STROOCK SPECIAL BULLETIN

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1 STROOCK & STROOCK & LAVAN LLP STROOCK SPECIAL BULLETIN Final Regulations Implementing the Volcker Rule: Proprietary Trading March 21, 2014 I. Introduction On December 10, 2013, in connection with Title VI of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act ), 1 the Office of the Comptroller of the Currency (the OCC ), the Board of Governors of the Federal Reserve System (the Board ), the Federal Deposit Insurance Corporation (the FDIC ), the Securities and Exchange Commission (the SEC ) and the Commodity Futures Trading Commission (the CFTC ) (each, an Agency and collectively, the Agencies ) adopted final regulations (the Final Rule ) to implement section 619 of the Dodd-Frank Act, the so-called Volcker Rule. Section 619 of the Dodd-Frank Act adds a new section 13 to the Bank Holding Company Act of 1956 (the BHC Act ), which generally prohibits any banking entity 2 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, subject to numerous exemptions. The adoption of the Final Rule arrives more than two years after the Agencies introduction of proposed regulations implementing the Volcker Rule (the Proposed Rule ). While the Final Rule retains the basic framework of the Proposed Rule, the Final Rule incorporates a substantial number of refinements and clarifications, in part due to the high volume of comments received by the Agencies on virtually all aspects of the Proposed Rule. This Stroock Special Bulletin summarizes key provisions of the proprietary trading aspects of the Final Rule and highlights key differences from the Proposed Rule. 3 II. Restrictions on Proprietary Trading A. Proprietary Trading Section.3 of the Final Rule 4 implements the prohibition against proprietary trading by any STROOCK & STROOCK & LAVAN LLP NEW YORK LOS ANGELES MIAMI WASHINGTON, DC 180 MAIDEN LANE, NEW YORK, NY TEL FAX

2 banking entity under section 13(a)(1)(A) of the BHC Act, subject to certain exemptions. The Agencies have adopted a definition of proprietary trading that is substantially similar to the proposed definition. Under the Final Rule, proprietary trading is defined as engaging as principal for the trading account of a banking entity in any purchase or sale of one or more financial instruments. The Final Rule s definitions of trading account and financial instrument are discussed below. B. Trading Account A trading account under the Final Rule includes three types of accounts. 1. Short-Term Trading Account First, a trading account includes any account used by a banking entity to purchase or sell one or more financial instruments principally 5 for the purpose of: (i) short-term 6 resale; (ii) benefitting from actual or expected short-term price movements; (iii) realizing short-term arbitrage profits; or (iv) hedging one or more positions resulting from the purchases or sales of any of the financial instruments described in clauses (i), (ii) or (iii) (the Short-Term Trading Account ). a. Rebuttable Presumption Any purchase or sale of a financial instrument by a banking entity is subject to a rebuttable presumption that any financial instrument held by a banking entity for fewer than sixty days following the purchase or sale of such financial instrument is for a Short-Term Trading Account, unless the banking entity can demonstrate, based on all relevant facts and circumstances, that the banking entity did not purchase or sell the financial instrument principally for any of the short-term purposes described in clauses (i) through (iv) in Section II.B.1 of this Bulletin. This provision has been adopted with some clarifying changes to the Proposed Rule, which stated that any account used to acquire or take a covered financial position that was held for sixty days or less would be a trading account under the short-term trading prong, unless the banking entity was able to demonstrate that the position was not acquired principally for short-term trading purposes. First, the Final Rule replaces account with financial instrument to clarify that the presumption applies only to the purchase or sale of a financial instrument that is held for fewer than sixty days and not to the entire account used to make the purchase or sale. Second, because the language of the Final Rule uses financial instrument as opposed to the Proposed Rule s use of covered financial position, the Final Rule clarifies that the rebuttable presumption applies also to basis trades, in which a banking entity buys one instrument and sells a substantially similar instrument (or otherwise transfers the first instrument s risk). Finally, the references to acquire or take a financial position have been replaced with references to purchase or sell a financial instrument to maintain consistency with definitions used throughout the Final Rule. 2. Market Risk Rule Trading Account The second type of trading account is an account used by certain banking entities to purchase or sell one or more financial instruments that are both positions covered under the Market Risk Capital Rules 7 and trading positions (or hedges of other Market Risk Capital Rule covered positions), if the banking entity, or any affiliate of the banking entity, is an insured depository institution, bank holding company, or savings and loan holding company, and calculates risk-based capital ratios under the Market Risk Capital Rules. 2

3 3. Dealer Trading Account The third type of trading account is one used by a banking entity that is engaged in the business of a dealer, 8 swap dealer 9 or security-based swap dealer, 10 whether in or outside of the United States, to purchase or sell one or more financial instruments for any purpose (the Dealer Trading Account ). The Agencies note in the release accompanying the Final Rule that this definition applies only to financial instruments purchased or sold in connection with the activities that require the banking entity to be licensed or registered as a dealer, swap dealer or security-based swap dealer. Therefore, if a banking entity does not currently analyze whether a particular activity would require it to register as a dealer, this prong would require that banking entity to engage in a new regulatory analysis. The Agencies also note that, as proposed in the Proposed Rule, the Dealer Trading Account covers activities of a banking entity engaged in the business of a dealer, swap dealer, or security-based swap dealer outside of the United States, to the extent the instrument is purchased or sold in connection with the activities of such business. With respect to foreign dealers, rather than permit foreign dealers to rely on regulations of the relevant foreign regulator, the Agencies state that a foreign banking entity acting as a dealer outside the United States would need to qualify for the exemption for trading conducted by foreign banking entities, on the basis that subjecting domestic and foreign dealers to different requirements may lead to regulatory arbitrage and inconsistent applications of the Final Rule. C. Financial Instrument The definition of financial instrument has been adopted as proposed and includes any: (i) security, including an option on a security; (ii) derivative, including an option on a derivative; or (iii) contract of sale of a commodity for future delivery, or option on a contract of sale of a commodity for future delivery. 11 A financial instrument does not include: (i) a loan; (ii) a commodity that is not an excluded commodity 12 (other than foreign exchange or currency), a derivative, a contract of sale of a commodity for future delivery or an option on a contract of sale of a commodity for future delivery; or (iii) foreign exchange or currency. D. Proprietary Trading Exclusions The Final Rule excludes from the prohibition on proprietary trading certain activities that do not involve short-term trading activities covered by section 13 of the BHC Act. As discussed in more detail below, these exclusions include any purchase or sale of a financial instrument: (i) under certain repurchase and reverse repurchase agreements and securities lending agreements; (ii) for bona fide liquidity management purposes; (iii) by certain clearing agencies or derivatives clearing organizations ( DCOs ) in connection with clearing activities; (iv) by a member of a clearing agency, DCO or designated financial market utility ( DFMU ) engaged in excluded clearing activities; (v) to satisfy existing delivery obligations; (vi) to satisfy an obligation of the banking entity in connection with a judicial, administrative, self-regulatory organization, or arbitration proceeding; (vii) solely as broker, agent or custodian; (viii) through a deferred compensation or similar plan; or (ix) to satisfy a debt previously contracted. 1. Repurchase and Reverse Repurchase Agreements and Securities Lending The Final Rule excludes from the restriction on proprietary trading certain transactions that the 3

4 Agencies believe operate in economic substance as secured loans and are not based on expected or anticipated movements in asset prices. These include a purchase or sale of a financial instrument by a banking entity that arises under: (i) a repurchase or reverse repurchase agreement pursuant to which the banking entity has simultaneously agreed, in writing, to both purchase and sell a stated asset, at stated prices, and on stated dates or on demand with the same counterparty; or (ii) a transaction in which the banking entity lends or borrows a security temporarily to or from another party pursuant to a written securities lending agreement under which the lender retains the economic interests of an owner of such security, and has the right to terminate the transaction and to recall the loaned security on terms agreed by the parties. In response to comments that repurchase agreements may be used for prohibited proprietary trading and that the exclusion should be narrowed, the Agencies stated that these transactions will be monitored to ensure this exclusion is not being used to engage in prohibited proprietary trading and that, in order to minimize evasion of the rule, the exclusion covers only transactions pursuant to the repurchase agreement, reverse repurchase agreement, or securities lending agreement and not any collateral or position being financed by such agreement. Furthermore, if a repurchase or reverse repurchase agreement is being used to finance a purchase of a financial instrument, any other transaction involving such financial instrument will not qualify for this exclusion. Short positions resulting from securities lending agreements also will not qualify for this exclusion. 2. Liquidity Management Activities In the interest of ensuring that banking entities have sufficient, readily marketable assets available to meet expected near-term liquidity needs while maintaining compliance with the prohibition on proprietary trading, the Final Rule excludes from such prohibition any purchase or sale of a security by a banking entity for the purpose of liquidity management in accordance with a documented liquidity management plan of the banking entity. One key modification to this exclusion from the proposed version is that the availability of the exclusion under the Final Rule is limited to securities rather than financial instruments generally. Additionally, while most of the requirements of the liquidity management plan have been adopted as proposed, 13 the Final Rule requires that the plan specifically contemplate and authorize the particular securities to be used for liquidity management purposes as well as the amount, types and risks of such securities. 14 The Final Rule also requires that the plan include written policies and procedures, internal controls, analysis, and independent testing to ensure that the purchase and sale of securities that are not permitted under sections.6(a) or (b) of the Final Rule (addressing permitted trading in domestic and foreign government obligations) are for the purpose of liquidity management and in accordance with the liquidity management plan. To give additional clarity, the Agencies note that the exclusion does not apply to activities undertaken with the stated purpose or effect of hedging aggregate risks incurred by the banking entity or its affiliates related to asset-liability mismatches or other general market risks to which the entity or affiliates may be exposed, or to any trading activities that expose banking entities to substantial risk from fluctuations in market values, unrelated to the management of near-term funding needs, regardless of the stated purpose of the activities. 4

5 3. Transactions of Derivatives Clearing Organizations and Clearing Agencies In consideration of the fact that a banking entity may serve as a central counterparty for clearing and settlement activities in which purchases and sales of financial instruments play an integral role, the Final Rule excludes from the restriction on proprietary trading the purchase and sale of financial instruments by a clearing agency or a DCO in connection with its clearing activities. This exclusion has been adopted with two key changes. First, the Proposed Rule proposed to address clearing and settlement activities by excluding from the definition of trading account any account used to acquire or take one or more financial positions by a DCO registered under the CEA or a clearing agency registered under the Exchange Act in connection with clearing derivatives or securities transactions. In response to comments that the exclusion should extend to a banking entity s clearing-related activities, such as clearing a trade for a customer, trading with a clearinghouse, or accepting positions of the defaulting member, the Agencies have expanded the exclusion so that it applies to the purchase and sale of financial instruments by a banking entity that is a clearing agency or DCO in connection with clearing financial instrument transactions. Second, the scope of the exclusion has been expanded so that a foreign clearing agency or DCO that is a banking entity can utilize the exclusion. 4. Excluded Clearing-Related Activities of Clearinghouse Members The Final Rule excludes from the prohibition on proprietary trading certain excluded clearing activities by a banking entity that is a member of a clearing agency, DCO or DFMU. The list of excluded clearing activities includes: (i) any purchase or sale necessary to correct error trades made by or on behalf of customers with respect to customer transactions that are cleared, provided the purchase or sale is conducted in accordance with certain regulations, rules, or procedures; (ii) any purchase or sale related to the management of a default or threatened imminent default of a customer, subject to certain conditions, or of a default or threatened imminent default of another clearing member, the clearing agency, DCO or DFMU itself; or (iii) any purchase or sale required by the rules or procedures of a clearing agency, DCO, or DFMU that mitigates risk to such agency, organization, or utility that would result from the clearing by a clearing member of security-based swaps that reference the member or an affiliate of the member. Whether the exclusion applies to a purchase or sale of a financial instrument carried out under the rules of a clearing agency, DCO, or DFMU as part of establishing accurate prices to be used by the clearing agency, DCO, or DFMU in its end-of-day settlement process will depend on the facts and circumstances. 5. New Exclusions from Proprietary Trading In response to numerous requests by commenters, the Final Rule adds a number of new exclusions from prohibited proprietary trading. First, a purchase or sale by a banking entity that satisfies an existing delivery obligation of the banking entity or its customers, including to prevent or close out a failure to deliver, in connection with delivery, clearing, or settlement activity, is not proprietary trading under the Final Rule. The Agencies have added this exclusion to address short sales and failures to deliver, particularly among SEC-registered broker-dealers that may be subject to SEC rules or rules of a clearing agency, securities exchange or national securities 5

6 association that require a banking entity to purchase securities to meet an existing delivery obligation in order to prevent or close out a failure to deliver. Also excluded is any purchase or sale of a financial instrument by a banking entity: (i) that satisfies an obligation of such banking entity in connection with a judicial, administrative, self-regulatory organization, or arbitration proceeding; (ii) that is acting solely as agent, broker, or custodian; (iii) through a deferred compensation or similar plan; or (iv) in the ordinary course of collecting a debt previously contracted in good faith. This last exclusion would allow SECregistered broker-dealers to continue providing margin loans to their customers and take possession of margined collateral following a customer s default or failure to meet a margin call and allow CFTCregistered swap dealers or SEC-registered securitybased swap dealers to take, hold, and exchange any margin collateral as counterparty to a cleared or uncleared swap or security-based swap transaction, in accordance with the relevant Agency rules. III. Underwriting Exemption A. Acting as Underwriter The Final Rule exempts from prohibited proprietary trading certain underwriting activities conducted by a banking entity for a distribution of securities where the trading desk s underwriting position is related to such distribution. The underwriting exemption has been adopted with five key changes from the Proposed Rule, as discussed below. 1. Underwriting Position First, the Final Rule has been modified to clarify that the underwriting exemption is intended to apply not on a transaction-by-transaction basis, but on a distribution-by-distribution basis. In other words, the exemption will focus on a long or short position in one or more securities held by a banking entity or its affiliate, and managed by a particular trading desk, in connection with a particular distribution of securities for which such banking entity or affiliate is acting as underwriter. To that end, the Agencies have replaced the phrase purchase or sale with the term underwriting position. While a trading desk may not aggregate securities positions acquired in connection with more than one distribution to determine its underwriting position, a trading desk s underwriting position can include positions in securities held at different affiliated legal entities, so long as it is able to provide records identifying such positions to the relevant regulatory agency. 2. Trading Desk The underwriting exemption will apply at the trading desk level of organization. A trading desk in this context is intended to encompass what is commonly thought of as an underwriting desk, which operates as an individual unit and reflects the level at which the profit and loss of employees engaged in underwriting activities is attributed. By limiting the application of the underwriting exemption to the aggregate trading activities of a limited group of employees on a single desk, and thereby limiting the location where underwriting activity will occur as well as the aggregate trading volume required to be reviewed, the Agencies expect facilitation of monitoring and reviewing compliance with the exemption. A trading desk may manage an underwriting position that includes positions held by different affiliated legal entities and include employees working on behalf of multiple affiliated legal entities or booking trades in multiple affiliated entities, regardless of the geographic location of individual traders. 6

7 3. Distribution The Final Rule defines the term distribution to mean: (i) an offering of securities, whether or not subject to registration under the Securities Act of 1933 (the Securities Act ), that is distinguished from ordinary trading transactions by the presence of special selling efforts and selling methods; or (ii) an offering of securities made pursuant to an effective registration statement under the Securities Act. As in the Proposed Rule, the factors considered under Regulation M of the Exchange Act will be used to analyze the presence of special selling efforts and selling methods. 15 In a departure from the Proposed Rule, the final definition eliminates any reference to the magnitude of an offering, as the Agencies state that the special selling analysis should suffice in determining whether or not a distribution qualifies as exempted underwriting activity. A second prong to the definition of distribution has been added by the Agencies as an alternative test, independent of the special selling efforts prong, in order to provide a bright-line test to the analysis. Under this prong, any SEC-registered offering will qualify for the underwriting exemption and will include, among other things, offerings made pursuant to a shelf registration statement (whether on a continuous or delayed basis), bought deals, market offerings, debt offerings, asset-backed security offerings, initial public offerings, and other registered offerings whether the offering is issuer-driven, selling security holder-driven, or arises as a result of a reverse inquiry 16 and regardless of how it is conducted (i.e., whether by direct communication, exchange transactions, or automated execution system). In response to inquiries from commenters, the Agencies noted that the treatment of securities acquired and resold in connection with a bridge loan facility will depend on the facts and circumstances. 4. Underwriter An underwriter is defined in the Final Rule as: (i) a person who has agreed with an issuer or selling security holder to: (A) purchase securities from the issuer or selling security holder for distribution; (B) engage in a distribution of securities for or on behalf of the issuer or selling security holder; or (C) manage a distribution of securities for or on behalf of the issuer or selling security holder; or (ii) a person who has agreed to participate or is participating in a distribution of such securities for or on behalf of the issuer or selling security holder. This final definition incorporates a number of changes from the proposed definition. First, the Agencies have defined the terms selling security holder and issuer to provide additional clarity. A selling security holder is defined as any person, other than an issuer, on whose behalf a distribution is made, consistent with the parallel definition in Regulation M. The term issuer is given the definition used in the Securities Act. 17 The final definition also now makes clear that a selling group member need not have a written agreement with the underwriter to participate in a distribution that qualifies for the underwriting exemption. As it did in the Proposed Rule, the Agencies provide as guidance a number of activities that may indicate when a banking entity is acting as an underwriter, while noting that the precise activities will depend on the liquidity of the securities being underwritten and the type of distribution being conducted. 18 In response to inquiries from commenters regarding authorized participants ( APs ) to an exchange-traded fund ( ETF ) issuer, the Agencies note that whether an AP may rely on the underwriting exemption will depend on the facts and circumstances and that many AP activities may be 7

8 better suited for analysis under the market-making exemption, as discussed below. 5. Activities Conducted In Connection With a Distribution In response to concerns raised by certain commenters that the use of the word solely in the proposed definition of underwriting position may be interpreted as excluding certain auxiliary but necessary activities that accompany underwriting activities for a distribution of securities, the Agencies have eliminated the word solely and instead used the phrase in connection with which would cover certain activities related to underwriting activities that are intended to effectuate the distribution process and provide benefits to issuers, selling security holders, or purchasers in the distribution. 19 B. Near-Term Customer Demand Requirement The Final Rule requires that the amount and types of securities in a trading desk s underwriting position be designed not to exceed the reasonably expected near-term demands of clients, customers, or counterparties, and that reasonable efforts be made to sell or otherwise reduce the underwriting position within a reasonable period, taking into account the liquidity, maturity, and depth of the market for the relevant type of security. A reasonable expectation of near-term demands may be based on factors such as current market conditions and prior experience with similar offerings of securities. Although a banking entity need not engage in book-building or similar marketing efforts to determine investor demand, such efforts may form the basis for a trading desk s reasonable expectation of demand. The requirement that reasonable efforts be made to sell or otherwise reduce the underwriting position within a reasonable period has been added to the Final Rule in order to address the issue of when a banking entity may retain an unsold allotment when acting as an underwriter. A reasonable period under the requirement may vary depending on the liquidity, maturity and depth of the market for the relevant type of securities. C. Compliance Program Consistent with the Proposed Rule, the Final Rule requires that a banking entity making use of the underwriting exemption establish and maintain a compliance program that is reasonably designed to ensure the banking entity s compliance with the underwriting exemption s requirements. The compliance program must contain written policies and procedures, internal controls, analysis and independent testing generally addressing: (i) the products, instruments or exposures each trading desk may transact in or manage as part of its underwriting activities; (ii) limits for each trading desk, based on the nature and amount of the trading desk s underwriting activities; (iii) internal controls and monitoring of each trading desk s compliance with its limits; and (iv) authorization procedures, including escalation procedures, that require approval, analysis and independent review of any trade that would exceed a trading desk s limits. D. Compensation Requirement Similar to the proposed rule, the underwriting exemption requires that the compensation arrangements of persons performing the banking entity s underwriting activities be designed not to reward or incentivize prohibited proprietary trading. In finalizing this requirement, the Agencies draw a distinction between compensation structures that reward speculative trading, which is prohibited, and compensation arrangements that reward successful underwriting, which involves some risk-taking. To illustrate, while a banking entity will be permitted to 8

9 take into account revenues resulting from movements in the price of securities that the banking entity underwrites to the extent that such revenues reflect the effectiveness with which personnel have managed underwriting risk, a compensation plan based purely on net profit and loss with no consideration for inventory control or risk undertaken to achieve those profits would not meet the Final Rule s compensation requirement. E. Registration Requirement Consistent with the Proposed Rule, the Final Rule requires that a banking entity must be licensed or registered to engage in underwriting activity in accordance with applicable law. Banking entities engaged in the business of a securities dealer outside the United States will only be subject to licensing or registration if required under applicable foreign law, provided no U.S. registration or licensing requirements apply. F. Source of Revenue Requirement The Final Rule eliminates the proposed requirement that the underwriting activities of a banking entity be designed to generate revenues primarily from fees, commissions, underwriting spread, or other income not attributable to appreciation in the value of covered financial positions or hedging of covered financial positions, as the Agencies believe that the Final Rule includes sufficient controls around an underwriter s source of revenue. IV. Market-Making Exemption The Final Rule exempts from prohibited proprietary trading market making-related activities of a banking entity that meet certain standards. This aspect of the Final Rule has been adopted with some modifications intended to: (i) address differences in market making-related activities across markets and asset classes; (ii) focus on analyzing the overall financial exposure and market-maker inventory held by a trading desk rather than a transaction-bytransaction analysis; and (iii) focus on the operational functionality of the desk rather than its legal status. A. Requirement to Routinely Stand Ready to Purchase and Sell A banking entity relying on the market-making exemption must ensure that the trading desk that establishes and manages the financial exposure routinely stands ready to purchase and sell one or more types of financial instruments related to its financial exposure and is willing and available to quote, purchase and sell, or otherwise enter into long and short positions in those types of financial instruments for its own account, in commercially reasonable amounts and throughout market cycles on a basis appropriate for the liquidity, maturity, and depth of the market for the relevant types of financial instruments. The final version of this requirement incorporates a number of refinements to address common concerns raised by commenters regarding the proposed requirement. 1. Trading Desk The final market-making exemption focuses on financial exposure managed by a trading desk of a banking entity and such trading desk s market-maker inventory. A trading desk is defined as the smallest discrete unit of organization of a banking entity that purchases or sells financial instruments for the trading account of the banking entity or an affiliate thereof, which is consistent with the Agencies formulation of the market-making exemption requirements to apply to a relatively granular level of organization within a banking entity. A single trading desk may encompass 9

10 individual traders sitting in different geographic locations if warranted. Additionally, a single trading desk may include employees working on behalf of multiple affiliated legal entities or booking trades in multiple affiliated entities. The Agencies are not including in the final definition the phrase other organization unit of a banking entity, as proposed, as the Agencies are concerned that such an approach would have provided banking entities with too much discretion to independently determine the organizational level at which the requirements should apply, including a more aggregated level of organization, which could lead to evasion of the general prohibition on proprietary trading. 2. Market-Making Inventory and Financial Exposure The market-making exemption focuses on two key aspects of market-making activity: a trading desk s market-maker inventory and its overall financial exposure. Therefore, the Agencies have adopted a holistic approach to determining marketmaking activity, rather than one based on a transaction-by-transaction analysis. Market-maker inventory is defined to mean all of the positions in the financial instruments for which a trading desk stands ready to make a market in accordance with the requirements of the marketmaking exemption that are managed by the trading desk, including the trading desk s open positions or exposures arising from open transactions. The financial exposure of a trading desk is defined to mean the aggregate 20 risks of one or more financial instruments and any associated loans, commodities, or foreign exchange or currency, held by a banking entity or its affiliate and managed by a particular trading desk as part of the trading desk s market making-related activities. 21 Thus, the financial exposure of a trading desk would include not only the risks of financial instruments in the trading desk s market-maker inventory but also the financial instruments acquired to manage the risks of the positions in financial instruments for which the trading desk acts as a market-maker but does not itself make a market. 22 A trading desk s financial exposure and marketmaker inventory should be evaluated and monitored at a frequency that is appropriate for the trading desk s trading strategies and the characteristics of the financial instruments the desk trades, including historical intraday volatility. For example, a trading desk that repeatedly acquired and then terminated significant financial exposures throughout the day but that had little or no financial exposure at the end of the day should assess its financial exposure based on its intraday activities, not simply its end-of-day financial exposure. 23 A trading desk engaged in market making-related activities may direct another organizational unit of the banking entity or an affiliate to execute a riskmitigating transaction on the trading desk s behalf. In this case, the other organizational unit may rely on the market-making exemption for these purposes only if: (i) the other organizational unit acts in accordance with the trading desk s risk management policies and procedures established under the Final Rule; and (ii) the resulting risk-mitigating position is attributed to the trading desk s financial exposure (and not the other organizational unit s financial exposure) and is included in the trading desk s daily profit and loss calculation. Similarly, a trading desk may engage in a risk mitigating transaction with a second trading desk of the banking entity or an affiliate that is also engaged in permissible market making-related activities. In this case, the risk-mitigating position would be included in the first trading desk s financial exposure and the contra-risk would be included in the second trading desk s market-maker inventory 10

11 and financial exposure. In any of the situations described in this paragraph, the banking entity should be prepared to provide to the relevant Agency records identifying any related positions held at an affiliated entity. The trading desk must generally maintain its market-maker inventory and financial exposure within the appropriate limits, and to the extent that any such limit is exceeded, take steps to bring the trading desk into compliance with such limits as promptly as possible. This requirement will require a trading desk s market-maker inventory to be disaggregated from its other exposures to allow identification of the trading desk s hedging positions in instruments for which the trading desk does not make a market, which the Agencies recognize may impose certain costs for banking entities that do not currently do so. 3. Routinely Stand Ready to Buy and Sell To address comments that the Proposed Rule s requirement of regular and continuous quoting in a particular instrument is overly burdensome, given that it may be impractical for certain asset classes or markets, especially less liquid markets, to satisfy this aspect of the market-making exemption requirements, the Final Rule replaces the phrase regular or continuous with routinely. To meet this standard, a trading desk should have a pattern of providing price indications on either side of the market and a pattern of trading with customers on each side of the market. The Agencies note that this requirement applies to a trading desk s activity in one or more types of financial instruments and that such types of financial instruments must be related to its authorized market-maker inventory and authorized financial exposure. In addition to having a routine presence in the market, a trading desk must also be willing and available to quote, buy and sell, or otherwise enter into long and short positions in the relevant types of financial instruments for its own account in commercially reasonable amounts and throughout market cycles. Commercially reasonable amounts generally means the amounts requested by other market participants. Market-making through market cycles requires a trading desk to act as market-maker through both upward and downward moving markets, and not only when it is most favorable for it to do so. B. Near-Term Customer Demand Requirement The Final Rule requires that the amount, types, and risks of the financial instruments in the trading desk s market-maker inventory be designed not to exceed, on an ongoing basis, the reasonably expected near-term demands of clients, customers, or counterparties, based on certain market factors and analysis. This requirement as adopted in the Final Rule is substantively consistent with the proposed version and, like the proposed version, tracks the statutory language of the market-making exemption set forth in the BHC Act. The Proposed Rule had also provided guidance as to how a banking entity could comply with this requirement, stating that a banking entity s expectations of near-term customer demand should generally be based on the unique customer base of the banking entity s specific market-making business lines and the near-term demand of those customers based on particular factors, beyond a general expectation of price appreciation. The Proposed Rule also stated that a trading desk or other organizational unit engaged wholly or principally in 11

12 trading that is not in response to, or driven by, customer demands (e.g., arbitrage trading with noncustomers) would not qualify for the exemption, regardless of whether the activities promote price transparency or liquidity. In response to numerous concerns raised by commenters that the proposed guidance would be unworkable in markets that are less liquid and where trades occur infrequently and customer demand is difficult to predict and that it would be difficult for a market-making business to divide its activities between those that are in response to customer demand and those that promote price transparency and liquidity, the Final Rule has adopted a revised set of factors, as described below, for banking entities to consider when applying the nearterm demand requirement. 1. Factors Used to Assess Reasonably Expected Near-term Customer Demand The key factors in determining reasonably expected near-term customer demand under the Final Rule include: (i) the liquidity, maturity, and depth of the market for the relevant types of financial instrument; and (ii) demonstrable analysis 24 of historical customer demand, current inventory of financial instruments, and market and other factors regarding the amount, types, and risks of or associated with financial instruments in which the trading desk makes a market, including through block trades. Such other factors include recent trading volumes and customer trends; trading patterns of specific customers or other observable customer demand patterns; analysis of the banking entity s business plan and ability to win new customer business; evaluation of expected demand under current market conditions compared to prior similar periods; schedule of maturities in customers existing portfolios; and expected market events, such as an index rebalancing, and announcements. 2. Clients, Customers and Counterparties The Agencies have added to the Final Rule definitions of the terms clients, customers and counterparties, which are defined as market participants that make use of the banking entity s market making-related services by obtaining such services, responding to quotations, or enter into a continuing relationship with respect to such services. Thus, for purposes of market-making on an exchange or other organized trading facility, a client, customer or counterparty is generally any person whose buy or sell order is executed against the banking entity s quotation posted on the exchange or other organized trading facility. For purposes of market-making in the over-the-counter market, a client, customer, or counterparty generally would be a person that makes use of the banking entity s intermediation services, either by requesting such services (possibly via a request-for-quote on an established trading facility) or entering into a continuing relationship with the banking entity with respect to such services. For purposes of determining the reasonably expected near-term demands of customers, a client, customer, or counterparty generally would not include a trading desk or other organizational unit of another entity that has $50 billion or more in total trading assets. There are two exceptions to this rule: first, if the trading desk has a documented reason for treating the trading desk or other organizational unit of such entity as a customer or second, if the trading desk s transactions are executed anonymously on an exchange or similar trading facility that permits trading on behalf of a broad range of market participants. The $50 billion threshold has been incorporated into the Final Rule on the basis that firms engaged in substantial trading activity do not typically act as customers to other markets, while 12

13 smaller, regional firms may seek liquidity from larger firms as part of their market making-related activities. In the context of ETFs, a client, customer or counterparty of an AP would be the market participant that seeks to create or redeem shares of the ETF as well as the ETF itself. The Agencies note that interdealer trading is permitted so long as the trading desk does not include in its determination of near-term client demands expected trading interests of a trading desk of an entity with aggregate trading assets and liabilities of $50 billion or greater (subject to the same exceptions as described in the foregoing paragraph). 3. Structured Products A trading desk may be able to use the marketmaking exemption to acquire some or all of the risk exposures associated with complex structured products if the trading desk has evidence of customer demand (i.e., prior express interest from customers) for each of the significant risks associated with the product. C. Compliance Program Requirement The Final Rule requires a banking entity engaged in market-making activity to establish and maintain an internal compliance program reasonably designed to ensure the banking entity s compliance with the requirements of the market-making exemption. Specifically, the program must include reasonably designed written policies and procedures, internal controls, analysis and independent testing generally addressing: (i) the financial instruments each trading desk stands ready to purchase and sell as a marketmaker; (ii) the trading desk s risk management framework in connection with its market makingrelated activities; (iii) limits for each trading desk; 25 (iv) internal controls and ongoing monitoring and analysis of each trading desk s compliance with its limits; and (v) authorization procedures, including escalation procedures, that require approval, analysis and independent review with respect to any trade that would exceed a trading desk s limits. D. Market Marking-Related Hedging Certain hedging transactions related to marketmaking are considered to be market making-related activity for purposes of the market-making exemption. In a departure from the Proposed Rule, the Final Rule does not require that market makingrelated hedging activities comply separately with the requirements found in the risk-mitigating hedging exemption if conducted or directed by the same trading desk conducting the market-making activity. Instead, the Final Rule requires that to the extent that any limit established pursuant to the compliance program requirement under the market-making exemption is exceeded, the trading desk must take action to bring the trading desk into compliance with the limits as promptly as possible. E. Compensation Requirement For a banking entity to utilize the market-making exemption, the compensation arrangements of persons performing the market-making activity must be designed not to reward or incentivize prohibited proprietary trading. One change to this requirement in the Final Rule is the replacement of the phrase proprietary risk-taking with proprietary trading, as the Agencies do not intend to preclude an employee of a market-making desk from being compensated for successful market-making, which involves some risk-taking. 13

14 F. Registration Requirement A banking entity making use of the marketmaking exemption must be licensed or registered to engage in market-making activity in accordance with applicable law. Similar to the registration requirement for a banking entity engaged in exempted underwriting activity, an adjustment to the Final Rule has been made so that a banking entity engaged in market-making activity outside the United States will only be subject to licensing or registration if required under applicable foreign law. G. Source of Revenue Analysis A noteworthy change to the Final Rule is the elimination of the proposed requirement that the market making-related activities of a trading desk or other organizational unit be designed to generate revenues primarily from fees, commissions, bid/ask spreads or other income not attributable to appreciation in the value of financial instrument positions it holds in trading accounts or the hedging of such positions. Instead, the Agencies have included a metrics data reporting requirement that collects information regarding the daily fluctuation in the value of a trading desk s positions to various sources and its volatility. These include: (i) profit and loss attributable to current positions that were also held by the banking entity as of the end of the prior day ( existing positions ); (ii) profit and loss attributable to new positions resulting from the current day s trading activity ( new positions ); and (iii) residual profit and loss that cannot be specifically attributed to existing positions or new positions. Thus the Agencies shifted the focus from revenue from particular sources to when the trading desk generates revenue from its positions. H. Appendix B of the Proposed Rule Appendix B of the Proposed Rule, which provided overviews of permitted market makingrelated activity and prohibited proprietary trading activity as well as guidelines to distinguish between the two activities, has not been included in the Final Rule, as the Final Rule already establishes detailed criteria to qualify for the market-making exemption. V. Permitted Risk-Mitigating Hedging Activities The Final Rule s prohibition on proprietary trading would not apply to risk-mitigating hedging activities of a banking entity that are in connection with and related to individual or aggregated positions, contracts, or other holdings of the banking entity and are designed to reduce the specific risks to the banking entity in connection with and related to such positions, contracts, or other holdings. In order to qualify for the hedging exemption, the hedging activity must meet the criteria described below. A. Compliance Program Requirement A banking entity must establish and maintain an internal compliance program designed to ensure compliance with the requirements of the hedging exemption and conduct its hedging activities in compliance with the program. As in the Proposed Rule, the compliance program requires a banking entity to develop reasonably designed written policies and procedures as well as internal controls and ongoing monitoring, management and authorization procedures, including escalation procedures. Additionally, the Final Rule requires that the banking entity s written policies and procedures identify what 14

15 positions, contracts or other holdings a particular trading desk may use in its risk-mitigating hedging activities as well as the position and aging limits with respect to such positions, contracts or other holdings. Furthermore, the Final Rule requires correlation analysis and independent testing to ensure that the hedging positions, techniques and strategies are reasonably expected to demonstrably reduce or significantly mitigate the specific, identifiable risks being hedged. The requirement of a correlation analysis represents a change from the Proposed Rule, which required only that a hedge maintain a correlation. B. Hedging of Specific Risks and Demonstrable Reduction of Risk Under the Final Rule, a banking entity s riskmitigating hedging activity must, at its inception, 26 including any adjustments thereto, be designed to reduce or significantly mitigate or demonstrably reduce or significantly mitigate specific, identifiable risks, including market risk, counterparty or other credit risk, currency or foreign exchange risk, interest rate risk, commodity price risk, basis risk, or similar risks, arising in connection with and related to identified positions, contracts, or other holdings of the banking entity, based upon the facts and circumstances of the identified underlying and hedging positions, contracts or other holdings and the risks and liquidity thereof. Unlike the Proposed Rule, which required that a banking entity show only a reasonable correlation between the hedge and the risk of the underlying asset, the Final Rule requires that the hedging activity be designed to reduce or significantly mitigate risk, and actually demonstrably reduce or significantly mitigate risk. Additionally, the Final Rule provides that the determination of whether an activity or strategy is risk-reducing or mitigating must, in the first instance, be made at the inception of the hedging activity. Also required is ongoing recalibration of the hedging activity to ensure that the relevant hedging requirements are satisfied and that the hedging activity does not constitute prohibited proprietary trading. In light of concerns raised by commenters that permitting portfolio hedging may encourage a masked form of prohibited proprietary trading, the Agencies have deferred to the statutory language in section 13 of the BHC Act which permits a banking entity to engage in risk-mitigating hedging activity in connection with and related to individual or aggregated positions. Accordingly, the Final Rule retains the ability of banking entities to engage in risk-mitigating hedging in connection with aggregated positions. Moreover, hedging of aggregated positions must mitigate one or more specific risks arising from identifiable positions, contracts or other holdings. C. Compensation The Final Rule adopts substantially as proposed the requirement that the compensation arrangements of persons performing risk-mitigating hedging activities be designed not to reward or incentivize prohibited proprietary trading. D. Documentation A banking entity engaging in risk-mitigating hedging is required to establish documentation containing the specific, identifiable risk of the identified positions, contracts, or other holdings, and the relevant specific risk-mitigating strategy related to a hedging transaction and the trading desk that is establishing and responsible for the hedge. A banking entity must create and retain records demonstrating 15

16 compliance with the documentation requirements for a minimum of five years, or such longer period as required under other law. 27 VI. Permitted Trading A. U.S. Government Obligations The Final Rule permits the trading of: (i) an obligation issued or guaranteed by the United States; (ii) an obligation, participation, or other instrument of, or issued or guaranteed by, an agency of the United States, the Government National Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, a Federal Home Loan Bank, the Federal Agricultural Mortgage Corporation or a Farm Credit System institution chartered under and subject to the provisions of the Farm Credit Act of 1971; (iii) an obligation of any State or any political subdivision thereof, including any municipal security; 28 or (iv) an obligation of the FDIC, or any entity formed by or on behalf of the FDIC, for the purpose of facilitating the disposal of assets acquired or held by the FDIC in its corporate capacity or as conservator or receiver under the Federal Deposit Insurance Act or Title II of the Dodd-Frank Act. Although the Agencies declined to provide an exemption for proprietary trading in derivatives on exempt government obligations, the Agencies note that banking entities may continue to use U.S. government obligations and derivatives on those obligations in marketmaking and risk-mitigating hedging activities permitted under the Final Rule. B. Foreign Government Obligations 1. Affiliates of Foreign Banking Entities in the United States The prohibition on proprietary trading does not extend to obligations of, or issued or guaranteed by, a foreign sovereign (including any multinational central bank of which the foreign sovereign is a member), or any agency or political subdivision of such foreign sovereign, by a banking entity, so long as: (i) the banking entity is organized under, or is directly or indirectly controlled by a banking entity that is organized under, the laws of a foreign sovereign and is not directly or indirectly controlled by a top-tier banking entity that is organized under the laws of the United States; (ii) the financial instrument is an obligation of, or issued or guaranteed by, the foreign sovereign under the laws of which the foreign banking entity is organized (including any multinational central bank of which the foreign sovereign is a member), or any agency or political subdivision of that foreign sovereign; and (iii) the purchase or sale as principal is not made by an insured depository institution. 2. Foreign Affiliates of a U.S. Banking Entity The prohibition on proprietary trading does not extend to obligations issued or guaranteed by a foreign sovereign (including any multinational central bank of which the foreign sovereign is a member), or any agency or political subdivision of that foreign 16

17 sovereign, by a foreign entity that is owned or controlled by a banking entity organized or established under the laws of the United States or any State, so long as: (i) the foreign entity is a foreign bank, 29 or is regulated by the foreign sovereign as a securities dealer; (ii) the financial instrument is an obligation of, or issued or guaranteed by, the foreign sovereign under the laws of which the foreign entity is organized (including any multinational central bank of which the foreign sovereign is a member), or any agency or political subdivision of that foreign sovereign; and (iii) the financial instrument is owned by the foreign entity and is not financed by an affiliate that is located in the United States or organized under the laws of the United States or of any State. C. On Behalf of Customers The Final Rule exempts from prohibited proprietary trading a purchase or sale of financial instruments by a banking entity acting as trustee or in a similar fiduciary capacity, so long as: (i) the transaction is conducted for the account of, or on behalf of, a customer; and (ii) the banking entity does not have or retain beneficial ownership of the financial instruments. The Final Rule has been adopted with several modifications. First, the proposal s express exemption for investment advisers has been removed, as investment advisers generally act in a fiduciary capacity on behalf of clients. Also omitted from the Final Rule is the proposal s express exemption for commodity trading advisors, as the legal relationship between a commodity trading advisor and its client depends on the facts and circumstances of each relationship. The Final Rule also provides that a banking entity may act as riskless principal in a transaction in which the banking entity, after receiving an order to purchase or sell a financial instrument from a customer, purchases or sells the financial instrument for its own account to offset the contemporaneous sale of the financial instrument to the customer, or to purchase from the customer. This is a customerdriven exemption, by which a banking entity may not purchase or sell a financial instrument without first having a customer order to buy or sell the instrument. Acting as riskless principal is generally understood to be equivalent to agency or brokerage transactions in which all of the risks associated with ownership of financial instruments are borne by customers. D. Regulated Insurance Company Prohibited proprietary trading does not apply to the purchase or sale of financial instruments by a banking entity that is an insurance company or an affiliate thereof if: (i) the insurance company or its affiliate purchases or sells the financial instruments solely for the general account of the insurance company or separate account established by the insurance company; (ii) the purchase or sale is conducted in compliance with, and subject to, the insurance company investment laws, regulations, and written guidance of the State or jurisdiction in which such insurance company is domiciled; and (iii) the appropriate Federal banking agencies, after consultation with the Financial Stability Oversight Council and the relevant insurance commissioners of the States and foreign jurisdictions, as appropriate, have not jointly determined, after notice and comment, that a particular law, regulation, or written guidance in clause (ii) is insufficient to protect the safety and soundness of the covered banking entity, or the financial stability of the United States. E. Foreign Banking Entities The Final Rule permits certain foreign banking entities (i.e., banking entities organized under foreign law and controlled only by entities organized under 17

18 foreign law) 30 to engage in proprietary trading that occurs solely outside of the United States if the purchase or sale by the banking entity is made pursuant to paragraph (9) or (13) of section 4(c) of the BHC Act and complies with certain restrictions: 1. The banking entity engaging as principal in the purchase or sale (including any personnel of the banking entity or its affiliate that arrange, negotiate or execute such purchase or sale) 31 is not located in the United States or organized under the laws of the United States or of any State; 2. The banking entity (including relevant personnel) that makes the decision to purchase or sell as principal is not located in the United States or organized under the laws of the United States or of any State; 3. The purchase or sale, including any transaction arising from risk-mitigating hedging related to the instruments purchased or sold, is not accounted for as principal directly or on a consolidated basis by any branch or affiliate that is located in the United States or organized under the laws of the United States or of any State; 4. No financing for the banking entity s purchases or sales is provided, directly or indirectly, by any branch or affiliate that is located in the United States or organized under the laws of the United States or of any State; and 5. The purchase or sale is not conducted with or through any U.S. entity, 32 other than: (i) a purchase or sale with the foreign operations of a U.S. entity if no personnel of such U.S. entity that are located in the United States are involved in the arrangement, negotiation, or execution of such purchase or sale; (ii) a purchase or sale with an unaffiliated market intermediary 33 acting as principal, provided the purchase or sale is promptly cleared and settled through a clearing agency or DCO acting as a central counterparty; or (iii) a purchase or sale through an unaffiliated market intermediary acting as agent, provided the purchase or sale is conducted anonymously on an exchange or similar trading facility and is promptly cleared and settled through a clearing agency or DCO acting as a central counterparty. VII. Limitations on Permitted Trading Activities The Final Rule has adopted, substantially as proposed, certain limitations on the permitted trading activities discussed above. No transaction will be permissible under the underwriting, market-making or risk-mitigating hedging exemptions or under the permitted trading categories if the transaction would: (i) involve or result in a material conflict of interest between the banking entity and its clients, customers or counterparties; (ii) result, directly or indirectly, in a material exposure by the banking entity to a high-risk asset or a high-risk trading strategy; or (iii) pose a threat to the safety and soundness of the banking entity or U.S. financial stability. A. Material Conflict of Interest A material conflict of interest between a banking entity and its clients, customers or counterparties will exist if the banking entity engages in any transaction or activity that would involve or result in the banking entity s interests being materially adverse to the interests of its client, customer or counterparty with respect to such transaction or activity. The Agencies note that the mere fact that a buyer and seller are on opposite sides of a transaction and have differing economic interests would not be deemed a material conflict of interest with respect to transactions relating to bona fide underwriting, market-making, risk-mitigating hedging or other permitted activities. If a material conflict of interest 18

19 exists, the banking entity could attempt to mitigate the conflict of interest in one of two ways. First, prior to effecting the transaction for which a conflict may arise, the banking entity can timely and effectively disclose the conflict in reasonable detail and in a manner sufficient to permit a reasonable client, customer or counterparty to meaningfully understand the conflict of interest and have an opportunity to negate, or substantially mitigate, any materially adverse effect on the client, customer or counterparty that was created by the conflict. Alternatively, a banking entity can mitigate a material conflict of interest through the use of information barriers reasonably designed to restrict the dissemination of information and through limiting knowledge and coordination of specific business activities among units of the entity. However, if a banking entity knows or should reasonably know that a material conflict of interest arising out of a specific transaction may involve a materially adverse effect on a client, customer or counterparty, a banking entity cannot rely on those information barriers to mitigate the conflict. In such cases, the transaction will be prohibited unless the banking entity timely and effectively disclosed the conflict as discussed above. B. High-Risk Asset and High- Risk Trading Strategy High-risk asset is defined under the Final Rule as an asset that would, if held by the banking entity, significantly increase the likelihood that the banking entity would incur a substantial financial loss or would pose a threat to the financial stability of the United States. Similarly, high-risk trading strategy is defined as a trading strategy that would, if engaged in by the banking entity, significantly increase the likelihood that the banking entity would incur a substantial financial loss or would pose a threat to the financial stability of the United States. VIII. Compliance Program The Final Rule requires implementation 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. The compliance program must generally include: (i) written policies and procedures reasonably designed to document, describe, monitor and limit trading activities; (ii) internal controls to monitor compliance; (iii) a management framework delineating responsibility and accountability for compliance with section 13 of the BHC Act; (iv) independent testing and audit of the effectiveness of the compliance program; (v) training for trading personnel and managers; and (vi) maintenance of records sufficient to demonstrate compliance with section 13 of the BHC Act and the Final Rule, which a banking entity must promptly provide to the relevant supervisory Agency upon request and retain for a period of no less than 5 years. The requirements of the compliance program have been formulated to account for the type, size, scope and complexity of a banking entity s activities; therefore, whether certain elements of the compliance requirements set forth in section.20, Appendix A or Appendix B of the Final Rule are applicable to a particular banking entity will vary depending on such factors. IX. Effective Date The Volcker Rule became effective on July 21, The Volcker Rule provided banking entities a period of two years, i.e., until July 21, 2014, to conform their activities and investments to the requirements of the statute. The statute also granted authority to the Board to extend the conformance period by up to three additional one-year terms. 19

20 Pursuant to this authority, the Board has extended the conformance period by one additional year to July 21, The Board has stated in its Order Approving Extension of Conformance Period issued December 10, 2013 that during the conformance period, each banking entity is expected to engage in good-faith efforts, appropriate for its activities and investments, to conform to and implement the requirements of the Final Rule by no later than the end of the conformance period. Good-faith efforts include evaluating the extent to which the banking entity is engaged in activities and investments covered by section 619 of the BHC Act and the Final Rule, and developing and implementing a conformance plan that is appropriately specific about how the banking entity will fully conform all of its covered activities and investments by the end of the conformance period. Banking entities that have stand-alone proprietary trading operations are expected to promptly terminate or divest those operations. Finally, the Board has stated that banking entities should not expand activities and make investments during the conformance period with an expectation that additional time to conform those activities or investments will be granted. By Conrad G. Bahlke, Partner in the Commodities and Derivatives Practice Group of Stroock & Stroock & Lavan LLP, and Anna J. Cho, an associate in Stroock s Corporate Practice Group. For More Information Conrad G. Bahlke Marvin J. Goldstein Lior J. Ohayon Mark N. Rae Anna J. Cho President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law on July 21, A banking entity is defined in section.2(c) of the Final Rule as: (i) any insured depository institution; (ii) any company that controls an insured depository institution; (iii) any company that is treated as a bank holding company for purposes of section 8 of the International Banking Act of 1978; and (iv) any affiliate or subsidiary of any of the foregoing entities. A banking entity does not include: (i) a covered fund that is not itself a banking entity under clauses (i), (ii) or (iii) above; or (ii) a portfolio company held under the merchant banking authority contained in section 4(k)(4)(H) or (I) of the BHC Act or any portfolio concern, as defined under 13 CFR , that is controlled by a small business investment company, as defined in section 103(3) of the Small Business Investment Act of 1958, so long as the portfolio company or portfolio concern is not itself a banking entity under clauses (i), (ii) or (iii) above; or (iii) the FDIC acting in its corporate capacity or as conservator or receiver under the Federal Deposit Insurance Act or Title II of the Dodd-Frank Act. 3. For a discussion of the portion of the Final Rule relating to covered funds, see U.S. Regulatory Agencies Adopt Final Regulations to Implement the Volcker Rule: Covered Fund Activities and Investments, by Tram N. Nguyen, Hillel M. Bennett, Lior J. Ohayon and Runjhun Kudaisya, Stroock Special Bulletin, February 28, 2014, available at 4. Sections of the Final Rule are numbered.1,.2, etc. in order to allow the Final Rule to be separately incorporated into each Agency s regulations. 5. The Final Rule does not expressly define the term principally. 6. The Final Rule does not expressly define the term shortterm and instead, provides a rebuttable presumption for identifying short-term trading accounts as described in Section II.B.1.a. 20

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