and other offerings and
related financial services.
The final rule may also impact capital formation. For example, by
reducing the scope of application of covered fund restrictions in the
final rule, the final rule relaxes restrictions related to banking
entity underwriting and market-making of certain private funds.
Moreover, the final rule modifies certain restrictions related to
banking entity relationships with certain covered funds. Further, as
discussed above, the final rule enables banking entities to engage
indirectly (through a fund structure) in certain of the same activities
that they are currently able to engage in directly (extending credit or
direct ownership stakes). To the degree that the implementing
regulations impede or otherwise constrain banking entity activities in
such funds, the final rule may result in a greater number of such
private funds being launched by banking entities, increasing capital
formation via private funds. The effects of the final rule on capital
formation are likely to flow through to investors (in the form of
greater availability or variety or private funds available for
investors) as well as an increase in the supply of capital available to
firms seeking to raise capital or obtain financing from private
funds.\789\
---------------------------------------------------------------------------
\789\ For example, the final rule could result in additional
venture capital being available in geographic areas where it has
been relatively less available. See supra Section V.F.3.i. (Venture
Capital Funds).
---------------------------------------------------------------------------
The possible effects of the final rule on allocative efficiency are
related to the final rule's likely impact on capital formation.
Specifically, as discussed above, the SEC believes that the final rule
may result in a greater number and variety of private funds launched by
banking entities. To the degree that banking entities may be able to
provide superior private funds due to their expertise or economies of
scale or scope, and to the degree that fund structures may be more
efficient than direct investments (due to, e.g., superior risk sharing
and pooling of expertise across fund investors), the final rule may
enhance the ability of market participants, investors, and issuers to
allocate their capital efficiently.
The SEC recognizes that the final rule may increase the ability of
banking entities to engage in certain types of activities involving
risk, and that increases in risk exposures of large groups of banking
entities may negatively impact capital formation, securities markets,
and the real economy, particularly during times of adverse economic
conditions. Moreover, losses on investment portfolios may discourage
capital market participation by various groups of investors. Three
important considerations may mitigate these potential risks. First, as
discussed throughout this economic analysis, banking entities already
engage in a variety of permissible activities involving risk, including
extensions of credit, underwriting, and market-making, and the
activities of many types of private funds that are excluded under the
final rule largely replicate permissible and traditional activities of
banking entities. Second, banking entities subject to the final rule
may also be subject to multiple prudential capital, margin, and
liquidity requirements that facilitate the safety and soundness of
banking entities and promote financial stability. Third, the additional
exclusions from the definition of covered fund each include a number of
conditions aimed at preventing evasion of section 13 of the BHC Act and
the final rule, promoting safety and soundness, and/or allowing for
customer oriented financial services provided on arms-length, market
terms.
Under the final rule, a banking entity is not prohibited from
acquiring or retaining an ownership interest in, or acting as sponsor
to, a covered fund if the banking entity organizes or offers the
covered fund and satisfies other requirements. One such requirement is
that the banking entity provide specified disclosures to prospective
and actual
[[Page 46496]]
investors in the covered fund.\790\ Under the final rule, banking
entities must provide the disclosures specified by Sec. __.11(a)(8) to
satisfy the exclusions for family wealth management vehicles and
customer facilitation vehicles and to satisfy the exclusions for credit
funds and venture capital funds if the banking entity is a sponsor,
investment adviser, or commodity trading advisor of the fund. To the
extent that the final rule leads banking entities to establish or
provide services to more of these vehicles, the volume of information
available to market participants could increase. Specifically, if
banking entities respond to the final rule by establishing or providing
services to more of these vehicles because they are excluded from the
definition of ``covered fund,'' then the amount of such disclosures
would increase accordingly.
---------------------------------------------------------------------------
\790\ Implementing regulations Sec. __.11(a)(8).
---------------------------------------------------------------------------
Importantly, the magnitude of all of the above effects on
competition, capital formation, and allocative efficiency will be
influenced by a large number of factors, such as prevailing
macroeconomic conditions, the financial condition of firms seeking to
raise capital, and of funds seeking to transact with banking entities,
market saturation, and search for higher yields by investors during low
interest rate environments. Moreover, the relative efficiency between
fund structures and the direct provision of capital is likely to vary
widely among banking entities and funds. The SEC recognizes that such
economic effects may be dampened or magnified in different phases of
the macroeconomic cycle and across various types of banking entities.
G. Congressional Review Act
For the OCC, Board, FDIC, SEC, and CFTC, the Office of Information
and Regulatory Affairs, pursuant to the Congressional Review Act, has
designated this rule as a ``major rule'' as defined by 5 U.S.C. 804(2).
List of Subjects
12 CFR Part 44
Banks, Banking, Compensation, Credit, Derivatives, Government
securities, Insurance, Investments, National banks, Penalties,
Reporting and recordkeeping requirements, Risk, Risk retention,
Securities, Trusts and trustees.
12 CFR Part 248
Administrative practice and procedure, Banks, banking, Conflict of
interests, Credit, Foreign banking, Government securities, Holding
companies, Insurance, Insurance companies, Investments, Penalties,
Reporting and recordkeeping requirements, Securities, State nonmember
banks, State savings associations, Trusts and trustees.
12 CFR Part 351
Banks, Banking, Capital, Compensation, Conflicts of interest,
Credit, Derivatives, Government securities, Insurance, Insurance
companies, Investments, Penalties, Reporting and recordkeeping
requirements, Risk, Risk retention, Securities, Trusts and trustees.
17 CFR Part 75
Banks, Banking, Compensation, Credit, Derivatives, Federal branches
and agencies, Federal savings associations, Government securities,
Hedge funds, Insurance, Investments, National banks, Penalties,
Proprietary trading, Reporting and recordkeeping requirements, Risk,
Risk retention, Securities, Swap dealers, Trusts and trustees, Volcker
rule.
17 CFR Part 255
Banks, Brokers, Dealers, Investment advisers, Recordkeeping,
Reporting, Securities.
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common Preamble, the Office of the
Comptroller of the Currency amends chapter I of title 12, Code of
Federal Regulations as follows:
PART 44--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
1. The authority citation for part 44 continues to read as follows:
Authority: 7 U.S.C. 27 et seq., 12 U.S.C. 1, 24, 92a, 93a, 161,
1461, 1462a, 1463, 1464, 1467a, 1813(q), 1818, 1851, 3101, 3102,
3108, 5412.
Subpart B--Proprietary Trading
0
2. Amend Sec. 44.6 by adding paragraph (f) to read as follows:
Sec. 44.6 Other permitted proprietary trading activities.
* * * * *
(f) Permitted trading activities of qualifying foreign excluded
funds. The prohibition contained in Sec. 44.3(a) does not apply to the
purchase or sale of a financial instrument by a qualifying foreign
excluded fund. For purposes of this paragraph (f), a qualifying foreign
excluded fund means a banking entity that:
(1) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(2)(i) Would be a covered fund if the entity were organized or
established in the United States, or
(ii) Is, or holds itself out as being, an entity or arrangement
that raises money from investors primarily for the purpose of investing
in financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the
acquisition or retention of an ownership interest in, sponsorship of,
or relationship with the entity, by another banking entity that meets
the following:
(i) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(ii) The banking entity's acquisition or retention of an ownership
interest in or sponsorship of the fund meets the requirements for
permitted covered fund activities and investments solely outside the
United States, as provided in Sec. 44.13(b);
(4) Is established and operated as part of a bona fide asset
management business; and
(5) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
Subpart C--Covered Funds Activities and Investments
0
3. Amend Sec. 44.10 by:
0
a. Revising paragraph (c)(1);
0
b. Revising paragraph (c)(3)(i);
0
c. Revising paragraph (c)(8);
0
d. Revising the heading of paragraph (c)(10) and revising paragraph
(c)(10)(i);
0
e. Revising paragraph (c)(11);
0
f. Adding paragraphs (c)(15), (16), (17), and (18);
0
g. Revising paragraph (d)(6); and
0
h. Adding paragraph (d)(11).
The revisions and additions read as follows:
Sec. 44.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
* * * * *
(c) * * *
(1) Foreign public funds. (i) Subject to paragraphs (c)(1)(ii) and
(iii) of this section, an issuer that:
[[Page 46497]]
(A) Is organized or established outside of the United States; and
(B) Is authorized to offer and sell ownership interests, and such
interests are offered and sold, through one or more public offerings.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless more than 75 percent of the
ownership interests in the issuer are sold to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and senior executive officers as defined in Sec.
225.71(c) of the Board's Regulation Y (12 CFR 225.71(c)) of such
entities.
(iii) For purposes of paragraph (c)(1)(i)(B) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
44.4(a)(3)) of securities in any jurisdiction outside the United States
to investors, including retail investors, provided that:
(A) The distribution is subject to substantive disclosure and
retail investor protection laws or regulations;
(B) With respect to an issuer for which the banking entity serves
as the investment manager, investment adviser, commodity trading
advisor, commodity pool operator, or sponsor, the distribution complies
with all applicable requirements in the jurisdiction in which such
distribution is being made;
(C) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(D) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
* * * * *
(3) * * *
(i) Is composed of no more than 10 unaffiliated co-venturers;
* * * * *
(8) Loan securitizations. (i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are composed solely of:
(A) Loans as defined in Sec. 44.2(t);
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
that is a security (other than special units of beneficial interest and
collateral certificates meeting the requirements of paragraph (c)(8)(v)
of this section) meets the requirements of paragraph (c)(8)(iii) of
this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section;
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section; and
(E) Debt securities, other than asset-backed securities and
convertible securities, provided that:
(1) The aggregate value of such debt securities does not exceed
five percent of the aggregate value of loans held under paragraph
(c)(8)(i)(A) of this section, cash and cash equivalents held under
paragraph (c)(8)(iii)(A) of this section, and debt securities held
under this paragraph (c)(8)(i)(E); and
(2) The aggregate value of the loans, cash and cash equivalents,
and debt securities for purposes of this paragraph is calculated at par
value at the most recent time any such debt security is acquired,
except that the issuing entity may instead determine the value of any
such loan, cash equivalent, or debt security based on its fair market
value if:
(i) The issuing entity is required to use the fair market value of
such assets for purposes of calculating compliance with concentration
limitations or other similar calculations under its transaction
agreements, and
(ii) The issuing entity's valuation methodology values similarly
situated assets consistently.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
except as permitted under paragraph (c)(8)(i)(E) of this section, the
assets or holdings of the issuing entity shall not include any of the
following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraphs
(c)(8)(iii), (iv), or (v) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities, other than
debt securities permitted under paragraph (c)(8)(i)(E) of this section,
if those securities are:
(A) Cash equivalents--which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the securitization's expected or potential need for
funds and whose currency corresponds to either the underlying loans or
the asset-backed securities--for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivatives directly relate to the
loans, the asset-backed securities, the contractual rights or other
assets described in paragraph (c)(8)(i)(B) of this section, or the debt
securities described in paragraph (c)(8)(i)(E) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, the
contractual rights or other assets described in paragraph (c)(8)(i)(B)
of this section, or the debt securities described in paragraph
(c)(8)(i)(E) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the
[[Page 46498]]
issuing entity are established under the direction of the same entity
that initiated the loan securitization.
* * * * *
(10) Qualifying covered bonds. (i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are composed solely
of assets that meet the conditions in paragraph (c)(8)(i) of this
section.
* * * * *
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked, or
that has voluntarily surrendered its license to operate as a small
business investment company in accordance with 13 CFR 107.1900 and does
not make any new investments (other than investments in cash
equivalents, which, for the purposes of this paragraph, means high
quality, highly liquid investments whose maturity corresponds to the
issuer's expected or potential need for funds and whose currency
corresponds to the issuer's assets) after such voluntary surrender;
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs) and including investments that qualify for
consideration under the regulations implementing the Community
Reinvestment Act (12 U.S.C. 2901 et seq.); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program;
(iii) That has elected to be regulated or is regulated as a rural
business investment company, as described in 15 U.S.C. 80b-3(b)(8)(A)
or (B), or that has terminated its participation as a rural business
investment company in accordance with 7 CFR 4290.1900 and does not make
any new investments (other than investments in cash equivalents, which,
for the purposes of this paragraph, means high quality, highly liquid
investments whose maturity corresponds to the issuer's expected or
potential need for funds and whose currency corresponds to the issuer's
assets) after such termination; or
(iv) That is a qualified opportunity fund, as defined in 26 U.S.C.
1400Z-2(d).
* * * * *
(15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and
(v) of this section, an issuer that satisfies the asset and activity
requirements of paragraphs (c)(15)(i) and (ii) of this section.
(i) Asset requirements. The issuer's assets must be composed solely
of:
(A) Loans as defined in Sec. 44.2(t);
(B) Debt instruments, subject to paragraph (c)(15)(iv) of this
section;
(C) Rights and other assets that are related or incidental to
acquiring, holding, servicing, or selling such loans or debt
instruments, provided that:
(1) Each right or asset held under this paragraph (c)(15)(i)(C)
that is a security is either:
(i) A cash equivalent (which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the issuer's expected or potential need for funds and
whose currency corresponds to either the underlying loans or the debt
instruments);
(ii) A security received in lieu of debts previously contracted
with respect to such loans or debt instruments; or
(iii) An equity security (or right to acquire an equity security)
received on customary terms in connection with such loans or debt
instruments; and
(2) Rights or other assets held under this paragraph (c)(15)(i)(C)
of this section may not include commodity forward contracts or any
derivative; and
(D) Interest rate or foreign exchange derivatives, if:
(1) The written terms of the derivative directly relate to the
loans, debt instruments, or other rights or assets described in
paragraph (c)(15)(i)(C) of this section; and
(2) The derivative reduces the interest rate and/or foreign
exchange risks related to the loans, debt instruments, or other rights
or assets described in paragraph (c)(15)(i)(C) of this section.
(ii) Activity requirements. To be eligible for the exclusion of
paragraph (c)(15) of this section, an issuer must:
(A) Not engage in any activity that would constitute proprietary
trading under Sec. 44.3(b)(l)(i), as if the issuer were a banking
entity; and
(B) Not issue asset-backed securities.
(iii) Requirements for a sponsor, investment adviser, or commodity
trading advisor. A banking entity that acts as a sponsor, investment
adviser, or commodity trading advisor to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section may not
rely on this exclusion unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 44.11(a)(8) of this
subpart, as if the issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the limitations imposed in Sec. 44.14, as if the
issuer were a covered fund, except the banking entity may acquire and
retain any ownership interest in the issuer.
(iv) Additional Banking Entity Requirements. A banking entity may
not rely on this exclusion with respect to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section unless:
(A) The banking entity does not, directly or indirectly, guarantee,
assume, or otherwise insure the obligations or performance of the
issuer or of any entity to which such issuer extends credit or in which
such issuer invests; and
(B) Any assets the issuer holds pursuant to paragraphs
(c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible
for the banking entity to acquire and hold directly under applicable
federal banking laws and regulations.
(v) Investment and Relationship Limits. A banking entity's
investment in, and relationship with, the issuer must:
(A) Comply with the limitations imposed in Sec. 44.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(16) Qualifying venture capital funds. (i) Subject to paragraphs
(c)(16)(ii) through (iv) of this section, an issuer that:
(A) Is a venture capital fund as defined in 17 CFR 275.203(l)-1;
and
(B) Does not engage in any activity that would constitute
proprietary trading under Sec. 44.3(b)(1)(i), as if the issuer were a
banking entity.
(ii) A banking entity that acts as a sponsor, investment adviser,
or commodity trading advisor to an issuer
[[Page 46499]]
that meets the conditions in paragraph (c)(16)(i) of this section may
not rely on this exclusion unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 44.11(a)(8), as if the
issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the restrictions in Sec. 44.14 as if the issuer
were a covered fund (except the banking entity may acquire and retain
any ownership interest in the issuer).
(iii) The banking entity must not, directly or indirectly,
guarantee, assume, or otherwise insure the obligations or performance
of the issuer.
(iv) A banking entity's ownership interest in or relationship with
the issuer must:
(A) Comply with the limitations imposed in Sec. 44.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(17) Family wealth management vehicles. (i) Subject to paragraph
(c)(17)(ii) of this section, any entity that is not, and does not hold
itself out as being, an entity or arrangement that raises money from
investors primarily for the purpose of investing in securities for
resale or other disposition or otherwise trading in securities, and:
(A) If the entity is a trust, the grantor(s) of the entity are all
family customers; and
(B) If the entity is not a trust:
(1) A majority of the voting interests in the entity are owned
(directly or indirectly) by family customers;
(2) A majority of the interests in the entity are owned (directly
or indirectly) by family customers;
(3) The entity is owned only by family customers and up to 5
closely related persons of the family customers; and
(C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this
section, up to an aggregate 0.5 percent of the entity's outstanding
ownership interests may be acquired or retained by one or more entities
that are not family customers or closely related persons if the
ownership interest is acquired or retained by such parties for the
purpose of and to the extent necessary for establishing corporate
separateness or addressing bankruptcy, insolvency, or similar concerns.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(17)(i) of this section with respect to an entity provided that the
banking entity (or an affiliate):
(A) Provides bona fide trust, fiduciary, investment advisory, or
commodity trading advisory services to the entity;
(B) Does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of such entity;
(C) Complies with the disclosure obligations under Sec.
44.11(a)(8), as if such entity were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of disclosure may be modified to accommodate the
specific circumstances of the entity;
(D) Does not acquire or retain, as principal, an ownership interest
in the entity, other than as described in paragraph (c)(17)(i)(C) of
this section;
(E) Complies with the requirements of Sec. Sec. 44.14(b) and
44.15, as if such entity were a covered fund; and
(F) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, complies with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the entity were an affiliate thereof.
(iii) For purposes of paragraph (c)(17) of this section, the
following definitions apply:
(A) Closely related person means a natural person (including the
estate and estate planning vehicles of such person) who has
longstanding business or personal relationships with any family
customer.
(B) Family customer means:
(1) A family client, as defined in Rule 202(a)(11)(G)-1(d)(4) of
the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1(d)(4));
or
(2) Any natural person who is a father-in-law, mother-in-law,
brother-in-law, sister-in-law, son-in-law or daughter-in-law of a
family client, or a spouse or a spousal equivalent of any of the
foregoing.
(18) Customer facilitation vehicles. (i) Subject to paragraph
(c)(18)(ii) of this section, an issuer that is formed by or at the
request of a customer of the banking entity for the purpose of
providing such customer (which may include one or more affiliates of
such customer) with exposure to a transaction, investment strategy, or
other service provided by the banking entity.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(18)(i) of this section with respect to an issuer provided that:
(A) All of the ownership interests of the issuer are owned by the
customer (which may include one or more of its affiliates) for whom the
issuer was created;
(B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to
an aggregate 0.5 percent of the issuer's outstanding ownership
interests may be acquired or retained by one or more entities that are
not customers if the ownership interest is acquired or retained by such
parties for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns; and
(C) The banking entity and its affiliates:
(1) Maintain documentation outlining how the banking entity intends
to facilitate the customer's exposure to such transaction, investment
strategy, or service;
(2) Do not, directly or indirectly, guarantee, assume, or otherwise
insure the obligations or performance of such issuer;
(3) Comply with the disclosure obligations under Sec. 44.11(a)(8),
as if such issuer were a covered fund, provided that the content may be
modified to prevent the disclosure from being misleading and the manner
of disclosure may be modified to accommodate the specific circumstances
of the issuer;
(4) Do not acquire or retain, as principal, an ownership interest
in the issuer, other than as described in paragraph (c)(18)(ii)(B) of
this section;
(5) Comply with the requirements of Sec. Sec. 44.14(b) and 44.15,
as if such issuer were a covered fund; and
(6) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, comply with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the issuer were an affiliate thereof.
* * * * *
(d) * * *
(6) Ownership interest. (i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund, excluding:
(1) The rights of a creditor to exercise remedies upon the
occurrence of an
[[Page 46500]]
event of default or an acceleration event; and
(2) The right to participate in the removal of an investment
manager for ``cause'' or participate in the selection of a replacement
manager upon an investment manager's resignation or removal. For
purposes of this paragraph (d)(6)(i)(A)(2), ``cause'' for removal of an
investment manager means one or more of the following events:
(i) The bankruptcy, insolvency, conservatorship or receivership of
the investment manager;
(ii) The breach by the investment manager of any material provision
of the covered fund's transaction agreements applicable to the
investment manager;
(iii) The breach by the investment manager of material
representations or warranties;
(iv) The occurrence of an act that constitutes fraud or criminal
activity in the performance of the investment manager's obligations
under the covered fund's transaction agreements;
(v) The indictment of the investment manager for a criminal
offense, or the indictment of any officer, member, partner or other
principal of the investment manager for a criminal offense materially
related to his or her investment management activities;
(vi) A change in control with respect to the investment manager;
(vii) The loss, separation or incapacitation of an individual
critical to the operation of the investment manager or primarily
responsible for the management of the covered fund's assets; or
(viii) Other similar events that constitute ``cause'' for removal
of an investment manager, provided that such events are not solely
related to the performance of the covered fund or the investment
manager's exercise of investment discretion under the covered fund's
transaction agreements;
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include:
(A) Restricted profit interest, which is an interest held by an
entity (or an employee or former employee thereof) in a covered fund
for which the entity (or employee thereof) serves as investment
manager, investment adviser, commodity trading advisor, or other
service provider, so long as:
(1) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(2) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(3) Any amounts invested in the covered fund, including any amounts
paid by the entity in connection with obtaining the restricted profit
interest, are within the limits of Sec. 44.12 of this subpart; and
(4) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(B) Any senior loan or senior debt interest that has the following
characteristics:
(1) Under the terms of the interest the holders of such interest do
not have the right to receive a share of the income, gains, or profits
of the covered fund, but are entitled to receive only:
(i) Interest at a stated interest rate, as well as commitment fees
or other fees, which are not determined by reference to the performance
of the underlying assets of the covered fund; and
(ii) Repayment of a fixed principal amount, on or before a maturity
date, in a contractually-determined manner (which may include
prepayment premiums intended solely to reflect, and compensate holders
of the interest for, forgone income resulting from an early
prepayment);
(2) The entitlement to payments under the terms of the interest are
absolute and could not be reduced based on losses arising from the
underlying assets of the covered fund, such as allocation of losses,
write-downs or charge-offs of the outstanding principal balance, or
reductions in the amount of interest due and payable on the interest;
and
(3) The holders of the interest are not entitled to receive the
underlying assets of the covered fund after all other interests have
been redeemed or paid in full (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event).
* * * * *
(11) Riskless principal transaction. Riskless principal transaction
means a transaction in which a banking entity, after receiving an order
from a customer to buy (or sell) a security, purchases (or sells) the
security in the secondary market for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
0
4. Amend Sec. 44.12 by:
0
a. Revising paragraph (b)(1)(ii);
0
b. Revising paragraph (b)(4);
0
c. Adding paragraph (b)(5);
0
d. Revising paragraph (c)(1); and
0
e. Revising paragraphs (d) and (e).
The revisions and addition read as follows:
[[Page 46501]]
Sec. 44.12 Permitted investment in a covered fund.
* * * * *
(b) * * *
(1) * * *
(ii) Treatment of registered investment companies, SEC-regulated
business development companies, and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies, or foreign
public fund as described in Sec. 44.10(c)(1) will not be considered to
be an affiliate of the banking entity so long as:
(A) The banking entity, together with its affiliates, does not own,
control, or hold with the power to vote 25 percent or more of the
voting shares of the company or fund; and
(B) The banking entity, or an affiliate of the banking entity,
provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
* * * * *
(4) Multi-tier fund investments. (i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
in the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 44.11 for the purpose of
investing in other covered funds (a ``fund of funds'') and that fund of
funds itself invests in another covered fund that the banking entity is
permitted to own, then the banking entity's permitted investment in
that other fund shall include any investment by the banking entity in
that other fund, as well as the banking entity's pro-rata share of any
ownership interest in the fund that is held through the fund of funds.
The investment of the banking entity may not represent more than 3
percent of the amount or value of any single covered fund.
(5) Parallel Investments and Co-Investments. (i) A banking entity
shall not be required to include in the calculation of the investment
limits under paragraph (a)(2) of this section any investment the
banking entity makes alongside a covered fund as long as the investment
is made in compliance with applicable laws and regulations, including
applicable safety and soundness standards.
(ii) A banking entity shall not be restricted under this section in
the amount of any investment the banking entity makes alongside a
covered fund as long as the investment is made in compliance with
applicable laws and regulations, including applicable safety and
soundness standards.
(c) * * *
(1)(i) For purposes of paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership interests held by a banking entity
shall be the sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
in covered funds (together with any amounts paid by the entity in
connection with obtaining a restricted profit interest under Sec.
44.10(d)(6)(ii)), on a historical cost basis;
(ii) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (c)(1)(i) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
* * * * *
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1)(i) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity in connection with
obtaining a restricted profit interest under Sec. 44.10(d)(6)(ii) of
subpart C of this part), on a historical cost basis, plus any earnings
received; and
(ii) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
in connection with obtaining a restricted profit interest under Sec.
44.10(d)(6)(ii) of subpart C of this part), if the banking entity
accounts for the profits (or losses) of the fund investment in its
financial statements.
(2) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (d)(1) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
(e) Extension of time to divest an ownership interest. (1)
Extension period. Upon application by a banking entity, the Board may
extend the period under paragraph (a)(2)(i) of this section for up to 2
additional years if the Board finds that an extension would be
consistent with safety and soundness and not detrimental to the public
interest.
(2) Application requirements. An application for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(3) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(3) Factors governing the Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted
[[Page 46502]]
sufficient investments from investors unaffiliated with the banking
entity to enable the banking entity to comply with the limitations in
paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers, or counterparties to which it owes a duty;
(vii) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(4) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(5) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
0
5. Amend Sec. 44.13 by adding paragraph (d) to read as follows:
Sec. 44.13 Other permitted covered fund activities and investments.
* * * * *
(d) Permitted covered fund activities and investments of qualifying
foreign excluded funds. (1) The prohibition contained in Sec. 44.10(a)
does not apply to a qualifying foreign excluded fund.
(2) For purposes of this paragraph (d), a qualifying foreign
excluded fund means a banking entity that:
(i) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(ii)(A) Would be a covered fund if the entity were organized or
established in the United States, or
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(iii) Would not otherwise be a banking entity except by virtue of
the acquisition or retention of an ownership interest in, sponsorship
of, or relationship with the entity, by another banking entity that
meets the following:
(A) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(B) The banking entity's acquisition of an ownership interest in or
sponsorship of the fund by the foreign banking entity meets the
requirements for permitted covered fund activities and investments
solely outside the United States, as provided in Sec. 44.13(b);
(iv) Is established and operated as part of a bona fide asset
management business; and
(v) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
0
6. Amend Sec. 44.14 by:
0
a. Revising paragraph (a)(2)(i);
0
b. Revising paragraph (a)(2)(ii)(C);
0
c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and
0
d. Revising paragraph (c).
The revisions and additions read as follows:
Sec. 44.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. Sec. 44.11, 44.12, or 44.13;
(ii) * * *
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity; and
(iii) Enter into a transaction with a covered fund that would be an
exempt covered transaction under 12 U.S.C. 371c(d) or Sec. 223.42 of
the Board's Regulation W (12 CFR 223.42) subject to the limitations
specified under 12 U.S.C. 371c(d) or Sec. 223.42 of the Board's
Regulation W (12 CFR 223.42), as applicable,
(iv) Enter into a riskless principal transaction with a covered
fund; and
(v) Extend credit to or purchase assets from a covered fund,
provided:
(A) Each extension of credit or purchase of assets is in the
ordinary course of business in connection with payment transactions;
settlement services; or futures, derivatives, and securities clearing;
(B) Each extension of credit is repaid, sold, or terminated by the
end of five business days; and
(C) The banking entity making each extension of credit meets the
requirements of Sec. 223.42(l)(1)(i) and (ii) of the Board's
Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of
credit was an intraday extension of credit, regardless of the duration
of the extension of credit.
(3) Any transaction or activity permitted under paragraphs
(a)(2)(iii), (iv) or (v) of this section must comply with the
limitations in Sec. 44.15.
* * * * *
(c) Restrictions on other permitted transactions. Any transaction
permitted under paragraphs (a)(2)(ii), (iii), or (iv) of this section
shall be subject to section 23B of the Federal Reserve Act (12 U.S.C.
371c-1) as if the counterparty were an affiliate of the banking entity
under section 23B.
Subpart D--Compliance Program Requirements; Violations
0
7. Amend Sec. 44.20 by:
0
a. Revising paragraph (a);
0
b. Revising the heading of paragraph (d) and revising paragraph (d)(1);
and
0
c. Revising the introductory text of paragraph (e).
The revisions and addition read as follows:
Sec. 44.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities or a qualifying
foreign excluded fund under section 44.6(f) or 44.13(d)) shall develop
and provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
* * * * *
(d) Reporting requirements under appendix A to this part. (1) A
banking
[[Page 46503]]
entity (other than a qualifying foreign excluded fund under section
44.6(f) or 44.13(d)) engaged in proprietary trading activity permitted
under subpart B shall comply with the reporting requirements described
in appendix A to this part, if:
* * * * *
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities (other than a
qualifying foreign excluded fund under section 44.6(f) or 44.13(d))
shall maintain records that include:
* * * * *
BOARD OF GOVERNORS OF THE FEDERAL RESERVE
12 CFR Chapter II
Authority and Issuance
For the reasons stated in the Common Preamble, the Board amends
chapter II of title 12, Code of Federal Regulations as follows:
PART 248--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS (Regulation VV)
0
8. The authority citation for part 248 continues to read as follows:
Authority: 12 U.S.C. 1851, 12 U.S.C. 221 et seq., 12 U.S.C.
1818, 12 U.S.C. 1841 et seq., and 12 U.S.C. 3103 et seq.
Subpart B--Proprietary Trading
0
9. Amend Sec. 248.6 by adding paragraph (f) to read as follows:
Sec. 248.6 Other permitted proprietary trading activities.
* * * * *
(f) Permitted trading activities of qualifying foreign excluded
funds. The prohibition contained in Sec. 248.3(a) does not apply to
the purchase or sale of a financial instrument by a qualifying foreign
excluded fund. For purposes of this paragraph (f), a qualifying foreign
excluded fund means a banking entity that:
(1) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(2)(i) Would be a covered fund if the entity were organized or
established in the United States, or
(ii) Is, or holds itself out as being, an entity or arrangement
that raises money from investors primarily for the purpose of investing
in financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the
acquisition or retention of an ownership interest in, sponsorship of,
or relationship with the entity, by another banking entity that meets
the following:
(i) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(ii) The banking entity's acquisition or retention of an ownership
interest in or sponsorship of the fund meets the requirements for
permitted covered fund activities and investments solely outside the
United States, as provided in Sec. 248.13(b);
(4) Is established and operated as part of a bona fide asset
management business; and
(5) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
Subpart C--Covered Funds Activities and Investments
0
10. Amend Sec. 248.10 by:
0
a. Revising paragraph (c)(1);
0
b. Revising paragraph (c)(3)(i);
0
c. Revising paragraph (c)(8);
0
d. Revising the heading of paragraph (c)(10) and revising paragraph
(c)(10)(i);
0
e. Revising paragraph (c)(11);
0
f. Adding paragraphs (c)(15), (16), (17), and (18);
0
g. Revising paragraph (d)(6); and
0
h. Adding paragraph (d)(11).
The revisions and additions read as follows:
Sec. 248.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
* * * * *
(c) * * *
(1) Foreign public funds. (i) Subject to paragraphs (c)(1)(ii) and
(iii) of this section, an issuer that:
(A) Is organized or established outside of the United States; and
(B) Is authorized to offer and sell ownership interests, and such
interests are offered and sold, through one or more public offerings.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless more than 75 percent of the
ownership interests in the issuer are sold to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and senior executive officers as defined in Sec.
225.71(c) of the Board's Regulation Y (12 CFR 225.71(c)) of such
entities.
(iii) For purposes of paragraph (c)(1)(i)(B) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
248.4(a)(3)) of securities in any jurisdiction outside the United
States to investors, including retail investors, provided that:
(A) The distribution is subject to substantive disclosure and
retail investor protection laws or regulations;
(B) With respect to an issuer for which the banking entity serves
as the investment manager, investment adviser, commodity trading
advisor, commodity pool operator, or sponsor, the distribution complies
with all applicable requirements in the jurisdiction in which such
distribution is being made;
(C) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(D) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
* * * * *
(3) * * *
(i) Is composed of no more than 10 unaffiliated co-venturers;
* * * * *
(8) Loan securitizations. (i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are composed solely of:
(A) Loans as defined in Sec. 248.2(t);
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
that is a security (other than special units of beneficial interest and
collateral certificates meeting the requirements of paragraph (c)(8)(v)
of this section) meets the requirements of paragraph (c)(8)(iii) of
this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section;
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section; and
[[Page 46504]]
(E) Debt securities, other than asset-backed securities and
convertible securities, provided that:
(1) The aggregate value of such debt securities does not exceed
five percent of the aggregate value of loans held under paragraph
(c)(8)(i)(A) of this section, cash and cash equivalents held under
paragraph (c)(8)(iii)(A) of this section, and debt securities held
under this paragraph (c)(8)(i)(E); and
(2) The aggregate value of the loans, cash and cash equivalents,
and debt securities for purposes of this paragraph is calculated at par
value at the most recent time any such debt security is acquired,
except that the issuing entity may instead determine the value of any
such loan, cash equivalent, or debt security based on its fair market
value if:
(i) The issuing entity is required to use the fair market value of
such assets for purposes of calculating compliance with concentration
limitations or other similar calculations under its transaction
agreements, and
(ii) The issuing entity's valuation methodology values similarly
situated assets consistently.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
except as permitted under paragraph (c)(8)(i)(E) of this section, the
assets or holdings of the issuing entity shall not include any of the
following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraphs
(c)(8)(iii), (iv), or (v) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities, other than
debt securities permitted under paragraph (c)(8)(i)(E) of this section,
if those securities are:
(A) Cash equivalents--which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the securitization's expected or potential need for
funds and whose currency corresponds to either the underlying loans or
the asset-backed securities--for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivatives directly relate to the
loans, the asset-backed securities, the contractual rights or other
assets described in paragraph (c)(8)(i)(B) of this section, or the debt
securities described in paragraph (c)(8)(i)(E) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, the
contractual rights or other assets described in paragraph (c)(8)(i)(B)
of this section, or the debt securities described in paragraph
(c)(8)(i)(E) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
* * * * *
(10) Qualifying covered bonds. (i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are composed solely
of assets that meet the conditions in paragraph (c)(8)(i) of this
section.
* * * * *
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked, or
that has voluntarily surrendered its license to operate as a small
business investment company in accordance with 13 CFR 107.1900 and does
not make any new investments (other than investments in cash
equivalents, which, for the purposes of this paragraph, means high
quality, highly liquid investments whose maturity corresponds to the
issuer's expected or potential need for funds and whose currency
corresponds to the issuer's assets) after such voluntary surrender;
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs) and including investments that qualify for
consideration under the regulations implementing the Community
Reinvestment Act (12 U.S.C. 2901 et seq.); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program;
(iii) That has elected to be regulated or is regulated as a rural
business investment company, as described in 15 U.S.C. 80b-3(b)(8)(A)
or (B), or that has terminated its participation as a rural business
investment company in accordance with 7 CFR 4290.1900 and does not make
any new investments (other than investments in cash equivalents, which,
for the purposes of this paragraph, means high quality, highly liquid
investments whose maturity corresponds to the issuer's expected or
potential need for funds and whose currency corresponds to the issuer's
assets) after such termination; or
(iv) That is a qualified opportunity fund, as defined in 26 U.S.C.
1400Z-2(d).
* * * * *
(15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and
(v) of this section, an issuer that satisfies the asset and activity
requirements of paragraphs (c)(15)(i) and (ii) of this section.
[[Page 46505]]
(i) Asset requirements. The issuer's assets must be composed solely
of:
(A) Loans as defined in Sec. 248.2(t);
(B) Debt instruments, subject to paragraph (c)(15)(iv) of this
section;
(C) Rights and other assets that are related or incidental to
acquiring, holding, servicing, or selling such loans or debt
instruments, provided that:
(1) Each right or asset held under this paragraph (c)(15)(i)(C)
that is a security is either:
(i) A cash equivalent (which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the issuer's expected or potential need for funds and
whose currency corresponds to either the underlying loans or the debt
instruments);
(ii) A security received in lieu of debts previously contracted
with respect to such loans or debt instruments; or
(iii) An equity security (or right to acquire an equity security)
received on customary terms in connection with such loans or debt
instruments; and
(2) Rights or other assets held under this paragraph (c)(15)(i)(C)
of this section may not include commodity forward contracts or any
derivative; and
(D) Interest rate or foreign exchange derivatives, if:
(1) The written terms of the derivative directly relate to the
loans, debt instruments, or other rights or assets described in
paragraph (c)(15)(i)(C) of this section; and
(2) The derivative reduces the interest rate and/or foreign
exchange risks related to the loans, debt instruments, or other rights
or assets described in paragraph (c)(15)(i)(C) of this section.
(ii) Activity requirements. To be eligible for the exclusion of
paragraph (c)(15) of this section, an issuer must:
(A) Not engage in any activity that would constitute proprietary
trading under Sec. 248.3(b)(l)(i), as if the issuer were a banking
entity; and
(B) Not issue asset-backed securities.
(iii) Requirements for a sponsor, investment adviser, or commodity
trading advisor. A banking entity that acts as a sponsor, investment
adviser, or commodity trading advisor to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section may not
rely on this exclusion unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 248.11(a)(8) of this
subpart, as if the issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the limitations imposed in Sec. 248.14, as if
the issuer were a covered fund, except the banking entity may acquire
and retain any ownership interest in the issuer.
(iv) Additional Banking Entity Requirements. A banking entity may
not rely on this exclusion with respect to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section unless:
(A) The banking entity does not, directly or indirectly, guarantee,
assume, or otherwise insure the obligations or performance of the
issuer or of any entity to which such issuer extends credit or in which
such issuer invests; and
(B) Any assets the issuer holds pursuant to paragraphs
(c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible
for the banking entity to acquire and hold directly under applicable
federal banking laws and regulations.
(v) Investment and Relationship Limits. A banking entity's
investment in, and relationship with, the issuer must:
(A) Comply with the limitations imposed in Sec. 248.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(16) Qualifying venture capital funds. (i) Subject to paragraphs
(c)(16)(ii) through (iv) of this section, an issuer that:
(A) Is a venture capital fund as defined in 17 CFR 275.203(l)-1;
and
(B) Does not engage in any activity that would constitute
proprietary trading under Sec. 248.3(b)(1)(i), as if the issuer were a
banking entity.
(ii) A banking entity that acts as a sponsor, investment adviser,
or commodity trading advisor to an issuer that meets the conditions in
paragraph (c)(16)(i) of this section may not rely on this exclusion
unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 248.11(a)(8), as if the
issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the restrictions in Sec. 248.14 as if the issuer
were a covered fund (except the banking entity may acquire and retain
any ownership interest in the issuer).
(iii) The banking entity must not, directly or indirectly,
guarantee, assume, or otherwise insure the obligations or performance
of the issuer.
(iv) A banking entity's ownership interest in or relationship with
the issuer must:
(A) Comply with the limitations imposed in Sec. 248.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(17) Family wealth management vehicles. (i) Subject to paragraph
(c)(17)(ii) of this section, any entity that is not, and does not hold
itself out as being, an entity or arrangement that raises money from
investors primarily for the purpose of investing in securities for
resale or other disposition or otherwise trading in securities, and:
(A) If the entity is a trust, the grantor(s) of the entity are all
family customers; and
(B) If the entity is not a trust:
(1) A majority of the voting interests in the entity are owned
(directly or indirectly) by family customers;
(2) A majority of the interests in the entity are owned (directly
or indirectly) by family customers;
(3) The entity is owned only by family customers and up to 5
closely related persons of the family customers; and
(C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this
section, up to an aggregate 0.5 percent of the entity's outstanding
ownership interests may be acquired or retained by one or more entities
that are not family customers or closely related persons if the
ownership interest is acquired or retained by such parties for the
purpose of and to the extent necessary for establishing corporate
separateness or addressing bankruptcy, insolvency, or similar concerns.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(17)(i) of this section with respect to an entity provided that the
banking entity (or an affiliate):
(A) Provides bona fide trust, fiduciary, investment advisory, or
commodity trading advisory services to the entity;
(B) Does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of such entity;
(C) Complies with the disclosure obligations under Sec.
248.11(a)(8), as if such entity were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of disclosure may be modified to
[[Page 46506]]
accommodate the specific circumstances of the entity;
(D) Does not acquire or retain, as principal, an ownership interest
in the entity, other than as described in paragraph (c)(17)(i)(C) of
this section;
(E) Complies with the requirements of Sec. Sec. 248.14(b) and
248.15, as if such entity were a covered fund; and
(F) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, complies with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the entity were an affiliate thereof.
(iii) For purposes of paragraph (c)(17) of this section, the
following definitions apply:
(A) Closely related person means a natural person (including the
estate and estate planning vehicles of such person) who has
longstanding business or personal relationships with any family
customer.
(B) Family customer means:
(1) A family client, as defined in Rule 202(a)(11)(G)-1(d)(4) of
the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1(d)(4));
or
(2) Any natural person who is a father-in-law, mother-in-law,
brother-in-law, sister-in-law, son-in-law or daughter-in-law of a
family client, or a spouse or a spousal equivalent of any of the
foregoing.
(18) Customer facilitation vehicles. (i) Subject to paragraph
(c)(18)(ii) of this section, an issuer that is formed by or at the
request of a customer of the banking entity for the purpose of
providing such customer (which may include one or more affiliates of
such customer) with exposure to a transaction, investment strategy, or
other service provided by the banking entity.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(18)(i) of this section with respect to an issuer provided that:
(A) All of the ownership interests of the issuer are owned by the
customer (which may include one or more of its affiliates) for whom the
issuer was created;
(B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to
an aggregate 0.5 percent of the issuer's outstanding ownership
interests may be acquired or retained by one or more entities that are
not customers if the ownership interest is acquired or retained by such
parties for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns; and
(C) The banking entity and its affiliates:
(1) Maintain documentation outlining how the banking entity intends
to facilitate the customer's exposure to such transaction, investment
strategy, or service;
(2) Do not, directly or indirectly, guarantee, assume, or otherwise
insure the obligations or performance of such issuer;
(3) Comply with the disclosure obligations under Sec.
248.11(a)(8), as if such issuer were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of disclosure may be modified to accommodate the
specific circumstances of the issuer;
(4) Do not acquire or retain, as principal, an ownership interest
in the issuer, other than as described in paragraph (c)(18)(ii)(B) of
this section;
(5) Comply with the requirements of Sec. Sec. 248.14(b) and
248.15, as if such issuer were a covered fund; and
(6) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, comply with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the issuer were an affiliate thereof.
* * * * *
(d) * * *
(6) Ownership interest. (i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund, excluding:
(1) The rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event; and
(2) The right to participate in the removal of an investment
manager for ``cause'' or participate in the selection of a replacement
manager upon an investment manager's resignation or removal. For
purposes of this paragraph (d)(6)(i)(A)(2), ``cause'' for removal of an
investment manager means one or more of the following events:
(i) The bankruptcy, insolvency, conservatorship or receivership of
the investment manager;
(ii) The breach by the investment manager of any material provision
of the covered fund's transaction agreements applicable to the
investment manager;
(iii) The breach by the investment manager of material
representations or warranties;
(iv) The occurrence of an act that constitutes fraud or criminal
activity in the performance of the investment manager's obligations
under the covered fund's transaction agreements;
(v) The indictment of the investment manager for a criminal
offense, or the indictment of any officer, member, partner or other
principal of the investment manager for a criminal offense materially
related to his or her investment management activities;
(vi) A change in control with respect to the investment manager;
(vii) The loss, separation or incapacitation of an individual
critical to the operation of the investment manager or primarily
responsible for the management of the covered fund's assets; or
(viii) Other similar events that constitute ``cause'' for removal
of an investment manager, provided that such events are not solely
related to the performance of the covered fund or the investment
manager's exercise of investment discretion under the covered fund's
transaction agreements;
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights
[[Page 46507]]
in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include:
(A) Restricted profit interest, which is an interest held by an
entity (or an employee or former employee thereof) in a covered fund
for which the entity (or employee thereof) serves as investment
manager, investment adviser, commodity trading advisor, or other
service provider, so long as:
(1) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(2) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(3) Any amounts invested in the covered fund, including any amounts
paid by the entity in connection with obtaining the restricted profit
interest, are within the limits of Sec. 248.12 of this subpart; and
(4) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(B) Any senior loan or senior debt interest that has the following
characteristics:
(1) Under the terms of the interest the holders of such interest do
not have the right to receive a share of the income, gains, or profits
of the covered fund, but are entitled to receive only:
(i) Interest at a stated interest rate, as well as commitment fees
or other fees, which are not determined by reference to the performance
of the underlying assets of the covered fund; and
(ii) Repayment of a fixed principal amount, on or before a maturity
date, in a contractually-determined manner (which may include
prepayment premiums intended solely to reflect, and compensate holders
of the interest for, forgone income resulting from an early
prepayment);
(2) The entitlement to payments under the terms of the interest are
absolute and could not be reduced based on losses arising from the
underlying assets of the covered fund, such as allocation of losses,
write-downs or charge-offs of the outstanding principal balance, or
reductions in the amount of interest due and payable on the interest;
and
(3) The holders of the interest are not entitled to receive the
underlying assets of the covered fund after all other interests have
been redeemed or paid in full (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event).
* * * * *
(11) Riskless principal transaction. Riskless principal transaction
means a transaction in which a banking entity, after receiving an order
from a customer to buy (or sell) a security, purchases (or sells) the
security in the secondary market for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
0
11. Amend Sec. 248.12 by:
0
a. Revising paragraph (b)(1)(ii);
0
b. Revising paragraph (b)(4);
0
c. Adding paragraph (b)(5);
0
d. Revising paragraph (c)(1); and
0
e. Revising paragraphs (d) and (e).
The revisions and addition read as follows:
Sec. 248.12 Permitted investment in a covered fund.
* * * * *
(b) * * *
(1) * * *
(ii) Treatment of registered investment companies, SEC-regulated
business development companies, and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies, or foreign
public fund as described in Sec. 248.10(c)(1) will not be considered
to be an affiliate of the banking entity so long as:
(A) The banking entity, together with its affiliates, does not own,
control, or hold with the power to vote 25 percent or more of the
voting shares of the company or fund; and
(B) The banking entity, or an affiliate of the banking entity,
provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
* * * * *
(4) Multi-tier fund investments. (i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
in the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 248.11 for the purpose of
investing in other covered funds (a ``fund of funds'') and that fund of
funds itself invests in another covered fund that the banking entity is
permitted to own, then the banking entity's permitted investment in
that other fund shall include any investment by the banking entity in
that other fund, as well as the banking entity's pro-rata share of any
ownership interest in the fund that is held through the fund of funds.
The investment of the banking entity may not represent more than 3
percent of the amount or value of any single covered fund.
(5) Parallel Investments and Co-Investments. (i) A banking entity
shall not be required to include in the calculation of the investment
limits under paragraph (a)(2) of this section any investment the
banking entity makes alongside a covered fund as long as the investment
is made in compliance with applicable laws and regulations, including
applicable safety and soundness standards.
(ii) A banking entity shall not be restricted under this section in
the amount of any investment the banking entity makes alongside a
covered fund as long as the investment is made in compliance with
applicable laws and regulations, including applicable safety and
soundness standards.
[[Page 46508]]
(c) * * *
(1)(i) For purposes of paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership interests held by a banking entity
shall be the sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
in covered funds (together with any amounts paid by the entity in
connection with obtaining a restricted profit interest under Sec.
248.10(d)(6)(ii)), on a historical cost basis;
(ii) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (c)(1)(i) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
* * * * *
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1)(i) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity in connection with
obtaining a restricted profit interest under Sec. 248.10(d)(6)(ii) of
subpart C of this part), on a historical cost basis, plus any earnings
received; and
(ii) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
in connection with obtaining a restricted profit interest under Sec.
248.10(d)(6)(ii) of subpart C of this part), if the banking entity
accounts for the profits (or losses) of the fund investment in its
financial statements.
(2) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (d)(1) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
(e) Extension of time to divest an ownership interest. (1)
Extension period. Upon application by a banking entity, the Board may
extend the period under paragraph (a)(2)(i) of this section for up to 2
additional years if the Board finds that an extension would be
consistent with safety and soundness and not detrimental to the public
interest.
(2) Application requirements. An application for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(3) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(3) Factors governing the Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers, or counterparties to which it owes a duty;
(vii) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(4) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(5) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
0
12. Amend Sec. 248.13 by adding paragraph (d) to read as follows:
Sec. 248.13 Other permitted covered fund activities and investments.
* * * * *
(d) Permitted covered fund activities and investments of qualifying
foreign excluded funds. (1) The prohibition contained in Sec.
248.10(a) does not apply to a qualifying foreign excluded fund.
(2) For purposes of this paragraph (d), a qualifying foreign
excluded fund means a banking entity that:
(i) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(ii)(A) Would be a covered fund if the entity were organized or
established in the United States, or
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(iii) Would not otherwise be a banking entity except by virtue of
the acquisition or retention of an ownership interest in, sponsorship
of, or relationship with the entity, by another banking entity that
meets the following:
(A) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is
[[Page 46509]]
organized, under the laws of the United States or of any State; and
(B) The banking entity's acquisition of an ownership interest in or
sponsorship of the fund by the foreign banking entity meets the
requirements for permitted covered fund activities and investments
solely outside the United States, as provided in Sec. 248.13(b);
(iv) Is established and operated as part of a bona fide asset
management business; and
(v) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
0
13. Amend Sec. 248.14 by:
0
a. Revising paragraph (a)(2)(i);
0
b. Revising paragraph (a)(2)(ii)(C);
0
c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and
0
d. Revising paragraph (c).
The revisions and additions read as follows:
Sec. 248.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. Sec. 248.11, 248.12, or
248.13;
(ii) * * *
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity; and
(iii) Enter into a transaction with a covered fund that would be an
exempt covered transaction under 12 U.S.C. 371c(d) or Sec. 223.42 of
the Board's Regulation W (12 CFR 223.42) subject to the limitations
specified under 12 U.S.C. 371c(d) or Sec. 223.42 of the Board's
Regulation W (12 CFR 223.42), as applicable,
(iv) Enter into a riskless principal transaction with a covered
fund; and
(v) Extend credit to or purchase assets from a covered fund,
provided:
(A) Each extension of credit or purchase of assets is in the
ordinary course of business in connection with payment transactions;
settlement services; or futures, derivatives, and securities clearing;
(B) Each extension of credit is repaid, sold, or terminated by the
end of five business days; and
(C) The banking entity making each extension of credit meets the
requirements of Sec. 223.42(l)(1)(i) and (ii) of the Board's
Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of
credit was an intraday extension of credit, regardless of the duration
of the extension of credit.
(3) Any transaction or activity permitted under paragraphs
(a)(2)(iii), (iv) or (v) must comply with the limitations in Sec.
248.15.
* * * * *
(c) Restrictions on other permitted transactions. Any transaction
permitted under paragraphs (a)(2)(ii), (iii), or (iv) of this section
shall be subject to section 23B of the Federal Reserve Act (12 U.S.C.
371c-1) as if the counterparty were an affiliate of the banking entity
under section 23B.
Subpart D--Compliance Program Requirements; Violations
0
14. Amend Sec. 248.20 by:
0
a. Revising paragraph (a);
0
b. Revising the heading of paragraph (d) and revising paragraph (d)(1)
; and
0
c. Revising the introductory text of paragraph (e).
The revisions and addition read as follows:
Sec. 248.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities or a qualifying
foreign excluded fund under Sec. Sec. 248.6(f) or 248.13(d)) shall
develop and provide for the continued administration of a compliance
program reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
* * * * *
(d) Reporting requirements under appendix A to this part. (1) A
banking entity (other than a qualifying foreign excluded fund under
section 248.6(f) or 248.13(d)) engaged in proprietary trading activity
permitted under subpart B shall comply with the reporting requirements
described in appendix A to this part, if:
* * * * *
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities (other than a
qualifying foreign excluded fund under section 248.6(f) or 248.13(d))
shall maintain records that include:
* * * * *
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Chapter III
Authority and Issuance
For the reasons set forth in the Common Preamble, the Federal
Deposit Insurance Corporation amends chapter III of title 12, Code of
Federal Regulations as follows:
PART 351--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
15. The authority citation for part 351 continues to read as follows:
Authority: 12 U.S.C. 1851; 1811 et seq.; 3101 et seq.; and 5412.
Subpart B--Proprietary Trading
0
16. Amend Sec. 351.6 by adding paragraph (f) to read as follows:
Sec. 351.6 Other permitted proprietary trading activities.
* * * * *
(f) Permitted trading activities of qualifying foreign excluded
funds. The prohibition contained in Sec. 351.3(a) does not apply to
the purchase or sale of a financial instrument by a qualifying foreign
excluded fund. For purposes of this paragraph (f), a qualifying foreign
excluded fund means a banking entity that:
(1) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(2)(i) Would be a covered fund if the entity were organized or
established in the United States, or
(ii) Is, or holds itself out as being, an entity or arrangement
that raises money from investors primarily for the purpose of investing
in financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the
acquisition or retention of an ownership interest in, sponsorship of,
or relationship with the entity, by another banking entity that meets
the following:
(i) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(ii) The banking entity's acquisition or retention of an ownership
interest in or sponsorship of the fund meets the requirements for
permitted covered fund activities and investments solely outside the
United States, as provided in Sec. 351.13(b);
[[Page 46510]]
(4) Is established and operated as part of a bona fide asset
management business; and
(5) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
Subpart C--Covered Funds Activities and Investments
0
17. Amend Sec. 351.10 by:
0
a. Revising paragraph (c)(1);
0
b. Revising paragraph (c)(3)(i);
0
c. Revising paragraph (c)(8);
0
d. Revising the heading of paragraph (c)(10) and revising paragraph
(c)(10)(i);
0
e. Revising paragraph (c)(11);
0
f. Adding paragraphs (c)(15), (16), (17), and (18);
0
g. Revising paragraph (d)(6); and
0
h. Adding paragraph (d)(11).
The revisions and additions read as follows:
Sec. 351.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
* * * * *
(c) * * *
(1) Foreign public funds. (i) Subject to paragraphs (c)(1)(ii) and
(iii) of this section, an issuer that:
(A) Is organized or established outside of the United States; and
(B) Is authorized to offer and sell ownership interests, and such
interests are offered and sold, through one or more public offerings.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless more than 75 percent of the
ownership interests in the issuer are sold to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and senior executive officers as defined in Sec.
225.71(c) of the Board's Regulation Y (12 CFR 225.71(c)) of such
entities.
(iii) For purposes of paragraph (c)(1)(i)(B) of this section, the
term public offering means a distribution (as defined in Sec.
351.4(a)(3)) of securities in any jurisdiction outside the United
States to investors, including retail investors, provided that:
(A) The distribution is subject to substantive disclosure and
retail investor protection laws or regulations;
(B) With respect to an issuer for which the banking entity serves
as the investment manager, investment adviser, commodity trading
advisor, commodity pool operator, or sponsor, the distribution complies
with all applicable requirements in the jurisdiction in which such
distribution is being made;
(C) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(D) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
* * * * *
(3) * * *
(i) Is composed of no more than 10 unaffiliated co-venturers;
* * * * *
(8) Loan securitizations. (i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are composed solely of:
(A) Loans as defined in Sec. 351.2(t);
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
that is a security (other than special units of beneficial interest and
collateral certificates meeting the requirements of paragraph (c)(8)(v)
of this section) meets the requirements of paragraph (c)(8)(iii) of
this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section;
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section; and
(E) Debt securities, other than asset-backed securities and
convertible securities, provided that:
(1) The aggregate value of such debt securities does not exceed
five percent of the aggregate value of loans held under paragraph
(c)(8)(i)(A) of this section, cash and cash equivalents held under
paragraph (c)(8)(iii)(A) of this section, and debt securities held
under this paragraph (c)(8)(i)(E); and
(2) The aggregate value of the loans, cash and cash equivalents,
and debt securities for purposes of this paragraph is calculated at par
value at the most recent time any such debt security is acquired,
except that the issuing entity may instead determine the value of any
such loan, cash equivalent, or debt security based on its fair market
value if:
(i) The issuing entity is required to use the fair market value of
such assets for purposes of calculating compliance with concentration
limitations or other similar calculations under its transaction
agreements, and
(ii) The issuing entity's valuation methodology values similarly
situated assets consistently.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
except as permitted under paragraph (c)(8)(i)(E) of this section, the
assets or holdings of the issuing entity shall not include any of the
following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraphs
(c)(8)(iii), (iv), or (v) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities, other than
debt securities permitted under paragraph (c)(8)(i)(E) of this section,
if those securities are:
(A) Cash equivalents--which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the securitization's expected or potential need for
funds and whose currency corresponds to either the underlying loans or
the asset-backed securities--for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivatives directly relate to the
loans, the asset-backed securities, the contractual rights or other
assets described in paragraph (c)(8)(i)(B) of this section, or the debt
securities described in paragraph (c)(8)(i)(E) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, the
contractual rights or other assets described in paragraph (c)(8)(i)(B)
[[Page 46511]]
of this section, or the debt securities described in paragraph
(c)(8)(i)(E) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
* * * * *
(10) Qualifying covered bonds. (i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are composed solely
of assets that meet the conditions in paragraph (c)(8)(i) of this
section.
* * * * *
(11) SBICs and public welfare investment funds. An issuer:
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked, or
that has voluntarily surrendered its license to operate as a small
business investment company in accordance with 13 CFR 107.1900 and does
not make any new investments (other than investments in cash
equivalents, which, for the purposes of this paragraph, means high
quality, highly liquid investments whose maturity corresponds to the
issuer's expected or potential need for funds and whose currency
corresponds to the issuer's assets) after such voluntary surrender;
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs) and including investments that qualify for
consideration under the regulations implementing the Community
Reinvestment Act (12 U.S.C. 2901 et seq.); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program;
(iii) That has elected to be regulated or is regulated as a rural
business investment company, as described in 15 U.S.C. 80b-3(b)(8)(A)
or (B), or that has terminated its participation as a rural business
investment company in accordance with 7 CFR 4290.1900 and does not make
any new investments (other than investments in cash equivalents, which,
for the purposes of this paragraph, means high quality, highly liquid
investments whose maturity corresponds to the issuer's expected or
potential need for funds and whose currency corresponds to the issuer's
assets) after such termination; or
(iv) That is a qualified opportunity fund, as defined in 26 U.S.C.
1400Z-2(d).
* * * * *
(15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and
(v) of this section, an issuer that satisfies the asset and activity
requirements of paragraphs (c)(15)(i) and (ii) of this section.
(i) Asset requirements. The issuer's assets must be composed solely
of:
(A) Loans as defined in Sec. 351.2(t);
(B) Debt instruments, subject to paragraph (c)(15)(iv) of this
section;
(C) Rights and other assets that are related or incidental to
acquiring, holding, servicing, or selling such loans or debt
instruments, provided that:
(1) Each right or asset held under this paragraph (c)(15)(i)(C)
that is a security is either:
(i) A cash equivalent (which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the issuer's expected or potential need for funds and
whose currency corresponds to either the underlying loans or the debt
instruments);
(ii) A security received in lieu of debts previously contracted
with respect to such loans or debt instruments; or
(iii) An equity security (or right to acquire an equity security)
received on customary terms in connection with such loans or debt
instruments; and
(2) Rights or other assets held under this paragraph (c)(15)(i)(C)
of this section may not include commodity forward contracts or any
derivative; and
(D) Interest rate or foreign exchange derivatives, if:
(1) The written terms of the derivative directly relate to the
loans, debt instruments, or other rights or assets described in
paragraph (c)(15)(i)(C) of this section; and
(2) The derivative reduces the interest rate and/or foreign
exchange risks related to the loans, debt instruments, or other rights
or assets described in paragraph (c)(15)(i)(C) of this section.
(ii) Activity requirements. To be eligible for the exclusion of
paragraph (c)(15) of this section, an issuer must:
(A) Not engage in any activity that would constitute proprietary
trading under Sec. 351.3(b)(l)(i), as if the issuer were a banking
entity; and
(B) Not issue asset-backed securities.
(iii) Requirements for a sponsor, investment adviser, or commodity
trading advisor. A banking entity that acts as a sponsor, investment
adviser, or commodity trading advisor to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section may not
rely on this exclusion unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 351.11(a)(8) of this
subpart, as if the issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the limitations imposed in Sec. 351.14, as if
the issuer were a covered fund, except the banking entity may acquire
and retain any ownership interest in the issuer.
(iv) Additional Banking Entity Requirements. A banking entity may
not rely on this exclusion with respect to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section unless:
(A) The banking entity does not, directly or indirectly, guarantee,
[[Page 46512]]
assume, or otherwise insure the obligations or performance of the
issuer or of any entity to which such issuer extends credit or in which
such issuer invests; and
(B) Any assets the issuer holds pursuant to paragraphs
(c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible
for the banking entity to acquire and hold directly under applicable
federal banking laws and regulations.
(v) Investment and Relationship Limits. A banking entity's
investment in, and relationship with, the issuer must:
(A) Comply with the limitations imposed in Sec. 351.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(16) Qualifying venture capital funds. (i) Subject to paragraphs
(c)(16)(ii) through (iv) of this section, an issuer that:
(A) Is a venture capital fund as defined in 17 CFR 275.203(l)-1;
and
(B) Does not engage in any activity that would constitute
proprietary trading under Sec. 351.3(b)(1)(i), as if the issuer were a
banking entity.
(ii) A banking entity that acts as a sponsor, investment adviser,
or commodity trading advisor to an issuer that meets the conditions in
paragraph (c)(16)(i) of this section may not rely on this exclusion
unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 351.11(a)(8), as if the
issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the restrictions in Sec. 351.14 as if the issuer
were a covered fund (except the banking entity may acquire and retain
any ownership interest in the issuer).
(iii) The banking entity must not, directly or indirectly,
guarantee, assume, or otherwise insure the obligations or performance
of the issuer.
(iv) A banking entity's ownership interest in or relationship with
the issuer must:
(A) Comply with the limitations imposed in Sec. 351.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(17) Family wealth management vehicles. (i) Subject to paragraph
(c)(17)(ii) of this section, any entity that is not, and does not hold
itself out as being, an entity or arrangement that raises money from
investors primarily for the purpose of investing in securities for
resale or other disposition or otherwise trading in securities, and:
(A) If the entity is a trust, the grantor(s) of the entity are all
family customers; and
(B) If the entity is not a trust:
(1) A majority of the voting interests in the entity are owned
(directly or indirectly) by family customers;
(2) A majority of the interests in the entity are owned (directly
or indirectly) by family customers;
(3) The entity is owned only by family customers and up to 5
closely related persons of the family customers; and
(C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this
section, up to an aggregate 0.5 percent of the entity's outstanding
ownership interests may be acquired or retained by one or more entities
that are not family customers or closely related persons if the
ownership interest is acquired or retained by such parties for the
purpose of and to the extent necessary for establishing corporate
separateness or addressing bankruptcy, insolvency, or similar concerns.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(17)(i) of this section with respect to an entity provided that the
banking entity (or an affiliate):
(A) Provides bona fide trust, fiduciary, investment advisory, or
commodity trading advisory services to the entity;
(B) Does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of such entity;
(C) Complies with the disclosure obligations under Sec.
351.11(a)(8), as if such entity were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of disclosure may be modified to accommodate the
specific circumstances of the entity;
(D) Does not acquire or retain, as principal, an ownership interest
in the entity, other than as described in paragraph (c)(17)(i)(C) of
this section;
(E) Complies with the requirements of Sec. Sec. 351.14(b) and
351.15, as if such entity were a covered fund; and
(F) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, complies with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the entity were an affiliate thereof.
(iii) For purposes of paragraph (c)(17) of this section, the
following definitions apply:
(A) Closely related person means a natural person (including the
estate and estate planning vehicles of such person) who has
longstanding business or personal relationships with any family
customer.
(B) Family customer means:
(1) A family client, as defined in Rule 202(a)(11)(G)-1(d)(4) of
the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1(d)(4));
or
(2) Any natural person who is a father-in-law, mother-in-law,
brother-in-law, sister-in-law, son-in-law or daughter-in-law of a
family client, or a spouse or a spousal equivalent of any of the
foregoing.
(18) Customer facilitation vehicles. (i) Subject to paragraph
(c)(18)(ii) of this section, an issuer that is formed by or at the
request of a customer of the banking entity for the purpose of
providing such customer (which may include one or more affiliates of
such customer) with exposure to a transaction, investment strategy, or
other service provided by the banking entity.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(18)(i) of this section with respect to an issuer provided that:
(A) All of the ownership interests of the issuer are owned by the
customer (which may include one or more of its affiliates) for whom the
issuer was created;
(B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to
an aggregate 0.5 percent of the issuer's outstanding ownership
interests may be acquired or retained by one or more entities that are
not customers if the ownership interest is acquired or retained by such
parties for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns; and
(C) The banking entity and its affiliates:
(1) Maintain documentation outlining how the banking entity intends
to facilitate the customer's exposure to such transaction, investment
strategy, or service;
(2) Do not, directly or indirectly, guarantee, assume, or otherwise
insure the obligations or performance of such issuer;
(3) Comply with the disclosure obligations under Sec.
351.11(a)(8), as if such issuer were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of
[[Page 46513]]
disclosure may be modified to accommodate the specific circumstances of
the issuer;
(4) Do not acquire or retain, as principal, an ownership interest
in the issuer, other than as described in paragraph (c)(18)(ii)(B) of
this section;
(5) Comply with the requirements of Sec. Sec. 351.14(b) and
351.15, as if such issuer were a covered fund; and
(6) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, comply with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the issuer were an affiliate thereof.
* * * * *
(d) * * *
(6) Ownership interest. (i) Ownership interest means any equity,
partnership, or other similar interest. An other similar interest means
an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund, excluding:
(1) The rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event; and
(2) The right to participate in the removal of an investment
manager for ``cause'' or participate in the selection of a replacement
manager upon an investment manager's resignation or removal. For
purposes of this paragraph (d)(6)(i)(A)(2), ``cause'' for removal of an
investment manager means one or more of the following events: (i) The
bankruptcy, insolvency, conservatorship or receivership of the
investment manager;
(ii) The breach by the investment manager of any material provision
of the covered fund's transaction agreements applicable to the
investment manager;
(iii) The breach by the investment manager of material
representations or warranties;
(iv) The occurrence of an act that constitutes fraud or criminal
activity in the performance of the investment manager's obligations
under the covered fund's transaction agreements;
(v) The indictment of the investment manager for a criminal
offense, or the indictment of any officer, member, partner or other
principal of the investment manager for a criminal offense materially
related to his or her investment management activities;
(vi) A change in control with respect to the investment manager;
(vii) The loss, separation or incapacitation of an individual
critical to the operation of the investment manager or primarily
responsible for the management of the covered fund's assets; or
(viii) Other similar events that constitute ``cause'' for removal
of an investment manager, provided that such events are not solely
related to the performance of the covered fund or the investment
manager's exercise of investment discretion under the covered fund's
transaction agreements;
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include:
(A) Restricted profit interest, which is an interest held by an
entity (or an employee or former employee thereof) in a covered fund
for which the entity (or employee thereof) serves as investment
manager, investment adviser, commodity trading advisor, or other
service provider, so long as:
(1) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(2) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(3) Any amounts invested in the covered fund, including any amounts
paid by the entity in connection with obtaining the restricted profit
interest, are within the limits of Sec. 351.12 of this subpart; and
(4) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(B) Any senior loan or senior debt interest that has the following
characteristics:
(1) Under the terms of the interest the holders of such interest do
not have the right to receive a share of the income, gains, or profits
of the covered fund, but are entitled to receive only:
(i) Interest at a stated interest rate, as well as commitment fees
or other fees, which are not determined by reference to the performance
of the underlying assets of the covered fund; and
(ii) Repayment of a fixed principal amount, on or before a maturity
date, in a contractually-determined manner (which may include
prepayment premiums intended solely to reflect, and compensate holders
of the interest for, forgone income resulting from an early
prepayment);
(2) The entitlement to payments under the terms of the interest are
absolute and could not be reduced based on losses arising from the
underlying assets of the covered fund, such as allocation of losses,
write-downs or charge-offs of the outstanding principal balance, or
reductions in the
[[Page 46514]]
amount of interest due and payable on the interest; and
(3) The holders of the interest are not entitled to receive the
underlying assets of the covered fund after all other interests have
been redeemed or paid in full (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event).
* * * * *
(11) Riskless principal transaction. Riskless principal transaction
means a transaction in which a banking entity, after receiving an order
from a customer to buy (or sell) a security, purchases (or sells) the
security in the secondary market for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
0
18. Amend Sec. 351.12 by:
0
a. Revising paragraph (b)(1)(ii);
0
b. Revising paragraph (b)(4);
0
c. Adding paragraph (b)(5);
0
d. Revising paragraph (c)(1); and
0
e. Revising paragraphs (d) and (e).
The revisions and addition read as follows:
Sec. 351.12 Permitted investment in a covered fund.
* * * * *
(b) * * *
(1) * * *
(ii) Treatment of registered investment companies, SEC-regulated
business development companies, and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies, or foreign
public fund as described in Sec. 351.10(c)(1) will not be considered
to be an affiliate of the banking entity so long as:
(A) The banking entity, together with its affiliates, does not own,
control, or hold with the power to vote 25 percent or more of the
voting shares of the company or fund; and
(B) The banking entity, or an affiliate of the banking entity,
provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
* * * * *
(4) Multi-tier fund investments. (i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
in the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 351.11 for the purpose of
investing in other covered funds (a ``fund of funds'') and that fund of
funds itself invests in another covered fund that the banking entity is
permitted to own, then the banking entity's permitted investment in
that other fund shall include any investment by the banking entity in
that other fund, as well as the banking entity's pro-rata share of any
ownership interest in the fund that is held through the fund of funds.
The investment of the banking entity may not represent more than 3
percent of the amount or value of any single covered fund.
(5) Parallel Investments and Co-Investments. (i) A banking entity
shall not be required to include in the calculation of the investment
limits under paragraph (a)(2) of this section any investment the
banking entity makes alongside a covered fund as long as the investment
is made in compliance with applicable laws and regulations, including
applicable safety and soundness standards.
(ii) A banking entity shall not be restricted under this section in
the amount of any investment the banking entity makes alongside a
covered fund as long as the investment is made in compliance with
applicable laws and regulations, including applicable safety and
soundness standards.
(c) * * *
(1)(i) For purposes of paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership interests held by a banking entity
shall be the sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
in covered funds (together with any amounts paid by the entity in
connection with obtaining a restricted profit interest under Sec.
351.10(d)(6)(ii)), on a historical cost basis;
(ii) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (c)(1)(i) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
* * * * *
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1)(i) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity in connection with
obtaining a restricted profit interest under Sec. 351.10(d)(6)(ii) of
subpart C of this part), on a historical cost basis, plus any earnings
received; and
(ii) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
in connection with obtaining a restricted profit interest under Sec.
351.10(d)(6)(ii) of subpart C of this part), if the banking entity
accounts for the profits (or losses) of the fund investment in its
financial statements.
(2) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (d)(1) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
(e) Extension of time to divest an ownership interest. (1)
Extension period. Upon application by a banking entity, the Board may
extend the period under paragraph (a)(2)(i) of this section for up to 2
additional years if the Board finds that an extension would be
consistent with safety and soundness and not detrimental to the public
interest.
(2) Application requirements. An application for extension must:
[[Page 46515]]
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(3) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(3) Factors governing the Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers, or counterparties to which it owes a duty;
(vii) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(4) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(5) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
0
19. Amend Sec. 351.13 by adding paragraph (d) to read as follows:
Sec. 351.13 Other permitted covered fund activities and investments.
* * * * *
(d) Permitted covered fund activities and investments of qualifying
foreign excluded funds. (1) The prohibition contained in Sec.
351.10(a) does not apply to a qualifying foreign excluded fund.
(2) For purposes of this paragraph (d), a qualifying foreign
excluded fund means a banking entity that:
(i) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(ii)(A) Would be a covered fund if the entity were organized or
established in the United States, or
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(iii) Would not otherwise be a banking entity except by virtue of
the acquisition or retention of an ownership interest in, sponsorship
of, or relationship with the entity, by another banking entity that
meets the following:
(A) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(B) The banking entity's acquisition of an ownership interest in or
sponsorship of the fund by the foreign banking entity meets the
requirements for permitted covered fund activities and investments
solely outside the United States, as provided in Sec. 351.13(b);
(iv) Is established and operated as part of a bona fide asset
management business; and
(v) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
0
20. Amend Sec. 351.14 by:
0
a. Revising paragraph (a)(2)(i);
0
b. Revising paragraph (a)(2)(ii)(C);
0
c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and
0
d. Revising paragraph (c).
The revisions and additions read as follows:
Sec. 351.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. Sec. 351.11, 351.12, or
351.13;
(ii) * * *
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity; and
(iii) Enter into a transaction with a covered fund that would be an
exempt covered transaction under 12 U.S.C. 371c(d) or Sec. 223.42 of
the Board's Regulation W (12 CFR 223.42) subject to the limitations
specified under 12 U.S.C. 371c(d) or Sec. 223.42 of the Board's
Regulation W (12 CFR 223.42), as applicable,
(iv) Enter into a riskless principal transaction with a covered
fund; and
(v) Extend credit to or purchase assets from a covered fund,
provided:
(A) Each extension of credit or purchase of assets is in the
ordinary course of business in connection with payment transactions;
settlement services; or futures, derivatives, and securities clearing;
(B) Each extension of credit is repaid, sold, or terminated by the
end of five business days; and
(C) The banking entity making each extension of credit meets the
requirements of Sec. 223.42(l)(1)(i) and (ii) of the Board's
Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of
credit was an intraday extension of credit, regardless of the duration
of the extension of credit.
(3) Any transaction or activity permitted under paragraphs
(a)(2)(iii), (iv) or (v) must comply with the limitations in Sec.
351.15.
* * * * *
(c) Restrictions on other permitted transactions. Any transaction
permitted under paragraphs (a)(2)(ii), (iii), or (iv) of this section
shall be subject to section 23B of the Federal Reserve Act (12 U.S.C.
371c-1) as if the counterparty were an affiliate of the banking entity
under section 23B.
Subpart D--Compliance Program Requirements; Violations
0
21. Amend Sec. 351.20 by:
0
a. Revising paragraph (a);
[[Page 46516]]
0
b. Revising the heading of paragraph (d) and revising paragraph (d)(1);
and
0
c. Revising the introductory text of paragraph (e).
The revisions and addition read as follows:
Sec. 351.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities or a qualifying
foreign excluded fund under section 351.6(f) or 351.13(d)) shall
develop and provide for the continued administration of a compliance
program reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
* * * * *
(d) Reporting requirements under appendix A to this part. (1) A
banking entity (other than a qualifying foreign excluded fund under
section 351.6(f) or 351.13(d)) engaged in proprietary trading activity
permitted under subpart B shall comply with the reporting requirements
described in appendix A to this part, if:
* * * * *
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities (other than a
qualifying foreign excluded fund under section 351.6(f) or 351.13(d))
shall maintain records that include:
* * * * *
COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Authority and Issuance
For the reasons set forth in the Common Preamble, the Commodity
Futures Trading Commission amends part 75 to chapter I of title 17 of
the Code of Federal Regulations as follows:
PART 75--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
22. The authority citation for part 75 continues to read as follows:
Authority: 12 U.S.C. 1851.
Subpart B--Proprietary Trading
0
23. Amend Sec. 75.6 by adding paragraph (f) to read as follows:
Sec. 75.6 Other permitted proprietary trading activities.
* * * * *
(f) Permitted trading activities of qualifying foreign excluded
funds. The prohibition contained in Sec. 75.3(a) does not apply to the
purchase or sale of a financial instrument by a qualifying foreign
excluded fund. For purposes of this paragraph (f), a qualifying foreign
excluded fund means a banking entity that:
(1) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(2)(i) Would be a covered fund if the entity were organized or
established in the United States, or
(ii) Is, or holds itself out as being, an entity or arrangement
that raises money from investors primarily for the purpose of investing
in financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the
acquisition or retention of an ownership interest in, sponsorship of,
or relationship with the entity, by another banking entity that meets
the following:
(i) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(ii) The banking entity's acquisition or retention of an ownership
interest in or sponsorship of the fund meets the requirements for
permitted covered fund activities and investments solely outside the
United States, as provided in Sec. 75.13(b);
(4) Is established and operated as part of a bona fide asset
management business; and
(5) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
Subpart C--Covered Funds Activities and Investments
0
24. Amend Sec. 75.10 by:
0
a. Revising paragraph (c)(1);
0
b. Revising paragraph (c)(3)(i);
0
c. Revising paragraph (c)(8);
0
d. Revising the heading of paragraph (c)(10) and revising paragraph
(c)(10)(i);
0
e. Revising paragraph (c)(11);
0
f. Adding paragraphs (c)(15), (16), (17), and (18);
0
g. Revising paragraph (d)(6); and
0
h. Adding paragraph (d)(11).
The revisions and additions read as follows:
Sec. 75.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
* * * * *
(c) * * *
(1) Foreign public funds. (i) Subject to paragraphs (c)(1)(ii) and
(iii) of this section, an issuer that:
(A) Is organized or established outside of the United States; and
(B) Is authorized to offer and sell ownership interests, and such
interests are offered and sold, through one or more public offerings.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless more than 75 percent of the
ownership interests in the issuer are sold to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and senior executive officers as defined in Sec.
225.71(c) of the Board's Regulation Y (12 CFR 225.71(c)) of such
entities.
(iii) For purposes of paragraph (c)(1)(i)(B) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
75.4(a)(3)) of securities in any jurisdiction outside the United States
to investors, including retail investors, provided that:
(A) The distribution is subject to substantive disclosure and
retail investor protection laws or regulations;
(B) With respect to an issuer for which the banking entity serves
as the investment manager, investment adviser, commodity trading
advisor, commodity pool operator, or sponsor, the distribution complies
with all applicable requirements in the jurisdiction in which such
distribution is being made;
(C) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(D) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
* * * * *
[[Page 46517]]
(3) * * *
(i) Is composed of no more than 10 unaffiliated co-venturers;
* * * * *
(8) Loan securitizations. (i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are composed solely of:
(A) Loans as defined in Sec. 75.2(t);
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
that is a security (other than special units of beneficial interest and
collateral certificates meeting the requirements of paragraph (c)(8)(v)
of this section) meets the requirements of paragraph (c)(8)(iii) of
this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section;
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section; and
(E) Debt securities, other than asset-backed securities and
convertible securities, provided that:
(1) The aggregate value of such debt securities does not exceed
five percent of the aggregate value of loans held under paragraph
(c)(8)(i)(A) of this section, cash and cash equivalents held under
paragraph (c)(8)(iii)(A) of this section, and debt securities held
under this paragraph (c)(8)(i)(E); and
(2) The aggregate value of the loans, cash and cash equivalents,
and debt securities for purposes of this paragraph is calculated at par
value at the most recent time any such debt security is acquired,
except that the issuing entity may instead determine the value of any
such loan, cash equivalent, or debt security based on its fair market
value if:
(i) The issuing entity is required to use the fair market value of
such assets for purposes of calculating compliance with concentration
limitations or other similar calculations under its transaction
agreements, and
(ii) The issuing entity's valuation methodology values similarly
situated assets consistently.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
except as permitted under paragraph (c)(8)(i)(E) of this section, the
assets or holdings of the issuing entity shall not include any of the
following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraphs
(c)(8)(iii), (iv), or (v) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities, other than
debt securities permitted under paragraph (c)(8)(i)(E) of this section,
if those securities are:
(A) Cash equivalents--which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the securitization's expected or potential need for
funds and whose currency corresponds to either the underlying loans or
the asset-backed securities--for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivatives directly relate to the
loans, the asset-backed securities, the contractual rights or other
assets described in paragraph (c)(8)(i)(B) of this section, or the debt
securities described in paragraph (c)(8)(i)(E) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, the
contractual rights or other assets described in paragraph (c)(8)(i)(B)
of this section, or the debt securities described in paragraph
(c)(8)(i)(E) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
* * * * *
(10) Qualifying covered bonds. (i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are composed solely
of assets that meet the conditions in paragraph (c)(8)(i) of this
section.
* * * * *
(11) * * *
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked, or
that has voluntarily surrendered its license to operate as a small
business investment company in accordance with 13 CFR 107.1900 and does
not make any new investments (other than investments in cash
equivalents, which, for the purposes of this paragraph, means high
quality, highly liquid investments whose maturity corresponds to the
issuer's expected or potential need for funds and whose currency
corresponds to the issuer's assets) after such voluntary surrender;
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs) and including investments that qualify for
consideration under the regulations implementing the Community
Reinvestment Act (12 U.S.C. 2901 et seq.); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are
[[Page 46518]]
defined in section 47 of the Internal Revenue Code of 1986 or a similar
State historic tax credit program;
(iii) That has elected to be regulated or is regulated as a rural
business investment company, as described in 15 U.S.C. 80b-3(b)(8)(A)
or (B), or that has terminated its participation as a rural business
investment company in accordance with 7 CFR 4290.1900 and does not make
any new investments (other than investments in cash equivalents, which,
for the purposes of this paragraph, means high quality, highly liquid
investments whose maturity corresponds to the issuer's expected or
potential need for funds and whose currency corresponds to the issuer's
assets) after such termination; or
(iv) That is a qualified opportunity fund, as defined in 26 U.S.C.
1400Z-2(d).
* * * * *
(15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and
(v) of this section, an issuer that satisfies the asset and activity
requirements of paragraphs (c)(15)(i) and (ii) of this section.
(i) Asset requirements. The issuer's assets must be composed solely
of:
(A) Loans as defined in Sec. 75.2(t);
(B) Debt instruments, subject to paragraph (c)(15)(iv) of this
section;
(C) Rights and other assets that are related or incidental to
acquiring, holding, servicing, or selling such loans or debt
instruments, provided that:
(1) Each right or asset held under this paragraph (c)(15)(i)(C)
that is a security is either:
(i) A cash equivalent (which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the issuer's expected or potential need for funds and
whose currency corresponds to either the underlying loans or the debt
instruments);
(ii) A security received in lieu of debts previously contracted
with respect to such loans or debt instruments; or
(iii) An equity security (or right to acquire an equity security)
received on customary terms in connection with such loans or debt
instruments; and
(2) Rights or other assets held under this paragraph (c)(15)(i)(C)
of this section may not include commodity forward contracts or any
derivative; and
(D) Interest rate or foreign exchange derivatives, if:
(1) The written terms of the derivative directly relate to the
loans, debt instruments, or other rights or assets described in
paragraph (c)(15)(i)(C) of this section; and
(2) The derivative reduces the interest rate and/or foreign
exchange risks related to the loans, debt instruments, or other rights
or assets described in paragraph (c)(15)(i)(C) of this section.
(ii) Activity requirements. To be eligible for the exclusion of
paragraph (c)(15) of this section, an issuer must:
(A) Not engage in any activity that would constitute proprietary
trading under Sec. 75.3(b)(l)(i), as if the issuer were a banking
entity; and
(B) Not issue asset-backed securities.
(iii) Requirements for a sponsor, investment adviser, or commodity
trading advisor. A banking entity that acts as a sponsor, investment
adviser, or commodity trading advisor to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section may not
rely on this exclusion unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 75.11(a)(8) of this
subpart, as if the issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the limitations imposed in Sec. 75.14, as if the
issuer were a covered fund, except the banking entity may acquire and
retain any ownership interest in the issuer.
(iv) Additional Banking Entity Requirements. A banking entity may
not rely on this exclusion with respect to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section unless:
(A) The banking entity does not, directly or indirectly, guarantee,
assume, or otherwise insure the obligations or performance of the
issuer or of any entity to which such issuer extends credit or in which
such issuer invests; and
(B) Any assets the issuer holds pursuant to paragraphs
(c)(15)(i)(B) or (i)(C)(l)(iii) of this section would be permissible
for the banking entity to acquire and hold directly under applicable
federal banking laws and regulations.
(v) Investment and Relationship Limits. A banking entity's
investment in, and relationship with, the issuer must:
(A) Comply with the limitations imposed in Sec. 75.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(16) Qualifying venture capital funds. (i) Subject to paragraphs
(c)(16)(ii) through (iv) of this section, an issuer that:
(A) Is a venture capital fund as defined in 17 CFR 275.203(l)-1;
and
(B) Does not engage in any activity that would constitute
proprietary trading under Sec. 75.3(b)(1)(i), as if the issuer were a
banking entity.
(ii) A banking entity that acts as a sponsor, investment adviser,
or commodity trading advisor to an issuer that meets the conditions in
paragraph (c)(16)(i) of this section may not rely on this exclusion
unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 75.11(a)(8), as if the
issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the restrictions in Sec. 75.14 as if the issuer
were a covered fund (except the banking entity may acquire and retain
any ownership interest in the issuer).
(iii) The banking entity must not, directly or indirectly,
guarantee, assume, or otherwise insure the obligations or performance
of the issuer.
(iv) A banking entity's ownership interest in or relationship with
the issuer must:
(A) Comply with the limitations imposed in Sec. 75.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(17) Family wealth management vehicles. (i) Subject to paragraph
(c)(17)(ii) of this section, any entity that is not, and does not hold
itself out as being, an entity or arrangement that raises money from
investors primarily for the purpose of investing in securities for
resale or other disposition or otherwise trading in securities, and:
(A) If the entity is a trust, the grantor(s) of the entity are all
family customers; and
(B) If the entity is not a trust:
(1) A majority of the voting interests in the entity are owned
(directly or indirectly) by family customers;
(2) A majority of the interests in the entity are owned (directly
or indirectly) by family customers;
(3) The entity is owned only by family customers and up to 5
closely related persons of the family customers; and
(C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this
section, up to an aggregate 0.5 percent of the
[[Page 46519]]
entity's outstanding ownership interests may be acquired or retained by
one or more entities that are not family customers or closely related
persons if the ownership interest is acquired or retained by such
parties for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(17)(i) of this section with respect to an entity provided that the
banking entity (or an affiliate):
(A) Provides bona fide trust, fiduciary, investment advisory, or
commodity trading advisory services to the entity;
(B) Does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of such entity;
(C) Complies with the disclosure obligations under Sec.
75.11(a)(8), as if such entity were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of disclosure may be modified to accommodate the
specific circumstances of the entity;
(D) Does not acquire or retain, as principal, an ownership interest
in the entity, other than as described in paragraph (c)(17)(i)(C) of
this section;
(E) Complies with the requirements of Sec. Sec. 75.14(b) and
75.15, as if such entity were a covered fund; and
(F) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, complies with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the entity were an affiliate thereof.
(iii) For purposes of paragraph (c)(17) of this section, the
following definitions apply:
(A) Closely related person means a natural person (including the
estate and estate planning vehicles of such person) who has
longstanding business or personal relationships with any family
customer.
(B) Family customer means:
(1) A family client, as defined in Rule 202(a)(11)(G)-1(d)(4) of
the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1(d)(4));
or
(2) Any natural person who is a father-in-law, mother-in-law,
brother-in-law, sister-in-law, son-in-law or daughter-in-law of a
family client, or a spouse or a spousal equivalent of any of the
foregoing.
(18) Customer facilitation vehicles. (i) Subject to paragraph
(c)(18)(ii) of this section, an issuer that is formed by or at the
request of a customer of the banking entity for the purpose of
providing such customer (which may include one or more affiliates of
such customer) with exposure to a transaction, investment strategy, or
other service provided by the banking entity.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(18)(i) of this section with respect to an issuer provided that:
(A) All of the ownership interests of the issuer are owned by the
customer (which may include one or more of its affiliates) for whom the
issuer was created;
(B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to
an aggregate 0.5 percent of the issuer's outstanding ownership
interests may be acquired or retained by one or more entities that are
not customers if the ownership interest is acquired or retained by such
parties for the purpose of and to the extent necessary for establishing
corporate separateness or addressing bankruptcy, insolvency, or similar
concerns; and
(C) The banking entity and its affiliates:
(1) Maintain documentation outlining how the banking entity intends
to facilitate the customer's exposure to such transaction, investment
strategy, or service;
(2) Do not, directly or indirectly, guarantee, assume, or otherwise
insure the obligations or performance of such issuer;
(3) Comply with the disclosure obligations under Sec. 75.11(a)(8),
as if such issuer were a covered fund, provided that the content may be
modified to prevent the disclosure from being misleading and the manner
of disclosure may be modified to accommodate the specific circumstances
of the issuer;
(4) Do not acquire or retain, as principal, an ownership interest
in the issuer, other than as described in paragraph (c)(18)(ii)(B) of
this section;
(5) Comply with the requirements of Sec. Sec. 75.14(b) and 75.15,
as if such issuer were a covered fund; and
(6) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, comply with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the issuer were an affiliate thereof.
* * * * *
(d) * * *
(6) Ownership interest. (i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund, excluding:
(1) The rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event; and
(2) The right to participate in the removal of an investment
manager for ``cause'' or participate in the selection of a replacement
manager upon an investment manager's resignation or removal. For
purposes of this paragraph (d)(6)(i)(A)(2), ``cause'' for removal of an
investment manager means one or more of the following events:
(i) The bankruptcy, insolvency, conservatorship or receivership of
the investment manager;
(ii) The breach by the investment manager of any material provision
of the covered fund's transaction agreements applicable to the
investment manager;
(iii) The breach by the investment manager of material
representations or warranties;
(iv) The occurrence of an act that constitutes fraud or criminal
activity in the performance of the investment manager's obligations
under the covered fund's transaction agreements;
(v) The indictment of the investment manager for a criminal
offense, or the indictment of any officer, member, partner or other
principal of the investment manager for a criminal offense materially
related to his or her investment management activities;
(vi) A change in control with respect to the investment manager;
(vii) The loss, separation or incapacitation of an individual
critical to the operation of the investment manager or primarily
responsible for the management of the covered fund's assets; or
(viii) Other similar events that constitute ``cause'' for removal
of an investment manager, provided that such events are not solely
related to the performance of the covered fund or the investment
manager's exercise of investment discretion under the covered fund's
transaction agreements;
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an
[[Page 46520]]
event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include:
(A) Restricted profit interest, which is an interest held by an
entity (or an employee or former employee thereof) in a covered fund
for which the entity (or employee thereof) serves as investment
manager, investment adviser, commodity trading advisor, or other
service provider, so long as:
(1) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(2) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(3) Any amounts invested in the covered fund, including any amounts
paid by the entity in connection with obtaining the restricted profit
interest, are within the limits of Sec. 75.12 of this subpart; and
(4) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(B) Any senior loan or senior debt interest that has the following
characteristics:
(1) Under the terms of the interest the holders of such interest do
not have the right to receive a share of the income, gains, or profits
of the covered fund, but are entitled to receive only:
(i) Interest at a stated interest rate, as well as commitment fees
or other fees, which are not determined by reference to the performance
of the underlying assets of the covered fund; and
(ii) Repayment of a fixed principal amount, on or before a maturity
date, in a contractually-determined manner (which may include
prepayment premiums intended solely to reflect, and compensate holders
of the interest for, forgone income resulting from an early
prepayment);
(2) The entitlement to payments under the terms of the interest are
absolute and could not be reduced based on losses arising from the
underlying assets of the covered fund, such as allocation of losses,
write-downs or charge-offs of the outstanding principal balance, or
reductions in the amount of interest due and payable on the interest;
and
(3) The holders of the interest are not entitled to receive the
underlying assets of the covered fund after all other interests have
been redeemed or paid in full (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event).
* * * * *
(11) Riskless principal transaction. Riskless principal transaction
means a transaction in which a banking entity, after receiving an order
from a customer to buy (or sell) a security, purchases (or sells) the
security in the secondary market for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
0
26. Amend Sec. 75.12 by:
0
a. Revising paragraph (b)(1)(ii);
0
b. Revising paragraph (b)(4);
0
c. Adding paragraph (b)(5);
0
d. Revising paragraph (c)(1); and
0
e. Revising paragraphs (d) and (e).
The revisions and addition read as follows:
Sec. 75.12 Permitted investment in a covered fund.
* * * * *
(b) * * *
(1) * * *
(ii) Treatment of registered investment companies, SEC-regulated
business development companies, and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies, or foreign
public fund as described in Sec. 75.10(c)(1) will not be considered to
be an affiliate of the banking entity so long as:
(A) The banking entity, together with its affiliates, does not own,
control, or hold with the power to vote 25 percent or more of the
voting shares of the company or fund; and
(B) The banking entity, or an affiliate of the banking entity,
provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
* * * * *
(4) Multi-tier fund investments. (i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
in the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 75.11 for the purpose of
investing in other covered funds (a ``fund of funds'') and that fund of
funds itself invests in another covered fund that the banking entity is
permitted to own, then the banking entity's permitted investment in
that other fund shall include any investment by the banking entity in
that other fund,
[[Page 46521]]
as well as the banking entity's pro-rata share of any ownership
interest in the fund that is held through the fund of funds. The
investment of the banking entity may not represent more than 3 percent
of the amount or value of any single covered fund.
(5) Parallel Investments and Co-Investments. (i) A banking entity
shall not be required to include in the calculation of the investment
limits under paragraph (a)(2) of this section any investment the
banking entity makes alongside a covered fund as long as the investment
is made in compliance with applicable laws and regulations, including
applicable safety and soundness standards.
(ii) A banking entity shall not be restricted under this section in
the amount of any investment the banking entity makes alongside a
covered fund as long as the investment is made in compliance with
applicable laws and regulations, including applicable safety and
soundness standards.
(c) * * *
(1)(i) For purposes of paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership interests held by a banking entity
shall be the sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
in covered funds (together with any amounts paid by the entity in
connection with obtaining a restricted profit interest under Sec.
75.10(d)(6)(ii)), on a historical cost basis;
(ii) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (c)(1)(i) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
* * * * *
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1)(i) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity in connection with
obtaining a restricted profit interest under Sec. 75.10(d)(6)(ii) of
subpart C of this part), on a historical cost basis, plus any earnings
received; and
(ii) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
in connection with obtaining a restricted profit interest under Sec.
75.10(d)(6)(ii) of subpart C of this part), if the banking entity
accounts for the profits (or losses) of the fund investment in its
financial statements.
(2) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (d)(1) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
(e) Extension of time to divest an ownership interest. (1)
Extension period. Upon application by a banking entity, the Board may
extend the period under paragraph (a)(2)(i) of this section for up to 2
additional years if the Board finds that an extension would be
consistent with safety and soundness and not detrimental to the public
interest.
(2) Application requirements. An application for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(3) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(3) Factors governing the Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers, or counterparties to which it owes a duty;
(vii) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(4) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(5) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
0
26. Amend Sec. 75.13 by adding paragraph (d) to read as follows:
Sec. 75.13 Other permitted covered fund activities and investments.
* * * * *
(d) Permitted covered fund activities and investments of qualifying
foreign excluded funds. (1) The prohibition
[[Page 46522]]
contained in Sec. 75.10(a) does not apply to a qualifying foreign
excluded fund.
(2) For purposes of this paragraph (d), a qualifying foreign
excluded fund means a banking entity that:
(i) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(ii)(A) Would be a covered fund if the entity were organized or
established in the United States, or
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(iii) Would not otherwise be a banking entity except by virtue of
the acquisition or retention of an ownership interest in, sponsorship
of, or relationship with the entity, by another banking entity that
meets the following:
(A) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(B) The banking entity's acquisition of an ownership interest in or
sponsorship of the fund by the foreign banking entity meets the
requirements for permitted covered fund activities and investments
solely outside the United States, as provided in Sec. 75.13(b);
(iv) Is established and operated as part of a bona fide asset
management business; and
(v) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
0
27. Amend Sec. 75.14 by:
0
a. Revising paragraph (a)(2)(i);
0
b. Revising paragraph (a)(2)(ii)(C);
0
c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and
0
d. Revising paragraph (c).
The revisions and additions read as follows:
Sec. 75.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. Sec. 75.11, 75.12, or 75.13;
(ii) * * *
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity; and
(iii) Enter into a transaction with a covered fund that would be an
exempt covered transaction under 12 U.S.C. 371c(d) or Sec. 223.42 of
the Board's Regulation W (12 CFR 223.42) subject to the limitations
specified under 12 U.S.C. 371c(d) or Sec. 223.42 of the Board's
Regulation W (12 CFR 223.42), as applicable,
(iv) Enter into a riskless principal transaction with a covered
fund; and
(v) Extend credit to or purchase assets from a covered fund,
provided:
(A) Each extension of credit or purchase of assets is in the
ordinary course of business in connection with payment transactions;
settlement services; or futures, derivatives, and securities clearing;
(B) Each extension of credit is repaid, sold, or terminated by the
end of five business days; and
(C) The banking entity making each extension of credit meets the
requirements of Sec. 223.42(l)(1)(i) and (ii) of the Board's
Regulation W (12 CFR 223.42(l)(1)(i) and(ii)), as if the extension of
credit was an intraday extension of credit, regardless of the duration
of the extension of credit.
(3) Any transaction or activity permitted under paragraphs
(a)(2)(iii), (iv) or (v) must comply with the limitations in Sec.
75.15.
* * * * *
(c) Restrictions on other permitted transactions. Any transaction
permitted under paragraphs (a)(2)(ii), (iii), or (iv) of this section
shall be subject to section 23B of the Federal Reserve Act (12 U.S.C.
371c-1) as if the counterparty were an affiliate of the banking entity
under section 23B.
Subpart D--Compliance Program Requirements; Violations
0
28. Amend Sec. 75.20 by:
0
a. Revising paragraph (a);
0
b. Revising the heading of paragraph (d) and revising paragraph (d)(1);
and
0
c. Revising the introductory text of paragraph (e).
The revisions and addition read as follows:
Sec. 75.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities or a qualifying
foreign excluded fund under section 75.6(f) or 75.13(d)) shall develop
and provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
* * * * *
(d) Reporting requirements under appendix A to this part. (1) A
banking entity (other than a qualifying foreign excluded fund under
section 75.6(f) or 75.13(d)) engaged in proprietary trading activity
permitted under subpart B shall comply with the reporting requirements
described in appendix A to this part, if:
* * * * *
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities (other than a
qualifying foreign excluded fund under section 75.6(f) or 75.13(d))
shall maintain records that include:
* * * * *
SECURITIES AND EXCHANGE COMMISSION
17 CFR Chapter II
Authority and Issuance
For the reasons set forth in the Common Preamble, the Securities
and Exchange Commission amends part 255 to chapter II of title 17 of
the Code of Federal Regulations as follows:
PART 255--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
29. The authority citation for part 255 continues to read as follows:
Authority: 12 U.S.C. 1851.
Subpart B--Proprietary Trading
0
30. Amend Sec. 255.6 by adding paragraph (f) to read as follows:
Sec. 255.6 Other permitted proprietary trading activities.
* * * * *
(f) Permitted trading activities of qualifying foreign excluded
funds. The prohibition contained in Sec. 255.3(a) does not apply to
the purchase or sale of a financial instrument by a qualifying foreign
excluded fund. For purposes of this paragraph (f), a qualifying foreign
excluded fund means a banking entity that:
(1) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(2)(i) Would be a covered fund if the entity were organized or
established in the United States, or
(ii) Is, or holds itself out as being, an entity or arrangement
that raises money
[[Page 46523]]
from investors primarily for the purpose of investing in financial
instruments for resale or other disposition or otherwise trading in
financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the
acquisition or retention of an ownership interest in, sponsorship of,
or relationship with the entity, by another banking entity that meets
the following:
(i) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(ii) The banking entity's acquisition or retention of an ownership
interest in or sponsorship of the fund meets the requirements for
permitted covered fund activities and investments solely outside the
United States, as provided in Sec. 255.13(b);
(4) Is established and operated as part of a bona fide asset
management business; and
(5) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
Subpart C--Covered Funds Activities and Investments
0
31. Amend Sec. 255.10 by:
0
a. Revising paragraph (c)(1);
0
b. Revising paragraph (c)(3)(i);
0
c. Revising paragraph (c)(8);
0
d. Revising the heading of paragraph (c)(10) and revising paragraph
(c)(10)(i);
0
e. Revising paragraph (c)(11);
0
f. Adding paragraphs (c)(15), (16), (17), and (18);
0
g. Revising paragraph (d)(6); and
0
h. Adding paragraph (d)(11).
The revisions and additions read as follows:
Sec. 255.10 Prohibition on acquiring or retaining an ownership
interest in and having certain relationships with a covered fund.
* * * * *
(c) * * *
(1) Foreign public funds. (i) Subject to paragraphs (c)(1)(ii) and
(iii) of this section, an issuer that:
(A) Is organized or established outside of the United States; and
(B) Is authorized to offer and sell ownership interests, and such
interests are offered and sold, through one or more public offerings.
(ii) With respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is, located in or
organized under the laws of the United States or of any State and any
issuer for which such banking entity acts as sponsor, the sponsoring
banking entity may not rely on the exemption in paragraph (c)(1)(i) of
this section for such issuer unless more than 75 percent of the
ownership interests in the issuer are sold to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring banking entity or such issuer;
and
(D) Directors and senior executive officers as defined in Sec.
225.71(c) of the Board's Regulation Y (12 CFR 225.71(c)) of such
entities.
(iii) For purposes of paragraph (c)(1)(i)(B) of this section, the
term ``public offering'' means a distribution (as defined in Sec.
255.4(a)(3)) of securities in any jurisdiction outside the United
States to investors, including retail investors, provided that:
(A) The distribution is subject to substantive disclosure and
retail investor protection laws or regulations;
(B) With respect to an issuer for which the banking entity serves
as the investment manager, investment adviser, commodity trading
advisor, commodity pool operator, or sponsor, the distribution complies
with all applicable requirements in the jurisdiction in which such
distribution is being made;
(C) The distribution does not restrict availability to investors
having a minimum level of net worth or net investment assets; and
(D) The issuer has filed or submitted, with the appropriate
regulatory authority in such jurisdiction, offering disclosure
documents that are publicly available.
* * * * *
(3) * * *
(i) Is composed of no more than 10 unaffiliated co-venturers;
* * * * *
(8) Loan securitizations. (i) Scope. An issuing entity for asset-
backed securities that satisfies all the conditions of this paragraph
(c)(8) and the assets or holdings of which are composed solely of:
(A) Loans as defined in Sec. 255.2(t);
(B) Rights or other assets designed to assure the servicing or
timely distribution of proceeds to holders of such securities and
rights or other assets that are related or incidental to purchasing or
otherwise acquiring and holding the loans, provided that each asset
that is a security (other than special units of beneficial interest and
collateral certificates meeting the requirements of paragraph (c)(8)(v)
of this section) meets the requirements of paragraph (c)(8)(iii) of
this section;
(C) Interest rate or foreign exchange derivatives that meet the
requirements of paragraph (c)(8)(iv) of this section;
(D) Special units of beneficial interest and collateral
certificates that meet the requirements of paragraph (c)(8)(v) of this
section; and
(E) Debt securities, other than asset-backed securities and
convertible securities, provided that:
(1) The aggregate value of such debt securities does not exceed
five percent of the aggregate value of loans held under paragraph
(c)(8)(i)(A) of this section, cash and cash equivalents held under
paragraph (c)(8)(iii)(A) of this section, and debt securities held
under this paragraph (c)(8)(i)(E); and
(2) The aggregate value of the loans, cash and cash equivalents,
and debt securities for purposes of this paragraph is calculated at par
value at the most recent time any such debt security is acquired,
except that the issuing entity may instead determine the value of any
such loan, cash equivalent, or debt security based on its fair market
value if:
(i) The issuing entity is required to use the fair market value of
such assets for purposes of calculating compliance with concentration
limitations or other similar calculations under its transaction
agreements, and
(ii) The issuing entity's valuation methodology values similarly
situated assets consistently.
(ii) Impermissible assets. For purposes of this paragraph (c)(8),
except as permitted under paragraph (c)(8)(i)(E) of this section, the
assets or holdings of the issuing entity shall not include any of the
following:
(A) A security, including an asset-backed security, or an interest
in an equity or debt security other than as permitted in paragraphs
(c)(8)(iii), (iv), or (v) of this section;
(B) A derivative, other than a derivative that meets the
requirements of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may hold securities, other than
debt securities permitted under paragraph (c)(8)(i)(E) of this section,
if those securities are:
(A) Cash equivalents--which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the securitization's expected or potential need for
funds and whose currency corresponds to either the underlying loans or
the asset-backed securities--for purposes of the rights and assets in
paragraph (c)(8)(i)(B) of this section; or
[[Page 46524]]
(B) Securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities.
(iv) Derivatives. The holdings of derivatives by the issuing entity
shall be limited to interest rate or foreign exchange derivatives that
satisfy all of the following conditions:
(A) The written terms of the derivatives directly relate to the
loans, the asset-backed securities, the contractual rights or other
assets described in paragraph (c)(8)(i)(B) of this section, or the debt
securities described in paragraph (c)(8)(i)(E) of this section; and
(B) The derivatives reduce the interest rate and/or foreign
exchange risks related to the loans, the asset-backed securities, the
contractual rights or other assets described in paragraph (c)(8)(i)(B)
of this section, or the debt securities described in paragraph
(c)(8)(i)(E) of this section.
(v) Special units of beneficial interest and collateral
certificates. The assets or holdings of the issuing entity may include
collateral certificates and special units of beneficial interest issued
by a special purpose vehicle, provided that:
(A) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate meets the requirements in
this paragraph (c)(8);
(B) The special unit of beneficial interest or collateral
certificate is used for the sole purpose of transferring to the issuing
entity for the loan securitization the economic risks and benefits of
the assets that are permissible for loan securitizations under this
paragraph (c)(8) and does not directly or indirectly transfer any
interest in any other economic or financial exposure;
(C) The special unit of beneficial interest or collateral
certificate is created solely to satisfy legal requirements or
otherwise facilitate the structuring of the loan securitization; and
(D) The special purpose vehicle that issues the special unit of
beneficial interest or collateral certificate and the issuing entity
are established under the direction of the same entity that initiated
the loan securitization.
* * * * *
(10) Qualifying covered bonds. (i) Scope. An entity owning or
holding a dynamic or fixed pool of loans or other assets as provided in
paragraph (c)(8) of this section for the benefit of the holders of
covered bonds, provided that the assets in the pool are composed solely
of assets that meet the conditions in paragraph (c)(8)(i) of this
section.
* * * * *
(11) * * *
(i) That is a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), or that has received from the Small Business Administration
notice to proceed to qualify for a license as a small business
investment company, which notice or license has not been revoked, or
that has voluntarily surrendered its license to operate as a small
business investment company in accordance with 13 CFR 107.1900 and does
not make any new investments (other than investments in cash
equivalents, which, for the purposes of this paragraph, means high
quality, highly liquid investments whose maturity corresponds to the
issuer's expected or potential need for funds and whose currency
corresponds to the issuer's assets) after such voluntary surrender;
(ii) The business of which is to make investments that are:
(A) Designed primarily to promote the public welfare, of the type
permitted under paragraph (11) of section 5136 of the Revised Statutes
of the United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs) and including investments that qualify for
consideration under the regulations implementing the Community
Reinvestment Act (12 U.S.C. 2901 et seq.); or
(B) Qualified rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic structure, as
such terms are defined in section 47 of the Internal Revenue Code of
1986 or a similar State historic tax credit program;
(iii) That has elected to be regulated or is regulated as a rural
business investment company, as described in 15 U.S.C. 80b-3(b)(8)(A)
or (B), or that has terminated its participation as a rural business
investment company in accordance with 7 CFR 4290.1900 and does not make
any new investments (other than investments in cash equivalents, which,
for the purposes of this paragraph, means high quality, highly liquid
investments whose maturity corresponds to the issuer's expected or
potential need for funds and whose currency corresponds to the issuer's
assets) after such termination; or
(iv) That is a qualified opportunity fund, as defined in 26 U.S.C.
1400Z-2(d).
* * * * *
(15) Credit funds. Subject to paragraphs (c)(15)(iii), (iv), and
(v) of this section, an issuer that satisfies the asset and activity
requirements of paragraphs (c)(15)(i) and (ii) of this section.
(i) Asset requirements. The issuer's assets must be composed solely
of:
(A) Loans as defined in Sec. 255.2(t);
(B) Debt instruments, subject to paragraph (c)(15)(iv) of this
section;
(C) Rights and other assets that are related or incidental to
acquiring, holding, servicing, or selling such loans or debt
instruments, provided that:
(1) Each right or asset held under this paragraph (c)(15)(i)(C)
that is a security is either:
(i) A cash equivalent (which, for the purposes of this paragraph,
means high quality, highly liquid investments whose maturity
corresponds to the issuer's expected or potential need for funds and
whose currency corresponds to either the underlying loans or the debt
instruments);
(ii) A security received in lieu of debts previously contracted
with respect to such loans or debt instruments; or
(iii) An equity security (or right to acquire an equity security)
received on customary terms in connection with such loans or debt
instruments; and
(2) Rights or other assets held under this paragraph (c)(15)(i)(C)
of this section may not include commodity forward contracts or any
derivative; and
(D) Interest rate or foreign exchange derivatives, if:
(1) The written terms of the derivative directly relate to the
loans, debt instruments, or other rights or assets described in
paragraph (c)(15)(i)(C) of this section; and
(2) The derivative reduces the interest rate and/or foreign
exchange risks related to the loans, debt instruments, or other rights
or assets described in paragraph (c)(15)(i)(C) of this section.
(ii) Activity requirements. To be eligible for the exclusion of
paragraph (c)(15) of this section, an issuer must:
(A) Not engage in any activity that would constitute proprietary
trading under Sec. 255.3(b)(l)(i), as if the issuer were a banking
entity; and
(B) Not issue asset-backed securities.
(iii) Requirements for a sponsor, investment adviser, or commodity
trading advisor. A banking entity that acts as a sponsor, investment
adviser, or commodity trading advisor to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section may not
rely on this exclusion unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under
[[Page 46525]]
Sec. 255.11(a)(8) of this subpart, as if the issuer were a covered
fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the limitations imposed in Sec. 255.14, as if
the issuer were a covered fund, except the banking entity may acquire
and retain any ownership interest in the issuer.
(iv) Additional Banking Entity Requirements. A banking entity may
not rely on this exclusion with respect to an issuer that meets the
conditions in paragraphs (c)(15)(i) and (ii) of this section unless:
(A) The banking entity does not, directly or indirectly, guarantee,
assume, or otherwise insure the obligations or performance of the
issuer or of any entity to which such issuer extends credit or in which
such issuer invests; and
(B) Any assets the issuer holds pursuant to paragraphs
(c)(15)(i)(B) or (i)(C)(1)(iii) of this section would be permissible
for the banking entity to acquire and hold directly under applicable
federal banking laws and regulations.
(v) Investment and Relationship Limits. A banking entity's
investment in, and relationship with, the issuer must:
(A) Comply with the limitations imposed in Sec. 255.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(16) Qualifying venture capital funds. (i) Subject to paragraphs
(c)(16)(ii) through (iv) of this section, an issuer that:
(A) Is a venture capital fund as defined in 17 CFR 275.203(l)-1;
and
(B) Does not engage in any activity that would constitute
proprietary trading under Sec. 255.3(b)(1)(i), as if the issuer were a
banking entity.
(ii) A banking entity that acts as a sponsor, investment adviser,
or commodity trading advisor to an issuer that meets the conditions in
paragraph (c)(16)(i) of this section may not rely on this exclusion
unless the banking entity:
(A) Provides in writing to any prospective and actual investor in
the issuer the disclosures required under Sec. 255.11(a)(8), as if the
issuer were a covered fund;
(B) Ensures that the activities of the issuer are consistent with
safety and soundness standards that are substantially similar to those
that would apply if the banking entity engaged in the activities
directly; and
(C) Complies with the restrictions in Sec. 255.14 as if the issuer
were a covered fund (except the banking entity may acquire and retain
any ownership interest in the issuer).
(iii) The banking entity must not, directly or indirectly,
guarantee, assume, or otherwise insure the obligations or performance
of the issuer.
(iv) A banking entity's ownership interest in or relationship with
the issuer must:
(A) Comply with the limitations imposed in Sec. 255.15, as if the
issuer were a covered fund; and
(B) Be conducted in compliance with, and subject to, applicable
banking laws and regulations, including applicable safety and soundness
standards.
(17) Family wealth management vehicles. (i) Subject to paragraph
(c)(17)(ii) of this section, any entity that is not, and does not hold
itself out as being, an entity or arrangement that raises money from
investors primarily for the purpose of investing in securities for
resale or other disposition or otherwise trading in securities, and:
(A) If the entity is a trust, the grantor(s) of the entity are all
family customers; and
(B) If the entity is not a trust:
(1) A majority of the voting interests in the entity are owned
(directly or indirectly) by family customers;
(2) A majority of the interests in the entity are owned (directly
or indirectly) by family customers;
(3) The entity is owned only by family customers and up to 5
closely related persons of the family customers; and
(C) Notwithstanding paragraph (c)(17)(i)(A) and (B) of this
section, up to an aggregate 0.5 percent of the entity's outstanding
ownership interests may be acquired or retained by one or more entities
that are not family customers or closely related persons if the
ownership interest is acquired or retained by such parties for the
purpose of and to the extent necessary for establishing corporate
separateness or addressing bankruptcy, insolvency, or similar concerns.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(17)(i) of this section with respect to an entity provided that the
banking entity (or an affiliate):
(A) Provides bona fide trust, fiduciary, investment advisory, or
commodity trading advisory services to the entity;
(B) Does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of such entity;
(C) Complies with the disclosure obligations under Sec.
255.11(a)(8), as if such entity were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of disclosure may be modified to accommodate the
specific circumstances of the entity;
(D) Does not acquire or retain, as principal, an ownership interest
in the entity, other than as described in paragraph (c)(17)(i)(C) of
this section;
(E) Complies with the requirements of Sec. Sec. 255.14(b) and
255.15, as if such entity were a covered fund; and
(F) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, complies with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the entity were an affiliate thereof.
(iii) For purposes of paragraph (c)(17) of this section, the
following definitions apply:
(A) Closely related person means a natural person (including the
estate and estate planning vehicles of such person) who has
longstanding business or personal relationships with any family
customer.
(B) Family customer means:
(1) A family client, as defined in Rule 202(a)(11)(G)-1(d)(4) of
the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1(d)(4));
or
(2) Any natural person who is a father-in-law, mother-in-law,
brother-in-law, sister-in-law, son-in-law or daughter-in-law of a
family client, or a spouse or a spousal equivalent of any of the
foregoing.
(18) Customer facilitation vehicles. (i) Subject to paragraph
(c)(18)(ii) of this section, an issuer that is formed by or at the
request of a customer of the banking entity for the purpose of
providing such customer (which may include one or more affiliates of
such customer) with exposure to a transaction, investment strategy, or
other service provided by the banking entity.
(ii) A banking entity may rely on the exclusion in paragraph
(c)(18)(i) of this section with respect to an issuer provided that:
(A) All of the ownership interests of the issuer are owned by the
customer (which may include one or more of its affiliates) for whom the
issuer was created;
(B) Notwithstanding paragraph (c)(18)(ii)(A) of this section, up to
an aggregate 0.5 percent of the issuer's outstanding ownership
interests may be acquired or retained by one or more entities that are
not customers if the ownership interest is acquired or retained by such
parties for the purpose
[[Page 46526]]
of and to the extent necessary for establishing corporate separateness
or addressing bankruptcy, insolvency, or similar concerns; and
(C) The banking entity and its affiliates:
(1) Maintain documentation outlining how the banking entity intends
to facilitate the customer's exposure to such transaction, investment
strategy, or service;
(2) Do not, directly or indirectly, guarantee, assume, or otherwise
insure the obligations or performance of such issuer;
(3) Comply with the disclosure obligations under Sec.
255.11(a)(8), as if such issuer were a covered fund, provided that the
content may be modified to prevent the disclosure from being misleading
and the manner of disclosure may be modified to accommodate the
specific circumstances of the issuer;
(4) Do not acquire or retain, as principal, an ownership interest
in the issuer, other than as described in paragraph (c)(18)(ii)(B) of
this section;
(5) Comply with the requirements of Sec. Sec. 255.14(b) and
255.15, as if such issuer were a covered fund; and
(6) Except for riskless principal transactions as defined in
paragraph (d)(11) of this section, comply with the requirements of 12
CFR 223.15(a), as if such banking entity and its affiliates were a
member bank and the issuer were an affiliate thereof.
* * * * *
(d) * * *
(6) Ownership interest. (i) Ownership interest means any equity,
partnership, or other similar interest. An ``other similar interest''
means an interest that:
(A) Has the right to participate in the selection or removal of a
general partner, managing member, member of the board of directors or
trustees, investment manager, investment adviser, or commodity trading
advisor of the covered fund, excluding:
(1) The rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event; and
(2) The right to participate in the removal of an investment
manager for ``cause'' or participate in the selection of a replacement
manager upon an investment manager's resignation or removal. For
purposes of this paragraph (d)(6)(i)(A)(2), ``cause'' for removal of an
investment manager means one or more of the following events:
(i) The bankruptcy, insolvency, conservatorship or receivership of
the investment manager;
(ii) The breach by the investment manager of any material provision
of the covered fund's transaction agreements applicable to the
investment manager;
(iii) The breach by the investment manager of material
representations or warranties;
(iv) The occurrence of an act that constitutes fraud or criminal
activity in the performance of the investment manager's obligations
under the covered fund's transaction agreements;
(v) The indictment of the investment manager for a criminal
offense, or the indictment of any officer, member, partner or other
principal of the investment manager for a criminal offense materially
related to his or her investment management activities;
(vi) A change in control with respect to the investment manager;
(vii) The loss, separation or incapacitation of an individual
critical to the operation of the investment manager or primarily
responsible for the management of the covered fund's assets; or
(viii) Other similar events that constitute ``cause'' for removal
of an investment manager, provided that such events are not solely
related to the performance of the covered fund or the investment
manager's exercise of investment discretion under the covered fund's
transaction agreements;
(B) Has the right under the terms of the interest to receive a
share of the income, gains or profits of the covered fund;
(C) Has the right to receive the underlying assets of the covered
fund after all other interests have been redeemed and/or paid in full
(excluding the rights of a creditor to exercise remedies upon the
occurrence of an event of default or an acceleration event);
(D) Has the right to receive all or a portion of excess spread (the
positive difference, if any, between the aggregate interest payments
received from the underlying assets of the covered fund and the
aggregate interest paid to the holders of other outstanding interests);
(E) Provides under the terms of the interest that the amounts
payable by the covered fund with respect to the interest could be
reduced based on losses arising from the underlying assets of the
covered fund, such as allocation of losses, write-downs or charge-offs
of the outstanding principal balance, or reductions in the amount of
interest due and payable on the interest;
(F) Receives income on a pass-through basis from the covered fund,
or has a rate of return that is determined by reference to the
performance of the underlying assets of the covered fund; or
(G) Any synthetic right to have, receive, or be allocated any of
the rights in paragraphs (d)(6)(i)(A) through (F) of this section.
(ii) Ownership interest does not include:
(A) Restricted profit interest, which is an interest held by an
entity (or an employee or former employee thereof) in a covered fund
for which the entity (or employee thereof) serves as investment
manager, investment adviser, commodity trading advisor, or other
service provider, so long as:
(1) The sole purpose and effect of the interest is to allow the
entity (or employee or former employee thereof) to share in the profits
of the covered fund as performance compensation for the investment
management, investment advisory, commodity trading advisory, or other
services provided to the covered fund by the entity (or employee or
former employee thereof), provided that the entity (or employee or
former employee thereof) may be obligated under the terms of such
interest to return profits previously received;
(2) All such profit, once allocated, is distributed to the entity
(or employee or former employee thereof) promptly after being earned
or, if not so distributed, is retained by the covered fund for the sole
purpose of establishing a reserve amount to satisfy contractual
obligations with respect to subsequent losses of the covered fund and
such undistributed profit of the entity (or employee or former employee
thereof) does not share in the subsequent investment gains of the
covered fund;
(3) Any amounts invested in the covered fund, including any amounts
paid by the entity in connection with obtaining the restricted profit
interest, are within the limits of Sec. 255.12 of this subpart; and
(4) The interest is not transferable by the entity (or employee or
former employee thereof) except to an affiliate thereof (or an employee
of the banking entity or affiliate), to immediate family members, or
through the intestacy, of the employee or former employee, or in
connection with a sale of the business that gave rise to the restricted
profit interest by the entity (or employee or former employee thereof)
to an unaffiliated party that provides investment management,
investment advisory, commodity trading advisory, or other services to
the fund.
(B) Any senior loan or senior debt interest that has the following
characteristics:
(1) Under the terms of the interest the holders of such interest do
not have the right to receive a share of the income,
[[Page 46527]]
gains, or profits of the covered fund, but are entitled to receive
only:
(i) Interest at a stated interest rate, as well as commitment fees
or other fees, which are not determined by reference to the performance
of the underlying assets of the covered fund; and
(ii) Repayment of a fixed principal amount, on or before a maturity
date, in a contractually-determined manner (which may include
prepayment premiums intended solely to reflect, and compensate holders
of the interest for, forgone income resulting from an early
prepayment);
(2) The entitlement to payments under the terms of the interest are
absolute and could not be reduced based on losses arising from the
underlying assets of the covered fund, such as allocation of losses,
write-downs or charge-offs of the outstanding principal balance, or
reductions in the amount of interest due and payable on the interest;
and
(3) The holders of the interest are not entitled to receive the
underlying assets of the covered fund after all other interests have
been redeemed or paid in full (excluding the rights of a creditor to
exercise remedies upon the occurrence of an event of default or an
acceleration event).
* * * * *
(11) Riskless principal transaction. Riskless principal transaction
means a transaction in which a banking entity, after receiving an order
from a customer to buy (or sell) a security, purchases (or sells) the
security in the secondary market for its own account to offset a
contemporaneous sale to (or purchase from) the customer.
0
32. Amend Sec. 255.12 by:
0
a. Revising paragraph (b)(1)(ii);
0
b. Revising paragraph (b)(4);
0
c. Adding paragraph (b)(5);
0
d. Revising paragraph (c)(1); and
0
e. Revising paragraphs (d) and (e).
The revisions and addition read as follows:
Sec. 255.12 Permitted investment in a covered fund.
* * * * *
(b) * * *
(1) * * *
(ii) Treatment of registered investment companies, SEC-regulated
business development companies, and foreign public funds. For purposes
of paragraph (b)(1)(i) of this section, a registered investment
company, SEC-regulated business development companies, or foreign
public fund as described in Sec. 255.10(c)(1) will not be considered
to be an affiliate of the banking entity so long as:
(A) The banking entity, together with its affiliates, does not own,
control, or hold with the power to vote 25 percent or more of the
voting shares of the company or fund; and
(B) The banking entity, or an affiliate of the banking entity,
provides investment advisory, commodity trading advisory,
administrative, and other services to the company or fund in compliance
with the limitations under applicable regulation, order, or other
authority.
* * * * *
(4) Multi-tier fund investments. (i) Master-feeder fund
investments. If the principal investment strategy of a covered fund
(the ``feeder fund'') is to invest substantially all of its assets in
another single covered fund (the ``master fund''), then for purposes of
the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of
this section, the banking entity's permitted investment in such funds
shall be measured only by reference to the value of the master fund.
The banking entity's permitted investment in the master fund shall
include any investment by the banking entity in the master fund, as
well as the banking entity's pro-rata share of any ownership interest
in the master fund that is held through the feeder fund; and
(ii) Fund-of-funds investments. If a banking entity organizes and
offers a covered fund pursuant to Sec. 255.11 for the purpose of
investing in other covered funds (a ``fund of funds'') and that fund of
funds itself invests in another covered fund that the banking entity is
permitted to own, then the banking entity's permitted investment in
that other fund shall include any investment by the banking entity in
that other fund, as well as the banking entity's pro-rata share of any
ownership interest in the fund that is held through the fund of funds.
The investment of the banking entity may not represent more than 3
percent of the amount or value of any single covered fund.
(5) Parallel Investments and Co-Investments. (i) A banking entity
shall not be required to include in the calculation of the investment
limits under paragraph (a)(2) of this section any investment the
banking entity makes alongside a covered fund as long as the investment
is made in compliance with applicable laws and regulations, including
applicable safety and soundness standards.
(ii) A banking entity shall not be restricted under this section in
the amount of any investment the banking entity makes alongside a
covered fund as long as the investment is made in compliance with
applicable laws and regulations, including applicable safety and
soundness standards.
(c) * * *
(1)(i) For purposes of paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership interests held by a banking entity
shall be the sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
in covered funds (together with any amounts paid by the entity in
connection with obtaining a restricted profit interest under Sec.
255.10(d)(6)(ii)), on a historical cost basis;
(ii) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (c)(1)(i) of
this section, an investment by a director or employee of a banking
entity who acquires a restricted profit interest in his or her personal
capacity in a covered fund sponsored by the banking entity will be
attributed to the banking entity if the banking entity, directly or
indirectly, extends financing for the purpose of enabling the director
or employee to acquire the restricted profit interest in the fund and
the financing is used to acquire such ownership interest in the covered
fund.
* * * * *
(d) Capital treatment for a permitted investment in a covered fund.
For purposes of calculating compliance with the applicable regulatory
capital requirements, a banking entity shall deduct from the banking
entity's tier 1 capital (as determined under paragraph (c)(2) of this
section) the greater of:
(1)(i) The sum of all amounts paid or contributed by the banking
entity in connection with acquiring or retaining an ownership interest
(together with any amounts paid by the entity in connection with
obtaining a restricted profit interest under Sec. 255.10(d)(6)(ii) of
subpart C of this part), on a historical cost basis, plus any earnings
received; and
(ii) The fair market value of the banking entity's ownership
interests in the covered fund as determined under paragraph (b)(2)(ii)
or (b)(3) of this section (together with any amounts paid by the entity
in connection with obtaining a restricted profit interest under Sec.
255.10(d)(6)(ii) of subpart C of this part), if the banking entity
accounts for the profits (or losses) of the fund investment in its
financial statements.
(2) Treatment of employee and director restricted profit interests
financed by the banking entity. For purposes of paragraph (d)(1) of
this section, an investment by a director or
[[Page 46528]]
employee of a banking entity who acquires a restricted profit interest
in his or her personal capacity in a covered fund sponsored by the
banking entity will be attributed to the banking entity if the banking
entity, directly or indirectly, extends financing for the purpose of
enabling the director or employee to acquire the restricted profit
interest in the fund and the financing is used to acquire such
ownership interest in the covered fund.
(e) Extension of time to divest an ownership interest. (1)
Extension period. Upon application by a banking entity, the Board may
extend the period under paragraph (a)(2)(i) of this section for up to 2
additional years if the Board finds that an extension would be
consistent with safety and soundness and not detrimental to the public
interest.
(2) Application requirements. An application for extension must:
(i) Be submitted to the Board at least 90 days prior to the
expiration of the applicable time period;
(ii) Provide the reasons for application, including information
that addresses the factors in paragraph (e)(3) of this section; and
(iii) Explain the banking entity's plan for reducing the permitted
investment in a covered fund through redemption, sale, dilution or
other methods as required in paragraph (a)(2) of this section.
(3) Factors governing the Board determinations. In reviewing any
application under paragraph (e)(1) of this section, the Board may
consider all the facts and circumstances related to the permitted
investment in a covered fund, including:
(i) Whether the investment would result, directly or indirectly, in
a material exposure by the banking entity to high-risk assets or high-
risk trading strategies;
(ii) The contractual terms governing the banking entity's interest
in the covered fund;
(iii) The date on which the covered fund is expected to have
attracted sufficient investments from investors unaffiliated with the
banking entity to enable the banking entity to comply with the
limitations in paragraph (a)(2)(i) of this section;
(iv) The total exposure of the covered banking entity to the
investment and the risks that disposing of, or maintaining, the
investment in the covered fund may pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of divesting or disposing of the
investment within the applicable period;
(vi) Whether the investment or the divestiture or conformance of
the investment would involve or result in a material conflict of
interest between the banking entity and unaffiliated parties, including
clients, customers, or counterparties to which it owes a duty;
(vii) The banking entity's prior efforts to reduce through
redemption, sale, dilution, or other methods its ownership interests in
the covered fund, including activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board believes appropriate.
(4) Authority to impose restrictions on activities or investment
during any extension period. The Board may impose such conditions on
any extension approved under paragraph (e)(1) of this section as the
Board determines are necessary or appropriate to protect the safety and
soundness of the banking entity or the financial stability of the
United States, address material conflicts of interest or other unsound
banking practices, or otherwise further the purposes of section 13 of
the BHC Act and this part.
(5) Consultation. In the case of a banking entity that is primarily
regulated by another Federal banking agency, the SEC, or the CFTC, the
Board will consult with such agency prior to acting on an application
by the banking entity for an extension under paragraph (e)(1) of this
section.
0
33. Amend Sec. 255.13 by adding paragraph (d) to read as follows:
Sec. 255.13 Other permitted covered fund activities and investments.
* * * * *
(d) Permitted covered fund activities and investments of qualifying
foreign excluded funds. (1) The prohibition contained in Sec.
255.10(a) does not apply to a qualifying foreign excluded fund.
(2) For purposes of this paragraph (d), a qualifying foreign
excluded fund means a banking entity that:
(i) Is organized or established outside the United States, and the
ownership interests of which are offered and sold solely outside the
United States;
(ii)(A) Would be a covered fund if the entity were organized or
established in the United States, or
(B) Is, or holds itself out as being, an entity or arrangement that
raises money from investors primarily for the purpose of investing in
financial instruments for resale or other disposition or otherwise
trading in financial instruments;
(iii) Would not otherwise be a banking entity except by virtue of
the acquisition or retention of an ownership interest in, sponsorship
of, or relationship with the entity, by another banking entity that
meets the following:
(A) The banking entity is not organized, or directly or indirectly
controlled by a banking entity that is organized, under the laws of the
United States or of any State; and
(B) The banking entity's acquisition of an ownership interest in or
sponsorship of the fund by the foreign banking entity meets the
requirements for permitted covered fund activities and investments
solely outside the United States, as provided in Sec. 255.13(b);
(iv) Is established and operated as part of a bona fide asset
management business; and
(v) Is not operated in a manner that enables the banking entity
that sponsors or controls the qualifying foreign excluded fund, or any
of its affiliates, to evade the requirements of section 13 of the BHC
Act or this part.
0
34. Amend Sec. 255.14 by:
0
a. Revising paragraph (a)(2)(i);
0
b. Revising paragraph (a)(2)(ii)(C);
0
c. Adding paragraphs (a)(2)(iii), (iv), (v), and (3); and
0
d. Revising paragraph (c).
The revisions and additions read as follows:
Sec. 255.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(i) Acquire and retain any ownership interest in a covered fund in
accordance with the requirements of Sec. Sec. 255.11, 255.12, or
255.13;
(ii) * * *
(C) The Board has not determined that such transaction is
inconsistent with the safe and sound operation and condition of the
banking entity; and
(iii) Enter into a transaction with a covered fund that would be an
exempt covered transaction under 12 U.S.C. 371c(d) or Sec. 223.42 of
the Board's Regulation W (12 CFR 223.42) subject to the limitations
specified under 12 U.S.C. 371c(d) or Sec. 223.42 of the Board's
Regulation W (12 CFR 223.42), as applicable,
(iv) Enter into a riskless principal transaction with a covered
fund; and
(v) Extend credit to or purchase assets from a covered fund,
provided:
(A) Each extension of credit or purchase of assets is in the
ordinary course of business in connection with payment transactions;
settlement services; or futures, derivatives, and securities clearing;
(B) Each extension of credit is repaid, sold, or terminated by the
end of five business days; and
(C) The banking entity making each extension of credit meets the
requirements of Sec. 223.42(l)(1)(i) and (ii) of the Board's
Regulation W (12 CFR
[[Page 46529]]
223.42(l)(1)(i) and(ii)), as if the extension of credit was an intraday
extension of credit, regardless of the duration of the extension of
credit.
(3) Any transaction or activity permitted under paragraphs
(a)(2)(iii), (iv) or (v) must comply with the limitations in Sec.
255.15.
* * * * *
(c) Restrictions on other permitted transactions. Any transaction
permitted under paragraphs (a)(2)(ii), (iii), or (iv) of this section
shall be subject to section 23B of the Federal Reserve Act (12 U.S.C.
371c-1) as if the counterparty were an affiliate of the banking entity
under section 23B.
Subpart D--Compliance Program Requirements; Violations
0
35. Amend Sec. 255.20 by:
0
a. Revising paragraph (a);
0
b. Revising the heading of paragraph (d) and revising paragraph (d)(1);
and
0
c. Revising the introductory text of paragraph (e).
The revisions and addition read as follows:
Sec. 255.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities or a qualifying
foreign excluded fund under section 255.6(f) or 255.13(d)) shall
develop and provide for the continued administration of a compliance
program reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
* * * * *
(d) Reporting requirements under appendix A to this part. (1) A
banking entity (other than a qualifying foreign excluded fund under
section 255.6(f) or 255.13(d)) engaged in proprietary trading activity
permitted under subpart B shall comply with the reporting requirements
described in appendix A to this part, if:
* * * * *
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities (other than a
qualifying foreign excluded fund under section 255.6(f) or 255.13(d))
shall maintain records that include:
* * * * *
Brian P. Brooks,
Acting Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System.
Ann E. Misback,
Secretary of the Board.
Federal Deposit Insurance Corporation.
By order of the Board of Directors.
Dated at Washington, DC, on or about June 25, 2020.
James P. Sheesley,
Acting Assistant Executive Secretary.
Issued in Washington, DC, on June 25, 2020 by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
By the Securities and Exchange Commission.
Vanessa A. Countryman,
Secretary.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and Private
Equity Funds--CFTC Voting Summary and CFTC Commissioners' Statements
Appendix 1--CFTC Voting Summary
On this matter, CFTC Chairman Tarbert and Commissioners Quintenz
and Stump voted in the affirmative. CFTC Commissioners Behnam and
Berkovitz voted in the negative. The document submitted to the CFTC
Commissioners for a vote did not include Section V.F. SEC Economic
Analysis.
Appendix 2--Supporting Statement of CFTC Chairman Heath P. Tarbert
As I have previously remarked, the Volcker Rule is ``among the
most well-intentioned but poorly designed regulations in the history
of American finance.'' \1\ While today's final rule does not fix the
fundamental flaws of the Volcker Rule \2\--only congressional action
can do that--it at least represents a more accurate reading of the
law Congress actually passed and brings us a step closer to a
reasonable implementation of the rule.\3\
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\1\ See Statement of Chairman Heath P. Tarbert in Support of
Revisions to the Volcker Rule (Sept. 16, 2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement091619.
\2\ See, e.g., Economic Growth, Regulatory Relief, and Consumer
Protection Act, Public Law No: 115-174 (May 24, 2018) (amending
section 13 of the Bank Holding Company Act by narrowing the
definition of ``banking entity'' in the Volcker Rule to exclude
certain community banks).
\3\ See Statement of Chairman Heath P. Tarbert in Support of
Further Revisions to the Volcker Rule (Jan. 30, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement013020b.
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Specifically, the Volcker Rule will now no longer be applied to
investments Congress never intended to be included in the first
place, such as credit funds, venture capital funds, customer
facilitation vehicles, and family wealth management vehicles. The
final rule also contains important modifications to several existing
exclusions from the prohibition on activities related to private
equity and hedge funds (the ``covered funds'' provisions)--for
foreign public funds, loan securitizations, and small business
investment companies. In these ways, the final rule begins to
address the over-breadth of the covered funds definition and related
requirements.
I am therefore pleased to support adoption of the proposed
revisions to the Volcker Rule's covered funds provisions. While only
a modest step forward, these refinements will nonetheless enhance
the regulatory experience and provide clarity for market
participants who have struggled to comply with the Volcker Rule.
Appendix 3--Dissenting Statement of CFTC Commissioner Rostin Behnam
I respectfully dissent as to the Commission's decision to
finalize additional revisions to the Volcker Rule. As we approach
the ten year anniversary of the Dodd-Frank Act,\1\ and cautiously
begin mapping a path out of the current pandemic, I believe it is a
good time to reflect on the lessons learned from the 2008 financial
crisis, the efficacy of our responses, and whether our objectives
have changed, or just our perspective. One of the many critically
important provisions of the Dodd-Frank Act is the Volcker Rule. The
Volcker Rule, in simple terms, contains two basic prohibitions: (1)
Banking entities may not engage in proprietary trading; and (2)
banking entities cannot have an ownership interest in, sponsor, or
have certain relationships with a covered fund.
---------------------------------------------------------------------------
\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
Last September, the Commission, along with other Federal
agencies (the ``Agencies''),\2\ approved changes that significantly
weakened the prohibition on propriety trading by narrowing the scope
of financial instruments subject to the Volcker Rule.\3\ I did not
support those changes.\4\ Today, the Commission, again in tandem
with the Agencies, completes the dismantling that began in 2018,\5\
and votes to significantly weaken the prohibition on ownership of
[[Page 46530]]
covered funds. Again, I cannot support these changes.
---------------------------------------------------------------------------
\2\ The Office of the Comptroller of the Currency, Treasury; the
Board of Governors of the Federal Reserve System; the Federal
Deposit Insurance Corporation; and the Securities and Exchange
Commission.
\3\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, 84 FR 61974 (Nov. 14, 2019).
\4\ Id. at 62275.
\5\ See Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, 83 FR 33432 (proposed July 17, 2018).
---------------------------------------------------------------------------
I voted against the 2018 proposal, and earlier this year, voted
against the proposal that strikes the final blow today.\6\ In voting
against the 2020 proposal, I quoted the late Paul Volcker's letter
to the Chairman of the Federal Reserve, which he penned last
September, when the Agencies approved the changes breaking down the
proprietary trading prohibition.\7\ Mr. Volcker warned that the
amended rule ``amplifies risk in the financial system, increases
moral hazard and erodes protections against conflicts of interest
that were so glaringly on display during the last crisis.'' \8\ Mr.
Volcker's words apply equally well to the changes that the
Commission finalizes today regarding covered funds--particularly the
erosion of the existing protections regarding conflicts of interest.
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\6\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, 85 FR 12120, 12204 (proposed Feb. 28, 2020).
\7\ Id.
\8\ Jesse Hamilton and Yalman Onaran, ``Volcker the Man Blasts
Volcker the Rule in Letter to Fed Chair,'' Bloomberg (Sep. 10,
2019), https://www.bloomberg.com/news/articles/2019-09-10/volcker-the-man-blasts-volcker-the-rule-in-letter-to-fed-chair.
---------------------------------------------------------------------------
As the tenth anniversary of the Dodd-Frank Act sadly coincides
with a different kind of crisis, I think it is critical to take a
hard look at how far we have come in ten years, and how well markets
have adapted to carefully crafted policy intended to create a more
resilient financial system. Chipping away, particularly at a time of
great uncertainty, risks a reversion to the past, when in fact, we
should only be looking forward.
Appendix 4--Dissenting Statement of CFTC Commissioner Dan M. Berkovitz
The Volcker covered funds final release (``Covered Funds Rule'')
adopts with only minor changes the rule amendments as proposed by
the agencies in January of this year (``the Proposal''). I voted
against \1\ the Proposal because the agencies had only superficially
considered the additional risks that banks would incur under the
loosened regulations. Nothing in the Covered Funds Rule final
release dispels this concern. Therefore I dissent from the final
release.
---------------------------------------------------------------------------
\1\ Dissenting Statement of Commissioner Dan M. Berkovitz
Regarding Volcker Covered Funds Proposal (Jan. 30, 2020), available
at: https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement013020.
---------------------------------------------------------------------------
Congress enacted the original Volcker rule after the 2008
financial crisis to protect American taxpayers from again having to
bailout banks that are insured by the FDIC or have access to Federal
Reserve Bank financial support. This goal was to be achieved by
preventing the government-supported banks from undertaking risky
proprietary trading activities and from owning hedge funds or
private equity funds. The new Covered Funds Rule, together with the
rollbacks in the Volcker proprietary trading regulations adopted in
2019,\2\ will undermine many of the risk-reducing benefits of the
original Volcker rule.
---------------------------------------------------------------------------
\2\ Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds, 84 FR 61974 (Nov. 14, 2019).
---------------------------------------------------------------------------
The original Volcker covered funds regulations were not perfect.
The foreign public funds exception and the so called ``super 23A''
provisions governing activities banks can undertake with covered
funds needed careful adjustments. However, the Covered Funds Rule
goes much, much further. It creates broad new exclusions from the
covered funds definition with inadequate analysis as to whether
these activities were intended to be permitted under the statute or
pose serious risk to the banks and the United States financial
system.
I addressed some of these new exclusions in more detail in my
dissenting statement on the Proposal.\3\ Of these, the new ``venture
capital funds'' exclusion perhaps best illustrates the extent to
which the Covered Funds Rule undermines the very purpose of the
Volcker rule. Venture capital serves an important function in our
financial markets by providing needed capital to startup companies.
But venture capital investing is very risky. One study found that
about 75% of venture capital-backed firms in the United States did
not return capital to investors.\4\ Another article on venture
capital noted that ``VC funds haven't significantly outperformed the
public markets since the late 1990s, and since 1997 less cash has
been returned to VC investors than they have invested.'' \5\ This is
exactly the type of risky private equity fund \6\ investing by
government-supported banks that Congress intended the Volcker rule
to curtail.
---------------------------------------------------------------------------
\3\ Supra footnote 1.
\4\ Deborah Gage, The Venture Capital Secret: 3 out of 4 Start-
Ups Fail, Wall Street Journal (Sept. 20, 2012) (citing research by
Shikhar Ghosh, a senior lecturer at Harvard Business School),
available at https://www.wsj.com/articles/SB10000872396390443720204578004980476429190.
\5\ Diane Mulcahy, Six Myths About Venture Capitalists, Harvard
Business Review (May 2013), available at https://hbr.org/2013/05/six-myths-about-venture-capitalists.
\6\ Interestingly, while the Proposal acknowledged that venture
capital funds are a subset of private equity funds for purposes of
Volcker, in the preamble to the Covered Funds Rule, the agencies
provide a tortured, speculative analysis of statutory construction
trying to explain that Congress ``may'' have meant to exclude
venture capital funds, despite no real evidence to that effect. To
the contrary, three of the four statements from members of Congress
in the legislative record cited in the Covered Funds Rule clearly
show that they assumed that venture capital funds are private equity
funds under the Volcker rule. See Covered Funds Rule, section
IV.C.2.i.
---------------------------------------------------------------------------
In adopting the Covered Funds Rule, the agencies failed to
analyze any data or other information that lays out the risks of
venture capital investing. The agencies simply exclude venture
capital funds from Volcker regulation. The Covered Funds Rule makes,
at best, a weak case that venture capital investments promote and
protect the safety and soundness of banking entities and the United
States financial system by allowing banks to diversify investments.
The weakness of that assertion is clear when one considers that
allowing any investments in hedge funds and private equity funds
would do the same, and yet that risk taking activity is precisely
what Congress prohibited.
The banking industry does not need to take on the additional
risks permitted by the Covered Funds Rule to be successful. U.S.
banks have performed well in recent years. Recent Global League
Tables ranking global banks by amount of banking business activity
shows that three or four U.S. banks are ranked among the top five
banks in the world in almost every table, including the tables for
foreign markets banking.\7\ While many factors impact banking
success, the relative strength of U.S. banks internationally belies
suggestions that the new laws and regulations adopted in the wake of
the 2008 financial crisis are hurting the competitiveness of U.S.
banks. We should recognize, rather than undermine, the success of
U.S. banks since the 2008 financial crisis and adoption of the Dodd-
Frank Act in 2010.
---------------------------------------------------------------------------
\7\ See GlobalCapital.com, Global League Tables, available at
https://www.globalcapital.com/data/all-league-tables.
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To date, U.S. banks also have performed well during the Covid-19
pandemic. But our financial system continues to face many
extraordinary risks from the effects of the pandemic. In the middle
of this latest shock to our financial system, we should not be
rushing out a final rule that permits greater risk taking by banks.
Rather, we should take stock of the data available to us, and make
carefully reasoned, incremental changes that are consistent with the
Congressional intent for the Volcker rule.
[FR Doc. 2020-15525 Filed 7-30-20; 8:45 am]
BILLING CODE 4810-33-P