[Federal Register Volume 76, Number 7 (Tuesday, January 11, 2011)]
[Proposed Rules]
[Pages 1889-1922]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-32189]



[[Page 1889]]

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Part IV

Department of the Treasury
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Office of the Comptroller of the Currency



12 CFR Part 3



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Federal Reserve System
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12 CFR Parts 208 and 225



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Federal Deposit Insurance Corporation
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12 CFR Part 325



Risk-Based Capital Guidelines: Market Risk; Proposed Rule

Federal Register / Vol. 76 , No. 7 / Tuesday, January 11, 2011 / 
Proposed Rules

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket ID: OCC-2010-0003]
RIN 1557-AC99

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-1401]
RIN No. 7100-AD61

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AD70


Risk-Based Capital Guidelines: Market Risk

AGENCY: Office of the Comptroller of the Currency, Department of the 
Treasury; Board of Governors of the Federal Reserve System; and Federal 
Deposit Insurance Corporation.

ACTION: Notice of proposed rulemaking with request for public comment.

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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of 
Governors of the Federal Reserve System (Board), and Federal Deposit 
Insurance Corporation (FDIC) are requesting comment on a proposal to 
revise their market risk capital rules to modify their scope to better 
capture positions for which the market risk capital rules are 
appropriate; reduce procyclicality in market risk capital requirements; 
enhance the rules' sensitivity to risks that are not adequately 
captured under the current regulatory measurement methodologies; and 
increase transparency through enhanced disclosures. The proposal does 
not include the methodologies adopted by the Basel Committee on Banking 
Supervision for calculating the specific risk capital requirements for 
debt and securitization positions due to their reliance on credit 
ratings, which is impermissible under the Dodd-Frank Wall Street Reform 
and Consumer Protection Act. The proposal, therefore, retains the 
current specific risk treatment for these positions until the agencies 
develop alternative standards of creditworthiness as required by the 
Act. The proposed rules are substantively the same across the agencies.

DATES: Comments on this notice of proposed rulemaking must be received 
by April 11, 2011.

ADDRESSES: Comments should be directed to:
    OCC: Because paper mail in the Washington, DC area and at the 
Agencies is subject to delay, commenters are encouraged to submit 
comments by the Federal eRulemaking Portal or e-mail, if possible. 
Please use the title ``Risk-Based Capital Guidelines: Market Risk'' to 
facilitate the organization and distribution of the comments. You may 
submit comments by any of the following methods:
     Federal eRulemaking Portal--``regulations.gov'': Go to 
http://www.regulations.gov. Select ``Document Type'' of ``Proposed 
Rules,'' and in ``Enter Keyword or ID Box,'' enter Docket ID ``OCC-
2010-0003,'' and click ``Search.'' On ``View By Relevance'' tab at 
bottom of screen, in the ``Agency'' column, locate the proposed rule 
for OCC, in the ``Action'' column, click on ``Submit a Comment'' or 
``Open Docket Folder'' to submit or view public comments and to view 
supporting and related materials for this rulemaking action.
     Click on the ``Help'' tab on the Regulations.gov home page 
to get information on using Regulations.gov, including instructions for 
submitting or viewing public comments, viewing other supporting and 
related materials, and viewing the docket after the close of the 
comment period.
     E-mail: regs.comments@occ.treas.gov.
     Mail: Office of the Comptroller of the Currency, 250 E 
Street, SW., Mail Stop 2-3, Washington, DC 20219.
     Fax: (202) 874-5274.
     Hand Delivery/Courier: 250 E Street, SW., Mail Stop 2-3, 
Washington, DC 20219.
    Instructions: You must include ``OCC'' as the agency name and 
``Docket ID OCC-2010-0003'' in your comment. In general, OCC will enter 
all comments received into the docket and publish them on the 
Regulations.gov Web site without change, including any business or 
personal information that you provide such as name and address 
information, e-mail addresses, or phone numbers. Comments received, 
including attachments and other supporting materials, are part of the 
public record and subject to public disclosure. Do not enclose any 
information in your comment or supporting materials that you consider 
confidential or inappropriate for public disclosure.
    You may review comments and other related materials that pertain to 
this proposed rule by any of the following methods:
     Viewing Comments Electronically: Go to http://www.regulations.gov. Select ``Document Type'' of ``Public 
Submissions,'' in ``Enter Keyword or ID Box,'' enter Docket ID ``OCC-
2010-0003,'' and click ``Search.'' Comments will be listed under ``View 
By Relevance'' tab at bottom of screen. If comments from more than one 
agency are listed, the ``Agency'' column will indicate which comments 
were received by the OCC.
     Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC, 250 E Street, SW., Washington, DC. 
For security reasons, the OCC requires that visitors make an 
appointment to inspect comments. You may do so by calling (202) 874-
4700. Upon arrival, visitors will be required to present valid 
government-issued photo identification and to submit to security 
screening in order to inspect and photocopy comments.
     Docket: You may also view or request available background 
documents and project summaries using the methods described above.
    Board: You may submit comments, identified by Docket No. R-1401 and 
RIN No. 7100-AD61, by any of the following methods:
     Agency Web Site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: regs.comments@federalreserve.gov. Include docket 
number in the subject line of the message.
     Federal eRulemaking Portal: ``Regulations.gov'': Go to 
http://www.regulations.gov and follow the instructions for submitting 
comments.
     FAX: (202) 452-3819 or (202) 452-3102.
     Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information. Public comments may also be viewed electronically or in 
paper form in Room MP-500 of the Board's Martin Building (20th and C

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Street, NW.) between 9 a.m. and 5 p.m. on weekdays.
    FDIC: You may submit comments by any of the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Agency Web site: http://www.FDIC.gov/regulations/laws/Federal/propose.html.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th 
Street, NW., Washington, DC 20429.
     Hand Delivered/Courier: The guard station at the rear of 
the 550 17th Street Building (located on F Street), on business days 
between 7 a.m. and 5 p.m.
     E-mail: comments@FDIC.gov.
    Instructions: Comments submitted must include ``FDIC'' and ``RIN 
[3064-AD70].'' Comments received will be posted without change to 
http://www.FDIC.gov/regulations/laws/Federal/propose.html, including 
any personal information provided.

FOR FURTHER INFORMATION CONTACT:
    OCC: Roger Tufts, Senior Economic Advisor, Capital Policy Division, 
(202) 874-4925, or Ron Shimabukuro, Senior Counsel, Carl Kaminski, 
Senior Attorney, or Hugh Carney, Attorney, Legislative and Regulatory 
Activities Division, (202) 874-5090, Office of the Comptroller of the 
Currency, 250 E Street, SW., Washington, DC 20219.
    Board: Anna Lee Hewko, (202) 530-6260, Assistant Director, Capital 
and Regulatory Policy, or Connie Horsley, (202) 452-5239, Senior 
Supervisory Financial Analyst, Division of Banking Supervision and 
Regulation; or April C. Snyder, Counsel, (202) 452-3099, or Benjamin W. 
McDonough, Counsel, (202) 452-2036, Legal Division. For the hearing 
impaired only, Telecommunication Device for the Deaf (TDD), (202) 263-
4869.
    FDIC: Bobby R. Bean, Chief, Policy Section, (202) 898-6705; Karl 
Reitz, Senior Capital Markets Specialist, (202) 898-6775; Jim 
Weinberger, Senior Policy Analyst, (202) 898-7034, Division of 
Supervision and Consumer Protection; or Mark Handzlik, Counsel, (202) 
898-3990; or Michael Phillips, Counsel, (202) 898-3581, Supervision 
Branch, Legal Division.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
    A. Background
    B. Summary of the Current Market Risk Capital Rule
    1. Covered Positions
    2. Capital Requirement for Market Risk
    3. Internal Models-Based Capital Requirement
    4. Specific Risk
    5. Calculation of the Risk-Based Capital Ratio
II. Proposed Revisions to the Market Risk Capital Rule
    A. Objectives of the Proposed Revisions
    B. Description of the Proposed Revisions to the Market Risk 
Capital Rule
    1. Scope
    2. Reservation of Authority
    3. Modification of the Definition of Covered Position
    4. Requirements for the Identification of Trading Positions and 
Management of Covered Positions
    5. General Requirements for Internal Models
    Model Approval and Ongoing Use Requirements
    Risks Reflected in Models
    Control, Oversight, and Validation Mechanisms
    Internal Assessment of Capital Adequacy
    Documentation
    6. Capital Requirement for Market Risk
    Determination of the Multiplication Factor
    7. VaR-Based Capital Requirement
    Quantitative Requirements for VaR-based Measure
    8. Stressed VaR-Based Capital Requirement
    Quantitative Requirements for Stressed VaR-based Measure
    9. Revised Modeling Standards for Specific Risk
    10. Standardized Specific Risk Capital Requirement
    Debt Positions
    Equity Positions
    Securitization Positions
    11. Incremental Risk Capital Requirement
    12. Comprehensive Risk Capital Requirement
    13. Disclosure Requirements
III. Regulatory Flexibility Act Analysis
IV. OCC Unfunded Mandates Reform Act of 1995 Determination
V. Paperwork Reduction Act
VI. Plain Language

I. Introduction

A. Background

    The first international capital framework for banks \1\ entitled 
International Convergence of Capital Measurement and Capital Standards 
(1988 Capital Accord) was developed by the Basel Committee on Banking 
Supervision (BCBS) \2\ and endorsed by the G-10 governors in 1988. The 
OCC, the Board, and the FDIC (collectively, the agencies) implemented 
the 1988 Capital Accord in 1989 through the issuance of the general 
risk-based capital rules.\3\ In 1996, the BCBS amended the 1988 Capital 
Accord to require banks to measure and hold capital to cover their 
exposure to market risk associated with foreign exchange and commodity 
positions and positions located in the trading account (the Market Risk 
Amendment (MRA) or market risk framework).\4\ The agencies implemented 
the MRA with an effective date of January 1, 1997 (market risk capital 
rule).\5\
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    \1\ For simplicity, and unless otherwise indicated, the preamble 
to this notice of proposed rulemaking uses the term ``bank'' to 
include banks, savings associations, and bank holding companies 
(BHCs). The terms ``bank holding company'' and ``BHC'' refer only to 
bank holding companies regulated by the Board.
    \2\ The BCBS is a committee of banking supervisory authorities, 
which was established by the central bank governors of the G-10 
countries in 1975. It consists of senior representatives of bank 
supervisory authorities and central banks from Argentina, Australia, 
Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, 
India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the 
Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, 
Sweden, Switzerland, Turkey, the United Kingdom, and the United 
States. Documents issued by the BCBS are available through the Bank 
for International Settlements Web site at http://www.bis.org.
    \3\ The agencies' general risk-based capital rules are at 12 CFR 
part 3, Appendix A (OCC); 12 CFR part 208, Appendix A and 12 CFR 
part 225, Appendix A (Board); and 12 CFR part 325, Appendix A 
(FDIC).
    \4\ In 1997, the BCBS modified the MRA to remove a provision 
pertaining to the specific risk capital charge under the internal 
models approach (see http://www.bis.org/press/p970918a.htm).
    \5\ 61 FR 47358 (September 6, 1996). The agencies' market risk 
capital rules are at 12 CFR part 3, Appendix B (OCC), 12 CFR part 
208, Appendix E and 12 CFR part 225, Appendix E (Board), and 12 CFR 
part 325, Appendix C (FDIC).
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    In June 2004, the BCBS issued a document entitled International 
Convergence of Capital Measurement and Capital Standards: A Revised 
Framework (New Accord or Basel II), which was intended for use by 
individual countries as the basis for national consultation and 
implementation. The New Accord sets forth a ``three-pillar'' framework 
that includes (i) risk-based capital requirements for credit risk, 
market risk, and operational risk (Pillar 1); (ii) supervisory review 
of capital adequacy (Pillar 2); and (iii) market discipline through 
enhanced public disclosures (Pillar 3).
    The New Accord retained much of the MRA; however, after its 
release, the BCBS announced that it would develop improvements to the 
market risk framework, especially with respect to the treatment of 
specific risk, which refers to the risk of loss on a position due to 
factors other than broad-based movements in market prices. As a result, 
in July 2005, the BCBS and the International Organization of Securities 
Commissions (IOSCO) published The Application of Basel II to Trading 
Activities and the Treatment of Double Default Effects. The BCBS 
incorporated the July 2005 changes into the June 2006 comprehensive 
version of the New Accord and follow its ``three-pillar'' structure. 
Specifically, the Pillar 1

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changes narrow the types of positions that are subject to the market 
risk framework and revise modeling standards and procedures for 
calculating minimum regulatory capital requirements; the Pillar 2 
changes require banks to conduct internal assessments of their capital 
adequacy with respect to market risk, taking into account the output of 
their internal models, valuation adjustments, and stress tests; and the 
Pillar 3 changes require banks to disclose certain quantitative and 
qualitative information, including their valuation techniques for 
covered positions, the soundness standard used for modeling purposes, 
and their internal capital adequacy assessment methodologies.
    In September 2006, the agencies issued a joint notice of proposed 
rulemaking (2006 proposal) in which they proposed amendments to their 
market risk capital rules that would implement the BCBS's changes to 
the market risk framework.\6\ The BCBS began work on significant 
changes to the market risk framework in 2007 due to issues highlighted 
by the financial crisis. As a result, the agencies did not finalize the 
2006 proposal. This joint notice of proposed rulemaking (proposed rule) 
incorporates aspects of the agencies' 2006 proposal as well as further 
revisions to the New Accord (and associated guidance) published by the 
BCBS in July 2009. These publications include Revisions to the Basel II 
Market Risk Framework, Guidelines for Computing Capital for Incremental 
Risk in the Trading Book, and Enhancements to the Basel II Framework 
(collectively, the 2009 revisions).
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    \6\ 71 FR 55958, (September 25, 2006). The 2006 proposal was 
issued jointly by the agencies and the Office of Thrift Supervision 
(OTS). In the proposal, the OTS, which had not previously adopted 
the MRA, proposed adopting a market risk capital rule.
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    The 2009 revisions to the market risk framework place additional 
prudential requirements on banks' internal models for measuring market 
risk and require enhanced qualitative and quantitative disclosures, 
particularly with respect to banks' securitization activities. The 
revisions also introduce an incremental risk capital requirement to 
capture default and credit quality migration risk for non-
securitization credit products. With respect to securitizations, the 
2009 revisions require banks to apply the standardized measurement 
method for specific risk to these positions, except for ``correlation 
trading'' positions (described further below), for which banks may 
choose to model all material price risks. The 2009 revisions also add a 
stressed Value-at-Risk (VaR)-based capital requirement to banks' VaR-
based capital requirement under the existing framework. In June, 2010, 
the BCBS published additional revisions to the market risk framework 
that included establishing a floor on the risk-based capital 
requirement for modeled correlation trading positions.\7\
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    \7\ The June 2010 revisions can be found, in their entirety, at 
http://bis.org/press/p100618/annex.pdf.
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    These revisions to the market risk framework and other proposed 
revisions are discussed more fully below. Part I.B. of this preamble 
summarizes and provides background on the current market risk capital 
rule. Part II describes the proposed revisions to the market risk 
capital rule that incorporate aspects of the BCBS 2005 and 2009 
revisions to the market risk framework.
    Question 1: The agencies request comment on all aspects of the 
proposed rule and specifically on whether and for what reasons certain 
aspects of the proposed rule present particular implementation 
challenges. Responses should be detailed as to the nature and impact of 
such challenges. What, if any, specific approaches (for example, 
transitional arrangements) should the agencies consider to address such 
challenges and why?

B. Summary of the Current Market Risk Capital Rule

    The current market risk capital rule supplements both the agencies' 
general risk-based capital rules and the advanced capital adequacy 
guidelines (advanced approaches rules) (collectively, the credit risk 
capital rules) \8\ by requiring any bank subject to the market risk 
capital rule to adjust its risk-based capital ratios to reflect market 
risk in its trading activities. The rule applies to a bank with 
worldwide, consolidated trading activity equal to 10 percent or more of 
total assets, or $1 billion or more. The primary Federal supervisor of 
a bank may apply the market risk capital rule to a bank if the 
supervisor deems it necessary or appropriate for safe and sound banking 
practices. In addition, the supervisor may exempt a bank that meets the 
threshold criteria from application of the rule if the supervisor 
determines the bank meets such criteria as a consequence of accounting, 
operational, or similar considerations, and the supervisor deems such 
an exemption to be consistent with safe and sound banking practices.
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    \8\ The agencies' advanced approaches rules are at 12 CFR part 
3, Appendix C (OCC); 12 CFR part 208, Appendix F and 12 CFR part 
225, Appendix G (Board); and 12 CFR part 325, Appendix D (FDIC). For 
purposes of this preamble, the term ``credit risk capital rules'' 
refers to the general risk-based capital rules and the advanced 
approaches rules (that also apply to operational risk), as 
applicable to the bank using the proposed rule.
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1. Covered Positions
    The current market risk capital rule requires a bank to maintain 
regulatory capital against the market risk of its covered positions. 
Covered positions are defined as all on- and off-balance sheet 
positions in the bank's trading account (as defined in the instructions 
to the Consolidated Reports of Condition and Income (Call Report) or to 
the FR Y-9C Consolidated Financial Statements for Bank Holding 
Companies (FR Y-9C)), and all foreign exchange and commodity positions, 
whether or not they are in the trading account. Covered positions 
exclude all positions in the trading account that, in form or 
substance, act as liquidity facilities that provide liquidity support 
to asset-backed commercial paper.
2. Capital Requirement for Market Risk
    The current market risk capital rule defines market risk as the 
risk of loss resulting from movements in market prices. Market risk 
consists of general market risk and specific risk components. General 
market risk is defined as changes in the market value of positions 
resulting from broad market movements, such as changes in the general 
level of interest rates, equity prices, foreign exchange rates, or 
commodity prices. Specific risk is defined as changes in the market 
value of a position due to factors other than broad market movements 
and includes event and default risk, as well as idiosyncratic risk.\9\
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    \9\ Idiosyncratic risk is the risk of loss in the value of a 
position that arises from changes in risk factors unique to that 
position. Event risk is the risk of loss on a position that could 
result from sudden and unexpected large changes in market prices or 
specific events other than the default of the issuer. Default risk 
is the risk of loss on a position that could result from the failure 
of an obligor to make timely payments of principal or interest on 
its debt obligation, and the risk of loss that could result from 
bankruptcy, insolvency, or similar proceeding. For credit 
derivatives, default risk means the risk of loss on a position that 
could result from the default of the reference exposure(s).
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    A bank that is subject to the market risk capital rule is required 
to use an internal model to calculate a VaR-based measure of its 
exposure to market risk. A bank's total risk-based capital requirement 
for covered positions generally consists of a VaR-based capital 
requirement plus an add-on for specific risk, if specific risk is not 
captured in the bank's internal VaR model.\10\ The VaR-based capital 
requirement is based

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on an estimate of the amount that the value of one or more positions 
could decline over a stated time horizon and at a stated confidence 
level. A bank may determine its capital requirement for specific risk 
using a standardized method or, with supervisory approval, may use 
internal models to measure its minimum capital requirement for specific 
risk.
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    \10\ The primary Federal supervisor of a bank may also permit 
the use of alternative techniques to measure the market risk of de 
minimis exposures, if the techniques adequately measure associated 
market risk.
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3. Internal Models-Based Capital Requirement
    In calculating the capital requirement for market risk, a bank is 
required to use an internal model that meets specified qualitative and 
quantitative criteria. The qualitative requirements reflect basic 
components of sound market risk management. For example, the current 
market risk capital rule requires an independent risk control unit that 
reports directly to senior management and an internal risk measurement 
model that is integrated into the daily management process. The 
quantitative criteria include the use of a VaR-based measure based on a 
99.0 percent, one-tailed confidence level. The VaR-based measure must 
be based on a price shock equivalent to a 10-business-day movement in 
rates or prices. Price changes estimated using shorter time periods 
must be adjusted to the 10-business-day standard. The minimum effective 
historical observation period for deriving the rate or price changes is 
one year and data sets must be updated at least every three months or 
more frequently if market conditions warrant. In all cases, under the 
current rule, a bank must have the capability to update its data sets 
more frequently than every three months in anticipation of market 
conditions that would require such updating.
    A bank need not use a single model to calculate its VaR-based 
measure. A bank's internal model may use any generally accepted 
approach, such as variance-covariance models, historical simulations, 
or Monte Carlo simulations. However, the level of sophistication of the 
bank's internal model must be commensurate with the nature and size of 
the positions it covers. The internal model must use risk factors 
sufficient to measure the market risk inherent in all covered 
positions. The risk factors must address interest rate risk, equity 
price risk, foreign exchange rate risk, and commodity price risk.
    The current market risk capital rule imposes backtesting 
requirements that must be calculated quarterly. A bank must compare its 
daily VaR-based measure for each of the preceding 250 business days to 
its actual daily trading profit or loss, which typically includes 
realized and unrealized gains and losses on portfolio positions as well 
as fee income and commissions associated with trading activities. If 
the quarterly backtesting shows that the bank's daily net trading loss 
exceeded its corresponding daily VaR-based measure, a backtesting 
exception has occurred. If a bank experiences more than four 
backtesting exceptions over the preceding 250 business days, it is 
generally required to apply a multiplication factor in excess of 3 when 
it calculates its risk-based capital ratio (see section I.B.5 of this 
preamble).
    A bank subject to the market risk capital rule is also required to 
conduct stress tests to assess the impact of adverse market events on 
its positions. The market risk capital rule does not prescribe specific 
stress-testing methodologies.
4. Specific Risk
    Under the current market risk capital rule, a bank may use an 
internal model to measure its exposure to specific risk if it has 
demonstrated to its primary Federal supervisor that the model measures 
the specific risk, including event and default risk, as well as 
idiosyncratic risk, of its debt and equity positions. A bank that 
incorporates specific risk in its internal model but fails to 
demonstrate that the model adequately measures all aspects of specific 
risk is subject to a specific risk add-on. In this case, if the bank 
can validly separate its VaR-based measure into a specific risk portion 
and a general market risk portion, the add-on is equal to the previous 
day's specific risk portion. If the bank cannot separate the VaR-based 
measure into a specific risk portion and a general market risk portion, 
the add-on is equal to the sum of the previous day's VaR-based measures 
for subportfolios of debt and equity positions that contain specific 
risk.
    If the bank does not model specific risk, it must calculate its 
specific risk capital requirement, or ``add-on,'' using a standardized 
method.\11\ Under this method, the specific risk add-on for debt 
positions is calculated by multiplying the absolute value of the 
current market value of each net long and net short position in a debt 
instrument by the appropriate specific risk-weighting factor in the 
rule. These specific risk-weighting factors range from zero to 8.0 
percent and are based on the identity of the obligor and, in the case 
of some positions, the credit rating and remaining contractual maturity 
of the position. Derivative instruments are risk-weighted according to 
the market value of the effective notional amount of the underlying 
position. A bank may net long and short debt positions (including 
derivatives) in identical debt issues or indices. A bank may also 
offset a ``matched'' position in a derivative and its corresponding 
underlying instrument.
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    \11\ See section 5(c) of the agencies' market risk capital rules 
for a description of this method.
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    Under the standardized method, the specific risk add-on for equity 
positions is the sum of the bank's net long and short positions in an 
equity, multiplied by a specific risk-weighting factor. A bank may net 
long and short positions (including derivatives) in identical equity 
issues or equity indices in the same market. The specific risk add-on 
is 8.0 percent of the net equity position, unless the bank's portfolio 
is both liquid and well-diversified, in which case the specific risk 
add-on is 4.0 percent. For positions that are index contracts 
comprising a well-diversified portfolio of equities, the specific risk 
add-on is 2.0 percent of the net long or net short position in the 
index.\12\
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    \12\ In addition, for futures contracts on broadly based indices 
that are matched by offsetting equity baskets, a bank may apply a 
2.0 percent specific risk requirement to the futures and stock 
basket positions if the basket comprises at least 90 percent of the 
capitalization of the index. The 2.0 percent specific risk 
requirement applies to only one side of certain futures-related 
arbitrage strategies when either: (i) The long and short positions 
are in exactly the same index at different dates or in different 
markets; or (ii) the long and short positions are in different but 
similar indices at the same date.
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5. Calculation of the Risk-Based Capital Ratio
    A bank subject to the current market risk capital rule must 
calculate its adjusted risk-based capital ratios as follows. First, the 
bank must calculate its adjusted risk-weighted assets, which equals its 
risk-weighted assets calculated under the general risk-based capital 
rule excluding the risk-weighted amounts of covered positions (except 
foreign exchange positions outside the trading account and over-the-
counter derivative instruments) \13\ and cash-secured securities 
borrowing receivables that meet the criteria of the market risk capital 
rule.
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    \13\ Foreign exchange positions outside the trading account and 
all over-the-counter derivative positions, regardless of whether 
they are in the trading account, must be included in a bank's risk-
weighted assets as determined under the general risk-based capital 
rules.
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    The bank then must calculate its measure for market risk, which 
equals the sum of the VaR-based capital requirement for market risk, 
the specific risk add-on (if any), and the capital

[[Page 1894]]

requirement for de minimis exposures (if any). The VaR-based capital 
requirement equals the greater of (i) the previous day's VaR-based 
measure; or (ii) the average of the daily VaR-based measures for each 
of the preceding 60 business days multiplied by three, or such higher 
multiplier as may be required under the backtesting requirements of the 
market risk capital rule. The measure for market risk is multiplied by 
12.5 to calculate market-risk-equivalent assets. The market-risk-
equivalent assets are added to adjusted risk-weighted assets to compute 
the denominator of the bank's risk-based capital ratio.
    To calculate the numerator, the bank must allocate tier 1 and tier 
2 capital equal to 8.0 percent of adjusted risk-weighted assets, and 
further allocate excess tier 1, excess tier 2, and tier 3 \14\ capital 
equal to the measure for market risk. The sum of tier 2 and tier 3 
capital allocated for market risk may not exceed 250 percent of tier 1 
capital. As a result, tier 1 capital must equal at least 28.6 percent 
of the measure for market risk. The sum of tier 2 (both allocated and 
excess) and allocated tier 3 capital may not exceed 100 percent of tier 
1 capital (both allocated and excess). Term subordinated debt and 
intermediate-term preferred stock and related surplus included in tier 
2 capital (both allocated and excess) may not exceed 50 percent of tier 
1 capital (both allocated and excess). The sum of tier 1 and tier 2 
capital (both allocated and excess) and allocated tier 3 capital is the 
numerator of the bank's total risk-based capital ratio.
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    \14\ Tier 1 and tier 2 capital are defined in the general risk-
based capital rules. Tier 3 capital is subordinated debt that is 
unsecured, is fully paid up, has an original maturity of at least 
two years, is not redeemable before maturity without prior approval 
by the primary Federal supervisor, includes a lock-in clause 
precluding payment of either interest or principal (even at 
maturity) if the payment would cause the issuing bank's risk-based 
capital ratio to fall or remain below the minimum required under the 
credit risk capital rules, and does not contain and is not covered 
by any covenants, terms, or restrictions that are inconsistent with 
safe and sound banking practices.
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II. Proposed Revisions to the Market Risk Capital Rule

A. Objectives of the Proposed Revisions

    The key objectives of the proposed revisions to the current market 
risk capital rule are to enhance the rule's sensitivity to risks that 
are not adequately captured by the current rule; to enhance modeling 
requirements in a manner that is consistent with advances in risk 
management since the initial implementation of the rule; to modify the 
definition of covered position to better capture positions for which 
treatment under the rule is appropriate; to address shortcomings in the 
modeling of certain risks; to address certain procyclicality concerns; 
and to increase transparency through enhanced disclosures. The 
objective of enhancing the risk sensitivity of the rule is particularly 
important because of banks' increased exposure to traded credit 
products, such as credit default swaps (CDSs) and asset-backed 
securities, in other structured products, and in less liquid products. 
The risks of these products are generally not fully captured in current 
VaR models, which rely on a 10-business-day, one-tail, 99.0 percent 
confidence level soundness standard.
    For example, the growth in traded credit products has increased 
default and credit migration risks that should be captured in a 
regulatory capital requirement for specific risk but have proved 
difficult to capture adequately within current specific risk models. 
The agencies did not contemplate risks associated with less liquid 
credit products when the market risk capital rule was first adopted. 
Therefore, the agencies propose to implement an incremental risk 
capital requirement that would apply to a bank that models specific 
risk for one or more portfolios of debt or, if applicable, equity 
positions, and to incorporate explicit measures of liquidity.
    In addition, to address the agencies' concerns about the 
appropriate treatment of covered positions that have limited price 
transparency, the agencies propose to require banks to have a well-
defined valuation process for all covered positions. The specific 
proposals are discussed below.

B. Description of the Proposed Revisions to the Market Risk Capital 
Rule

1. Scope
    The proposed market risk capital rule does not change the set of 
banks to which the rule applies. That is, the proposed rule continues 
to apply to any bank with aggregate trading assets and trading 
liabilities equal to 10 percent or more of total assets, or $1 billion 
or more. The proposed rule applies to a bank that meets the market risk 
capital rule applicability threshold regardless of whether the bank 
uses the general risk-based capital rules or the advanced approaches 
rules.
    The primary Federal supervisor of a bank that does not meet the 
threshold criteria may apply the market risk capital rule to the bank 
if the supervisor deems it necessary or appropriate given the level of 
market risk of the bank or to ensure safe and sound banking practices. 
The primary Federal supervisor may also exclude a bank that meets the 
threshold criteria from application of the rule if the supervisor 
determines that the exclusion is appropriate based on the level of 
market risk of the bank and is consistent with safe and sound banking 
practices.
    Question 2: The agencies seek comment on the appropriateness of the 
proposed applicability thresholds. What, if any, alternative thresholds 
should the agencies consider and why?
2. Reservation of Authority
    The proposed rule contains a reservation of authority that affirms 
the authority of a bank's primary Federal supervisor to require the 
bank to hold an overall amount of capital greater than would otherwise 
be required under the rule if the supervisor determines that the bank's 
risk-based capital requirements under the rule are not commensurate 
with the market risk of the bank's covered positions. In addition, the 
agencies anticipate that there may be instances when the proposed rule 
would generate a risk-based capital requirement for a specific covered 
position or portfolio of covered positions that is not commensurate 
with the risks of the covered position or portfolio. In these cases, a 
bank's primary Federal supervisor may require the bank to assign a 
different risk-based capital requirement to the covered position or 
portfolio of covered positions that better reflects the risk of the 
position or portfolio. The proposed rule also provides authority for a 
bank's primary Federal supervisor to require the bank to calculate 
capital requirements for specific positions or portfolios under the 
market risk capital rule or under either the general risk-based capital 
rules or advanced approaches rules, as appropriate, to more 
appropriately reflect the risks of the positions.
3. Modification of the Definition of Covered Position
    The proposed rule modifies the definition of a covered position to 
include trading assets and trading liabilities (as reported on schedule 
RC-D of the Call Report or Schedule HC-D of the Consolidated Financial 
Statements for Bank Holding Companies) that are trading positions. 
Under the proposal, a trading position is defined as a position that is 
held by the bank for the purpose of short-term resale or with the 
intent of benefiting from actual or expected short-term price 
movements, or to lock in arbitrage profits. Thus, the characterization 
of an

[[Page 1895]]

asset or liability as ``trading'' for purposes of U.S. Generally 
Accepted Accounting Principles (GAAP) will not necessarily determine 
whether the asset or liability is a ``trading position'' for purposes 
of the proposed rule. Commenters on the 2006 proposal expressed 
concerns that the proposed covered position definition would create 
inconsistencies between the regulatory capital treatment of certain 
trading assets and trading liabilities and the treatment of those 
positions under GAAP. The agencies, however, continue to believe that 
relying on the accounting definition of trading assets and trading 
liabilities, without modification, would not be appropriate because it 
includes positions that are not held with the intent or ability to 
trade.
    The proposed covered position definition includes trading assets 
and trading liabilities that hedge covered positions. In addition, the 
trading asset or trading liability must be free of any restrictive 
covenants on its tradability or the bank must be able to hedge its 
material risk elements in a two-way market. A trading asset or trading 
liability that hedges a trading position is a covered position only if 
the hedge is within the scope of the bank's hedging strategy (discussed 
below). The agencies encourage the sound risk management of trading 
positions. Therefore, the agencies include in the definition of a 
covered position any hedges that offset the risk of trading positions. 
The agencies are concerned, however, that a bank could craft its 
hedging strategies in order to bring non-trading positions that are 
more appropriately treated under the credit risk capital rules into the 
bank's covered positions. The agencies will review a bank's hedging 
strategies to ensure that they are not being manipulated in this 
manner. For example, mortgage-backed securities that are not held with 
the intent to trade, but that are hedged with interest rate swaps to 
mitigate interest rate risk, would be subject to the credit risk 
capital rules.
    Consistent with the current definition of covered position, under 
the proposed rule, a covered position also includes any foreign 
exchange or commodity position, whether or not it is a trading asset or 
trading liability. With prior supervisory approval, a bank may exclude 
from its covered positions any structural position in a foreign 
currency, which is defined as a position that is not a trading position 
and that is (i) a subordinated debt, equity, or minority interest in a 
consolidated subsidiary that is denominated in a foreign currency; (ii) 
capital assigned to foreign branches that is denominated in a foreign 
currency; (iii) a position related to an unconsolidated subsidiary or 
another item that is denominated in a foreign currency and that is 
deducted from the bank's tier 1 and tier 2 capital; or (iv) a position 
designed to hedge a bank's capital ratios or earnings against the 
effect of adverse exchange rate movements on (i), (ii), or (iii).
    Also consistent with the current rule, the proposed definition of a 
covered position explicitly excludes any position that, in form or 
substance, acts as a liquidity facility that provides support to asset-
backed commercial paper. In addition, the definition of covered 
position excludes all intangible assets, including servicing assets. 
Intangible assets are excluded because their risks are explicitly 
addressed in the credit risk capital rules, often through a deduction 
from capital.
    The proposed covered position definition excludes any equity 
position that is not publicly traded, other than a derivative that 
references a publicly traded equity; any direct real estate holding; 
and any position that a bank holds with the intent to securitize. 
Equity positions that are not publicly traded would include private 
equity investments, most hedge fund investments, and other such 
closely-held and non-liquid investments that are not easily marketable. 
Direct real estate holdings include real estate for which the bank 
holds title, such as ``other real estate owned'' held from foreclosure 
activities, and bank premises used by a bank as part of its ongoing 
business activities. With such real estate holdings, marketability and 
liquidity are uncertain or even impractical as the assets are an 
integral part of the bank's ongoing business. Indirect investments in 
real estate, such as through real estate investment trusts or special 
purpose vehicles, must meet the definition of a trading position in 
order to be a covered position. Positions that a bank holds with the 
intent to securitize include a ``pipeline'' or ``warehouse'' of loans 
being held for securitization; the agencies do not view the intent to 
securitize these positions as synonymous with the intent to trade them. 
Consistent with the 2009 revisions, the agencies believe all of these 
excluded positions have significant constraints in terms of a bank's 
ability to liquidate them readily and value them reliably on a daily 
basis.
    The proposed covered position definition excludes a credit 
derivative that the bank recognizes as a guarantee for purposes of 
calculating the amount of risk-weighted assets under the credit risk 
capital rules \15\ if it is used to hedge a position that is not a 
covered position (for example, a credit derivative hedge of a loan that 
is not a covered position). This requires the bank to include the 
credit derivative in its risk-weighted assets for credit risk and 
exclude it from its VaR-based measure for market risk. This proposed 
treatment of a credit derivative hedge avoids the mismatch that arises 
when the hedged position (for example, a loan) is not a covered 
position and the credit derivative hedge is a covered position. This 
mismatch has the potential to overstate the VaR-based measure of market 
risk if only one side of the transaction were reflected in that 
measure.
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    \15\ See 12 CFR part 3, section 3 (OCC); 12 CFR part 208, 
Appendix A, section II.B and 12 CFR part 225, Appendix A, section 
II.B (Board); and 12 CFR part 325, Appendix A, section II.B.3 
(FDIC). The treatment of guarantees is described in sections 33 and 
34 of the advanced approaches rules.
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    Question 3: The agencies request comment on all aspects of the 
proposed definition of covered position.
    Under the proposed rule, in addition to commodities and foreign 
exchange positions, covered positions include debt positions, equity 
positions and securitization positions. The proposal defines a debt 
position as a covered position that is not a securitization position or 
a correlation trading position and that has a value that reacts 
primarily to changes in interest rates or credit spreads. Examples of 
debt positions include corporate and government bonds, certain 
nonconvertible preferred stock, certain convertible bonds, and 
derivatives (including written and purchased options) for which the 
underlying instrument is a debt position.
    The proposal defines an equity position as a covered position that 
is not a securitization position or a correlation trading position and 
that has a value that reacts primarily to changes in equity prices. 
Examples of equity positions include voting or nonvoting common stock, 
certain convertible bonds, commitments to buy or sell equity 
instruments, equity indices, and a derivative for which the underlying 
instrument is an equity position.
    Under the proposal, a securitization is a transaction in which: (i) 
All or a portion of the credit risk of one or more underlying exposures 
is transferred to one or more third parties; (ii) the credit risk 
associated with the underlying exposures has been separated into at 
least two tranches that reflect different levels of seniority; (iii) 
performance of the securitization exposures depends upon the 
performance of the underlying exposures; (iv) all or substantially all 
of

[[Page 1896]]

the underlying exposures are financial exposures (such as loans, 
commitments, credit derivatives, guarantees, receivables, asset-backed 
securities, mortgage-backed securities, other debt securities, or 
equity securities); (v) for non-synthetic securitizations, the 
underlying exposures are not owned by an operating company; \16\ (vi) 
the underlying exposures are not owned by a small business investment 
company described in section 302 of the Small Business Investment Act 
of 1958 (15 U.S.C. 682); and (vii) the underlying exposures are not 
owned by a firm an investment in which qualifies as a community 
development investment under 12 U.S.C. 24 (Eleventh). Further, a bank's 
primary Federal supervisor may determine that a transaction in which 
the underlying exposures are owned by an investment firm that exercises 
substantially unfettered control over the size and composition of its 
assets, liabilities, and off-balance sheet exposures is not a 
securitization based on the transaction's leverage, risk profile, or 
economic substance. Generally, the agencies would consider investment 
firms that can easily change the size and composition of their capital 
structure, as well as the size and composition of their assets and off-
balance sheet exposures as eligible for exclusion from the 
securitization definition under this provision. Based on a particular 
transaction's leverage, risk profile, or economic substance, a bank's 
primary Federal supervisor may deem an exposure to a transaction to be 
a securitization exposure, even if the exposure does not meet the 
criteria in provisions (v), (vi), or (vii) above. A securitization 
position is a covered position that is (i) an on-balance sheet or off-
balance sheet credit exposure (including credit-enhancing 
representations and warranties) that arises from a securitization 
(including a resecuritization); or (ii) an exposure that directly or 
indirectly references a securitization exposure described in (i) above.
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    \16\ In a synthetic securitization, a company uses credit 
derivatives or guarantees to transfer a portion of the credit risk 
of one or more underlying exposures to third-party protection 
providers. The credit derivative or guarantee may be collateralized 
or uncollateralized.
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    A securitization position includes nth-to-default credit 
derivatives and resecuritization positions. The proposal defines an 
nth-to-default credit derivative as a credit derivative that provides 
credit protection only for the nth-defaulting reference exposure in a 
group of reference exposures. In addition, under the proposal, a 
resecuritization is a securitization in which one or more of the 
underlying exposures is a securitization exposure. A resecuritization 
position is (i) an on- or off-balance sheet exposure to a 
resecuritization; or (ii) an exposure that directly or indirectly 
references a resecuritization exposure described in (i).
    The proposal defines a correlation trading position as (i) a 
securitization position for which all or substantially all of the value 
of the underlying exposures is based on the credit quality of a single 
company for which a two-way market exists, or on commonly traded 
indices based on such exposures for which a two-way market exists on 
the indices; or (ii) a position that is not a securitization position 
and that hedges a position described in clause (i) above. Under the 
proposed definition, a correlation trading position does not include a 
resecuritization position, a derivative of a securitization position 
that does not provide a pro rata share in the proceeds of a 
securitization tranche, or a securitization position for which the 
underlying assets or reference exposures are retail exposures, 
residential mortgage exposures, or commercial mortgage exposures. 
Correlation trading positions are typically not rated by external 
credit rating agencies and may include CDO index tranches, bespoke CDO 
tranches, and nth-to-default credit derivatives. Standardized CDS 
indices and single-name CDSs are examples of instruments used to hedge 
these positions. While banks typically hedge correlation trading 
positions, hedging frequently does not reduce a bank's net exposure to 
a position because the hedges often do not perfectly match the 
position.
4. Requirements for the Identification of Trading Positions and 
Management of Covered Positions
    Section 3 of the proposal introduces new requirements for the 
identification of trading positions and the management of covered 
positions. The agencies believe that these new requirements are 
warranted based on the inclusion of more credit risk-related, less 
liquid, and less actively traded products in banks' covered positions. 
The risks of these positions may not be fully reflected in the 
requirements of the market risk capital rule and may be more 
appropriately captured under credit risk capital rules.
    The proposed rule requires a bank to have clearly defined policies 
and procedures for determining which of its trading assets and trading 
liabilities are trading positions as well as which of its trading 
positions are correlation trading positions. In determining the scope 
of trading positions, the bank must consider (i) the extent to which a 
position (or a hedge of its material risks) can be marked-to-market 
daily by reference to a two-way market; and (ii) possible impairments 
to the liquidity of a position or its hedge.
    In addition, the bank must have clearly defined trading and hedging 
strategies. The bank's trading and hedging strategies for its trading 
positions must be approved by senior management. The trading strategy 
must articulate the expected holding period of, and the market risk 
associated with, each portfolio of trading positions. The hedging 
strategy must articulate for each portfolio the level of market risk 
the bank is willing to accept and must detail the instruments, 
techniques, and strategies the bank will use to hedge the risk of the 
portfolio. The hedging strategy should be applied at the level at which 
trading positions are risk managed at the bank (for example, trading 
desk, portfolio levels).
    The proposed rule requires a bank to have clearly defined policies 
and procedures for actively managing all covered positions. In the 
context of non-traded commodities and foreign exchange positions, 
active management includes managing the risks of those positions within 
the bank's risk limits. For all covered positions, these policies and 
procedures, at a minimum, must require (i) marking positions to market 
or model on a daily basis; (ii) assessing on a daily basis the bank's 
ability to hedge position and portfolio risks and the extent of market 
liquidity; (iii) establishment and daily monitoring of limits on 
positions by a risk control unit independent of the trading business 
unit; (iv) daily monitoring by senior management of the information 
described in (i) through (iii) above; (v) at least annual reassessment 
by senior management of established limits on positions; and (vi) at 
least annual assessments by qualified personnel of the quality of 
market inputs to the valuation process, the soundness of key 
assumptions, the reliability of parameter estimation in pricing models, 
and the stability and accuracy of model calibration under alternative 
market scenarios.
    The proposed rule introduces new requirements for the prudent 
valuation of covered positions that include maintaining policies and 
procedures for valuation, marking positions to market or to model, 
independent price verification, and valuation adjustments or reserves. 
The valuation process must consider, as appropriate, unearned credit 
spreads, close-out costs, early termination costs, investing and 
funding

[[Page 1897]]

costs, future administrative costs, liquidity, and model risk. These 
new valuation requirements reflect the agencies' concerns about 
deficiencies in banks' valuation of less liquid trading positions, 
especially in light of the historical focus of the market risk capital 
rule on a 10-business-day time horizon and a one-tail, 99.0 percent 
confidence level, which has proved to be inadequate at times to reflect 
the full extent of the risks of less liquid positions.
5. General Requirements for Internal Models
    Model Approval and Ongoing Use Requirements. Under the proposed 
rule, a bank must receive the prior written approval of its primary 
Federal supervisor before using any internal model to calculate its 
market risk capital requirement. The 2006 proposal included a 
requirement that a bank receive prior written approval from its primary 
Federal supervisor before extending the use of an approved model to an 
additional business line or product type. Some commenters raised 
concerns that this requirement might unduly impede a new product launch 
pending regulatory approval. The agencies have not included this 
requirement in the proposed rule. Instead, the proposal requires that a 
bank promptly notify its primary Federal supervisor when the bank plans 
to extend the use of a model that the primary Federal supervisor has 
approved to an additional business line or product type.
    The proposed rule also requires a bank to notify its primary 
Federal supervisor promptly if it makes any change to its internal 
models that would result in a material change in the bank's amount of 
risk-weighted assets for a portfolio of covered positions or when the 
bank makes any material change to its modeling assumptions. The bank's 
primary Federal supervisor may rescind its approval, in whole or in 
part, of the use of any internal model, and determine an appropriate 
regulatory capital requirement for the covered positions to which the 
model would apply, if it determines that the model no longer complies 
with the market risk capital rule or fails to reflect accurately the 
risks of the bank's covered positions. For example, if adverse market 
events or other developments reveal that a material assumption in a 
bank's approved model is flawed, the bank's primary Federal supervisor 
may require the bank to revise its model assumptions and resubmit the 
model specifications for review by the supervisor.
    Financial markets evolve rapidly, and internal models that were 
state-of-the-art at the time they were approved for use in risk-based 
capital calculations can become less relevant as the risks of covered 
positions evolve and as the industry develops more sophisticated 
modeling techniques that better capture material risks. The proposed 
rule therefore requires a bank to review its internal models 
periodically, but no less frequently than annually, in light of 
developments in financial markets and modeling technologies, and to 
enhance those models as appropriate to ensure that they continue to 
meet the agencies' standards for model approval and employ risk 
measurement methodologies that are most appropriate for the bank's 
covered positions. It is essential that a bank continually improve its 
models to ensure that its market risk capital requirement reflects the 
risk of the bank's covered positions. A bank's primary Federal 
supervisor will closely scrutinize the bank's model review practices as 
a matter of safety and soundness.
    To support the model review and enhancement requirement discussed 
above, the agencies are considering imposing a capital supplement in 
circumstances in which a bank's internal model continues to meet the 
qualification requirements of the rule, but develops specific 
shortcomings in risk identification, risk aggregation and 
representation, or validation. The regulatory capital supplement would 
reflect the materiality of these shortcomings associated with the 
bank's current model and could result in a risk-weighted assets 
surcharge that would apply until such time that the bank enhances its 
model to the satisfaction of its primary Federal supervisor. For 
example, the capital supplement could take the form of a model risk 
multiplier similar to the backtesting multiplier for VaR-type models in 
section 4 of the proposed rule. Depending on the materiality of the 
shortcomings, the supervisor could increase the multiplier on any model 
above three, generally subject to the restriction that the resulting 
capital requirement not exceed the capital requirement that would apply 
under the proposed rule's standardized measurement method for specific 
risk.
    Question 4: Under what circumstances should the agencies require a 
model-specific capital supplement? What criteria could the agencies use 
to apply capital supplements consistently across banks? Aside from a 
capital supplement or withdrawal of model approval, how else could the 
agencies address concerns about outdated models?
    Risks Reflected in Models. Under the proposed rule, a bank must 
incorporate its internal models into its risk management process and 
integrate the internal models used for calculating its VaR-based 
measure into its daily risk management process. The level of 
sophistication of a bank's models must be commensurate with the 
complexity and amount of its covered positions. To measure market risk, 
a bank's internal models may use any generally accepted modeling 
approach, including but not limited to variance-covariance models, 
historical simulations, or Monte Carlo simulations. A bank's internal 
models must properly measure all material risks in the covered 
positions to which they are applied. The proposed rule requires that 
risks arising from less liquid positions and positions with limited 
price transparency be modeled conservatively under realistic market 
scenarios. The proposed rule also requires a bank to have a rigorous 
process for reestimating, reevaluating and updating its models to 
ensure continued applicability and relevance.
    Control, Oversight, and Validation Mechanisms. The proposed rule 
maintains the current requirement that a bank have a risk control unit 
that reports directly to senior management and is independent of its 
business trading units. In addition, the proposed rule provides 
specific model validation standards that are similar to those in the 
advanced approaches rules. Specifically, the proposal requires a bank 
to validate its internal models initially and on an ongoing basis. The 
validation process must be independent of the internal models' 
development, implementation, and operation, or the validation process 
must be subjected to an independent review of its adequacy and 
effectiveness. The review personnel do not necessarily have to be 
external to the bank in order to achieve the required independence. A 
bank should ensure that individuals who perform the review are not 
biased in their assessment due to their involvement in the development, 
implementation, or operation of the models.
    Under the proposed rule, validation must include an evaluation of 
the conceptual soundness of the internal models. This evaluation should 
include evaluation of empirical evidence and documentation supporting 
the methodologies used; important model assumptions and their 
limitations; adequacy and robustness of empirical data used in 
parameter estimation and model calibration; and evidence of a model's 
strengths and weaknesses.

[[Page 1898]]

Validation also must include an ongoing monitoring process that 
includes a review and verification of processes and the comparison of 
the bank's model outputs with relevant internal and external data 
sources or estimation techniques. The results of this comparison 
provide a valuable diagnostic tool for identifying potential weaknesses 
in a bank's models. As part of this comparison, the bank should 
investigate the source of any differences between the model estimates 
and the relevant internal or external data or estimation techniques and 
whether the extent of the differences is appropriate.
    Validation of internal models must include an outcomes analysis 
process that includes backtesting. Consistent with the 2009 revisions, 
the proposed rule requires a bank's validation process for internal 
models used to calculate its VaR-based measure to include an outcomes 
analysis process that includes a comparison of the changes in the 
bank's portfolio value that would have occurred were end-of-day 
positions to remain unchanged (therefore, excluding fees, commissions, 
reserves, net interest income, and intraday trading) with VaR-based 
measures during a sample period not used in model development.
    The proposed rule expands upon the current market risk rule's 
stress-testing requirement. Specifically, the proposal requires a bank 
to stress test the market risk of its covered positions at a frequency 
appropriate to each portfolio, and in no case less frequently than 
quarterly. The stress tests must take into account concentration risk, 
illiquidity under stressed market conditions, and other risks arising 
from the bank's trading activities that may not be captured adequately 
in the bank's internal models. For example, it may be appropriate for a 
bank to include in its stress testing the gapping of prices, one-way 
markets, nonlinear or deep out-of-the-money products, jumps-to-default, 
and significant changes in correlation. Relevant types of concentration 
risk include concentration by name, industry, sector, country, and 
market. Market concentration occurs when a bank holds a position that 
represents a concentrated share of the market for a security, and thus 
requires a longer than usual liquidity horizon to liquidate the 
position without impacting the market. A bank's primary Federal 
supervisor would evaluate the robustness and appropriateness of a 
bank's stress tests through the supervisory review process.
    The proposed rule requires a bank to have an internal audit 
function independent of business-line management that at least annually 
assesses the effectiveness of the controls supporting the bank's market 
risk measurement systems, including the activities of the business 
trading units and independent risk control unit, compliance with 
policies and procedures, and the calculation of the bank's measure for 
market risk. The internal audit function should review the bank's 
validation processes, including validation procedures, 
responsibilities, results, timeliness, and responsiveness to findings. 
Further, the internal audit function should evaluate the depth, scope, 
and quality of the risk management system review process and conduct 
appropriate testing to ensure that the conclusions of these reviews are 
well-founded. At least annually, the internal audit function must 
report its findings to the bank's board of directors (or a committee 
thereof).
    Internal Assessment of Capital Adequacy. The proposed rule requires 
that a bank have a rigorous process for assessing its overall capital 
adequacy in relation to its market risk. The assessment must take into 
account market concentration and liquidity risks under stressed market 
conditions, as well as other risks that may not be captured fully in 
the VaR-based measure.
    Documentation. Under the proposal, a bank must document adequately 
all material aspects of its internal models, the management and 
valuation of covered positions, its control, oversight, validation and 
review processes and results, and its internal assessment of capital 
adequacy. This documentation would facilitate the supervisory review 
process as well as the bank's internal audit or other review 
procedures.
6. Capital Requirement for Market Risk
    As under the current rule, the proposed rule requires a bank to 
calculate its risk-based capital ratio denominator as the sum of its 
adjusted risk-weighted assets and market risk equivalent assets. To 
calculate market risk equivalent assets, a bank must multiply its 
measure for market risk by 12.5. Under the proposed rule, a bank's 
measure for market risk equals the sum of its VaR-based capital 
requirement, its stressed VaR-based capital requirement, any specific 
risk add-ons, any incremental risk capital requirement, any 
comprehensive risk capital requirement, and any capital requirement for 
de minimis exposures, each calculated according to the requirements of 
the proposed rule as discussed further below. No adjustments are 
permitted to address potential double counting among any of these 
components of a bank's measure for market risk.
    Also, consistent with the current rule, under the proposed rule a 
bank's VaR-based capital requirement equals the greater of (i) the 
previous day's VaR-based measure, or (ii) the average of the daily VaR-
based measures for each of the preceding 60 business days multiplied by 
three, or such higher multiplication factor required based on 
backtesting results determined according to section 4 of the proposed 
rule and discussed further below. Similarly, under the proposed rule, a 
bank's stressed VaR-based capital requirement equals the greater of (i) 
the most recent stressed VaR-based measure; or (ii) the average of the 
weekly VaR-based measures for each of the preceding 12 weeks multiplied 
by three, or such higher multiplication factor as required based on 
backtesting results determined according to section 4 of the proposed 
rule. The multiplication factor applicable to the stressed-VaR based 
measure for purposes of this calculation is based on the backtesting 
results for its VaR-based measure; there is no separate backtesting 
requirement for the stressed VaR-based measure for purposes of 
calculating a bank's measure for market risk.
    The proposed rule requires a bank to include in its measure for 
market risk any specific risk add-on as required under section 7(c) of 
the proposed rule, determined using the standardized measurement method 
described in section 10 of the proposed rule. The proposed rule also 
requires a bank to include in its measure for market risk any capital 
requirement for de minimis exposures. Specifically, a bank must add to 
its measure for market risk the absolute value of the market value of 
those de minimis exposures that are not captured in the bank's VaR-
based measure unless the bank has obtained prior written approval from 
its primary Federal supervisor to calculate a capital requirement for 
the de minimis exposures using alternative techniques that 
appropriately measure the market risk associated with those exposures. 
With regard to a bank's total risk-based capital numerator, the 
proposed rule eliminates tier 3 capital and the associated allocation 
methodologies.
    Determination of the Multiplication Factor. The proposed rule 
modifies the current rule's regulatory backtesting framework for 
determining the multiplication factor based on the number of 
backtesting exceptions. Under the current market risk capital rule, a 
bank must compare its daily VaR-based measure to its actual daily 
trading profit or loss, which typically includes realized and 
unrealized gains and losses

[[Page 1899]]

on portfolio positions as well as fee income and commissions associated 
with trading activities. Under the proposed rule, each quarter, a bank 
must compare each of its most recent 250 business days' trading losses 
(excluding fees, commissions, reserves, intra-day trading, and net 
interest income) with the corresponding daily VaR-based measure 
calibrated to a one-day holding period and at a one-tail, 99.0 percent 
confidence level. The excluded components of trading profit and loss 
are not modeled as part of the VaR-based measure. Therefore, excluding 
them from the regulatory backtesting framework will improve the 
accuracy of the backtesting and provide a better assessment of the 
bank's internal model. Some commenters on the 2006 proposal raised 
concerns with this requirement; however, the agencies continue to 
believe that banks' trading and reporting systems are sufficiently 
sophisticated to allow this type of backtesting.
    Question 5: The agencies request comment on any challenges banks 
may face in formulating the measure of trading loss as proposed, 
particularly for smaller portfolios. More specifically, which, if any, 
of the items to be excluded from a bank's measure of trading loss 
(fees, commissions, reserves, intra-day trading, or net interest 
income) present difficulties and what is the nature of such 
difficulties?
7. VaR-Based Capital Requirement
    Consistent with the current rule, section 5 of the proposed rule 
requires a bank to use one or more internal models to calculate a daily 
VaR-based measure that reflects general market risk for all covered 
positions. The daily VaR-based measure also may reflect the bank's 
specific risk for one or more portfolios of debt or equity positions 
and must reflect the specific risk for any portfolios of correlation 
trading positions that are modeled under section 9 of the proposed 
rule.
    The proposal adds credit spread risk to the list of risk categories 
required to be captured in a bank's VaR-based measure (that is, in 
addition to interest rate risk, equity price risk, foreign exchange 
rate risk, and commodity price risk). The VaR-based measure may 
incorporate empirical correlations within and across risk categories, 
provided the bank validates and justifies the reasonableness of its 
process for measuring correlations. If the VaR-based measure does not 
incorporate empirical correlations across risk categories, the bank 
must add the separate measures from its internal models used to 
calculate the VaR-based measure for the appropriate market risk 
categories to determine the bank's aggregate VaR-based measure. The 
proposed rule continues to require models to include risks arising from 
the nonlinear price characteristics of option positions or positions 
with embedded optionality.
    Consistent with the 2009 revisions, under the proposed rule, a bank 
must be able to justify to the satisfaction of its primary Federal 
supervisor the omission of any risk factors from the calculation of its 
VaR-based measure that the bank includes in its pricing models. In 
addition, a bank must demonstrate to the satisfaction of its primary 
Federal supervisor the appropriateness of any proxies it uses to 
capture the risks of the bank's actual positions for which such proxies 
are used.
    Quantitative Requirements for VaR-based Measure. The proposed rule 
includes the same quantitative requirements for the daily VaR-based 
measure as the current market risk capital rule. These include the one-
tail, 99.0 percent confidence level, a ten-business-day holding period, 
and a historical observation period of at least one year.
    To calculate VaR-based measures using a 10-day holding period, the 
bank may calculate 10-business-day measures directly, or may convert 
VaR-based measures using holding periods other than 10 business days to 
the equivalent of a 10-business-day holding period. A bank that 
converts its VaR-based measure in this manner must be able to justify 
the reasonableness of its approach to the satisfaction of its primary 
Federal supervisor. For example, a bank that computes its VaR-based 
measure by multiplying a daily VaR amount by the square root of 10 
(that is, using the square root of time) should demonstrate that daily 
changes in portfolio value do not exhibit significant mean reversion, 
autocorrelation, or volatility clustering.\17\
---------------------------------------------------------------------------

    \17\ Using the square root of time assumes that daily portfolio 
returns are independent and identically distributed (IID). When the 
IID assumption is violated, the square root of time approximation is 
not appropriate.
---------------------------------------------------------------------------

    The proposed rule requires a bank's VaR-based measure to be based 
on data relevant to the bank's actual exposures and of sufficient 
quality to support the calculation of risk-based capital requirements. 
The bank must update data sets at least monthly, or more frequently as 
changes in market conditions or portfolio composition warrant. For 
banks that use a weighting scheme or other method for identifying the 
historical observation period, the bank must either: (i) Use an 
effective observation period of at least one year in which the average 
time lag of the observations is at least six months; or (ii) 
demonstrate to its primary Federal supervisor that the method used is 
more effective than that described in (i) at representing the 
volatility of the bank's trading portfolio over a full business cycle. 
In the latter case, a bank must update its data more frequently than 
monthly and in a manner appropriate for the type of weighting scheme. 
In general, a bank using a weighting scheme should update its data 
daily. Because the most recent observations typically are the most 
heavily weighted it is important to include these observations in the 
bank's VaR-based measure.
    The proposed rule requires a bank to retain and make available to 
its primary Federal supervisor model performance information on 
significant subportfolios. Taking into account the value and 
composition of a bank's covered positions, the subportfolios must be 
sufficiently granular to inform a bank and its supervisor about the 
ability of the bank's VaR model to reflect risk factors appropriately. 
A bank's primary Federal supervisor must approve the number of 
subportfolios it uses for subportfolio backtesting. While the proposed 
rule does not prescribe the basis for determining significant 
subportfolios, the primary Federal supervisor may consider the bank's 
evaluation of certain factors such as trading volume, product types and 
number of distinct traded products, business lines, and number of 
traders or trading desks.
    The proposed rule requires a bank to retain and make available to 
its primary Federal supervisor, with no less than a 60 day lag, 
information for each subportfolio for each business day over the 
previous two years (500 business days) that includes (i) A daily VaR-
based measure for the subportfolio calibrated to a one-tail, 99.0 
percent confidence level; (ii) the daily profit or loss for the 
subportfolio (that is, the net change in price of the positions held in 
the portfolio at the end of the previous business day); and (iii) the 
p-value of the profit or loss on each day (that is, the probability of 
observing a loss greater than reported in (ii) above, based on the 
model used to calculate the VaR-based measure described in (i) above).
    Daily information on the probability of observing a loss greater 
than that which occurred on any day is a useful metric for banks and 
supervisors to assess the quality of a bank's VaR model. For example, 
if a bank that used a historical simulation VaR model using the most 
recent 500 business days

[[Page 1900]]

experienced a loss equal to the second worst day of the 500, it would 
assign a probability of 0.004 (2/500) to that loss based on its VaR 
model. Applying this process over a given period provides information 
about the adequacy of the VaR model's ability to characterize the whole 
distribution of losses, including information on the size and number of 
backtesting exceptions. The requirement to create and retain this 
information at the subportfolio level may help identify particular 
products or business lines for which the model is not adequately 
measuring risk.
    Question 6: The agencies request comment on what, if any, 
challenges exist with the proposed subportfolio backtesting 
requirements described above. How might banks determine significant 
subportfolios of covered positions that would be subject to these 
requirements? What basis could be used to determine an appropriate 
number of subportfolios? Is the p-value a useful statistic for 
evaluating the efficacy of a bank's VaR model in gauging market risk? 
What, if any, other statistics should the agencies consider and why?
    The current market risk capital rule requires a bank to include in 
its VaR-based measure only covered positions. In contrast, the proposed 
rule allows a bank to include term repo-style transactions in its VaR-
based measure even though these positions may not meet the definition 
of a covered position, provided the bank includes all such term repo-
style transactions consistently over time. Under the proposed rule, a 
term repo-style transaction is a repurchase or reverse repurchase 
transaction, or a securities borrowing or securities lending 
transaction, including a transaction in which the bank acts as agent 
for a customer and indemnifies the customer against loss, that has an 
original maturity in excess of one business day, provided that it meets 
certain requirements, including being based solely on liquid and 
readily marketable securities or cash and subject to daily marking-to-
market and daily margin maintenance requirements.\18\ While repo-style 
transactions typically are close adjuncts to trading activities, GAAP 
traditionally has not permitted companies to report them as trading 
assets or trading liabilities. Repo-style transactions included in the 
VaR-based measure will continue to be subject to the requirements of 
the credit risk capital rules for calculating capital for counterparty 
credit risk.
---------------------------------------------------------------------------

    \18\ See Section 2, ``Definitions,'' of the proposed rule for a 
full definition of a term repo-style transaction.
---------------------------------------------------------------------------

8. Stressed VaR-based Capital Requirement
    Under section 6 of the proposed rule, a bank must calculate at 
least weekly a stressed VaR-based measure using the same internal 
model(s) used to calculate its VaR-based measure. The stressed VaR-
based measure supplements the VaR-based measure, which, due to inherent 
limitations, proved inadequate in producing capital requirements 
appropriate to the level of losses incurred at many banks during the 
financial market crisis that began in mid-2007. The stressed VaR-based 
measure mitigates the procyclicality of the minimum capital 
requirements for market risk and contributes to a more appropriate 
measure of the risks of a bank's covered positions.
    Quantitative Requirements for Stressed VaR-based Measure. To 
determine the stressed VaR-based measure, a bank must use the same 
model(s) used to calculate its VaR-based measure, but with model inputs 
calibrated to reflect historical data from a continuous 12-month period 
that reflects a period of significant financial stress appropriate to 
the bank's current portfolio. The stressed VaR-based measure must be 
calculated at least weekly and be no less than the bank's VaR-based 
measure. The agencies generally expect that a bank's stressed VaR-based 
measure will be substantially greater than its VaR-based measure.
    The proposed rule requires a bank to have policies and procedures 
that describe how it determines the period of significant financial 
stress used to calculate the bank's stressed VaR-based measure, and to 
be able to provide empirical support for the period used. These 
policies and procedures must address (i) how the bank links the period 
of significant financial stress used to calculate the stressed VaR-
based measure to the composition and directional bias of the bank's 
current portfolio; and (ii) the bank's process for selecting, 
reviewing, and updating the period of significant financial stress used 
to calculate the stressed VaR-based measure and for monitoring the 
appropriateness of the 12-month period in light of the bank's current 
portfolio. The bank must obtain the prior approval of its primary 
Federal supervisor for, and notify its primary Federal supervisor if 
the bank makes any material changes to, these policies and procedures. 
A bank's primary Federal supervisor may require it to use a different 
period of significant financial stress in the calculation of the bank's 
stressed VaR-based measure.
9. Revised Modeling Standards for Specific Risk
    The proposed rule more clearly specifies the modeling standards for 
specific risk and eliminates the current option for a bank to model 
some but not all material aspects of specific risk for an individual 
portfolio of debt or equity positions. As under the current market risk 
capital rule, a bank may use one or more internal models to measure the 
specific risk of a portfolio of debt or equity positions with specific 
risk. A bank must also use one or more internal models to measure the 
specific risk of a portfolio of correlation trading positions with 
specific risk that are modeled under section 9 of the proposed rule. A 
bank may not, however, model the specific risk of securitization 
positions that are not modeled under section 9 of the proposed rule. 
This treatment addresses regulatory arbitrage opportunities as well as 
deficiencies in the modeling of securitization positions that became 
more evident during the course of the financial market crisis that 
began in mid-2007.
    Under the proposed rule, the internal models must explain the 
historical price variation in the portfolio, be responsive to changes 
in market conditions, be robust to an adverse environment, and capture 
all material aspects of specific risk for the debt and equity 
positions. Specifically, the proposed revisions require that a bank's 
internal models capture event risk and idiosyncratic risk; capture and 
demonstrate sensitivity to material differences between positions that 
are similar but not identical; and capture and demonstrate sensitivity 
to changes in portfolio composition and concentrations. If a bank 
calculates an incremental risk measure for a portfolio of debt or 
equity positions under section 8 of the proposed rule, the bank is not 
required to capture default and credit migration risks in its internal 
models used to measure the specific risk of those portfolios.
    Under the current market risk capital rule, if a bank incorporates 
specific risk in its internal model but fails to demonstrate to its 
primary Federal supervisor that its internal model adequately measures 
all aspects of specific risk for a portfolio of debt and equity 
positions, the bank is subject to an internal models-based specific 
risk add-on for that portfolio. In contrast, the proposed rule requires 
a bank that does not have an approved internal model that captures all 
material aspects of specific risk for a particular portfolio of

[[Page 1901]]

debt, equity, or correlation trading positions to use the standardized 
measurement method (described in section 10 of the proposed rule) to 
calculate a specific risk add-on for that portfolio. This proposed 
change reflects the agencies' interest in creating incentives for more 
robust specific risk modeling. Due to concerns about the ability of a 
bank to model the specific risk of certain securitization positions, 
the proposed rule requires a bank to calculate a specific risk add-on 
under the standardized measurement method for all of its securitization 
positions that are not correlation trading positions modeled under 
section 9 of the proposed rule. The agencies note that not all debt, 
equity, or securitization positions have specific risk (for example, 
certain interest rate swaps). Under the proposed rule, there is no 
specific risk capital requirement for positions without specific risk. 
A bank should have clear policies and procedures for determining 
whether a position has specific risk.
    While the proposed rule continues to provide for flexibility and a 
combination of approaches to measure market risk, including the use of 
different models to measure the general market risk and the specific 
risk of one or more portfolios of debt and equity positions, the 
agencies strongly encourage banks to develop and implement models that 
integrate the measurement of VaR for general market risk and specific 
risk. A bank's use of a combination of approaches would be subject to 
supervisory review to ensure that the overall capital requirement for 
market risk is commensurate with the risks of the bank's covered 
positions.
10. Standardized Specific Risk Capital Requirement
    The proposed rule requires a bank to calculate a total specific 
risk add-on for each portfolio of debt and equity positions for which 
the bank's VaR-based measure does not capture all material aspects of 
specific risk and for each of its securitization positions that is not 
modeled under section 9 of the proposed rule. A bank must calculate 
each specific risk add-on in accordance with the requirements of the 
proposed rule. The bank must add the total specific risk add-on for 
each portfolio of positions to the bank's measure for market risk. The 
specific risk add-on for an individual debt or securitization position 
that represents purchased credit protection is capped at the market 
value of the protection.
    For debt, equity, and securitization positions that are derivatives 
with linear payoffs (for example, futures, equity swaps), a bank must 
apply a risk weighting factor to the market value of the effective 
notional amount of the underlying instrument or index portfolio. For 
debt, equity, and securitization positions that are derivatives with 
nonlinear payoffs (for example, options, interest rate caps, tranched 
positions), a bank must apply a risk weighting factor to the market 
value of the effective notional amount of the underlying instrument or 
portfolio multiplied by the derivative's delta (that is, the change of 
the derivative's value relative to changes in the price of the 
reference exposure). For a standard interest rate derivative, the 
effective notional amount refers to the apparent or stated notional 
principal amount. If the contract contains a multiplier or other 
leverage enhancement, the apparent or stated notional principal amount 
must be adjusted to reflect the effect of the multiplier or leverage 
enhancement in order to determine the effective notional amount. A swap 
must be included as an effective notional position in the underlying 
debt, equity, or securitization instrument or portfolio, with the 
receiving side treated as a long position and the paying side treated 
as a short position. Consistent with the current rules, a bank may net 
long and short positions (including derivatives) in identical issues or 
identical indices. A bank may also net positions in depositary receipts 
against an opposite position in an identical equity in different 
markets, provided that the bank includes the costs of conversion.
    The proposed rule also expands the recognition of hedging effects 
for debt and securitization positions. A set of transactions consisting 
of either a debt position and its credit derivative hedge or a 
securitization position and its credit derivative hedge has a specific 
risk add-on of zero if the debt or securitization position is fully 
hedged by a total return swap (or similar instrument where there is a 
matching of payments and changes in market value of the position) and 
there is an exact match between the reference obligation, the maturity, 
and the currency of the swap and the debt or securitization position.
    If a set of transactions consisting of either a debt position and 
its credit derivative hedge or a securitization position and its credit 
derivative hedge does not meet the criteria for no specific risk add-
on, the specific risk add-on for the set of transactions is equal to 
20.0 percent of the specific risk add-on for the side of the 
transaction with the higher specific risk add-on, provided that the 
credit risk of the position is fully hedged by a credit default swap 
(or similar instrument), and there is an exact match between the 
reference obligation of the credit derivative hedge and the debt or 
securitization position, the maturity of the credit derivative hedge 
and the debt or securitization position, and the currency of the credit 
derivative hedge and the debt or securitization position. For a set of 
transactions that consists of either a debt position and its credit 
derivative hedge or a securitization position and its credit derivative 
hedge that does not meet the criteria for full offset or the 80.0 
percent offset described above (for example, there is mismatch in the 
maturity of the credit derivative hedge and that of the debt or 
securitization position), but in which all or substantially all of the 
price risk has been hedged, the specific risk add-on is equal to the 
specific risk add-on for the side of the transaction with the larger 
specific risk add-on.
    Debt and Securitization Positions. While most securitization 
positions are considered debt positions under the current market risk 
capital rule, the agencies distinguish between securitization positions 
and debt positions in the proposed rule because of new proposed 
requirements that are uniquely applicable to securitization positions. 
Under the proposed rule, the total specific risk add-on for a portfolio 
of debt or securitization positions is the sum of the specific risk 
add-ons for individual debt or securitization positions, which are 
determined by multiplying the absolute value of the current market 
value of each net long or net short debt or securitization position by 
an appropriate risk-weighting factor for the position.
    The 2005 revisions to the market risk framework incorporated 
changes to the standardized measurement method used for calculating the 
specific risk add-ons for debt positions. For example, the 
``government'' category was expanded to include all sovereign debt, and 
the specific risk-weighting factor for sovereign debt was changed from 
zero percent to a range from zero to 12.0 percent based on the external 
rating of the obligor and the remaining contractual maturity of the 
debt position. Table 1 below provides an illustrative representation of 
the specific risk-weighting factors applicable to debt positions in the 
``government,'' ``qualifying,'' and ``other'' categories under the 
market risk framework.

[[Page 1902]]



                           Table 1--Specific Risk-Weighting Factors for Debt Positions
----------------------------------------------------------------------------------------------------------------
                                                                                                       Specific
                                        Illustrative external rating      Remaining contractual        risk (%)
               Category                         description                      maturity               weight
                                                                                                        factor
----------------------------------------------------------------------------------------------------------------
Government...........................  Highest investment grade to    .............................         0.00
                                        second highest investment
                                        grade (for example, AAA to
                                        AA-).
                                       Third highest investment       Residual term to final                0.25
                                        grade to lowest investment     maturity 6 months or less.
                                        grade (for example, A+ to
                                        BBB-).
                                                                      Residual term to final                1.00
                                                                       maturity greater than 6 and
                                                                       up to and including 24
                                                                       months.
                                                                      Residual term to final                1.60
                                                                       maturity exceeding 24 months.
                                       One category below investment  .............................         8.00
                                        grade to two categories
                                        below investment grade (for
                                        example, BB+ to B-).
                                       More than two categories       .............................        12.00
                                        below investment grade.
                                       Unrated......................  .............................         8.00
Qualifying...........................  Not applicable...............  Residual term to final                0.25
                                                                       maturity 6 months or less.
                                                                      Residual term to final                1.00
                                                                       maturity greater than 6 and
                                                                       up to and including 24
                                                                       months.
                                                                      Residual term to final                1.60
                                                                       maturity exceeding 24 months.
Other................................  One category below investment  .............................         8.00
                                        grade to two categories
                                        below investment grade (for
                                        example, BB+ to B-).
                                       More than two categories       .............................        12.00
                                        below investment grade, or
                                        equivalent based on a bank's
                                        internal ratings.
                                       Unrated......................  .............................         8.00
----------------------------------------------------------------------------------------------------------------

    The 2009 revisions to the market risk framework also incorporated 
changes to the specific risk-weighting factors under the standardized 
measurement method for rated securitization and re-securitization 
positions as well as other treatments for unrated securitization and 
re-securitization positions. For rated positions, the revisions apply 
risk weights according to whether the positions' external rating 
represents a long-term credit rating or a short-term credit rating and 
generally apply higher risk weights to rated re-securitization 
positions than to other rated securitization positions. Tables 2 and 3 
below provide illustrative representations of the specific risk-
weighting factors applicable to rated securitization and re-
securitization position under the market risk framework. This treatment 
was designed to address regulatory arbitrage opportunities as well as 
deficiencies in the modeling of securitization positions that became 
more evident during the course of the financial market crisis that 
began in mid-2007. This revised treatment also assigns a more risk-
sensitive capital requirement to securitization positions than applied 
previously.

    Table 2--Long-Term Credit Rating Specific Risk-Weighting Factors for Securitization and Re-Securitization
                                                    Positions
----------------------------------------------------------------------------------------------------------------
                                                                            Securitization
                                                                           exposure (that is
                                                                                 not a         Resecuritization
      Illustrative external rating                   Example               resecuritization     exposure risk-
              description                                                   exposure) risk-    weighting factor
                                                                           weighting factor           (%)
                                                                                  (%)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating........  AAA............................                1.60                3.20
Second-highest investment grade rating.  AA.............................                1.60                3.20
Third-highest investment grade rating..  A..............................                4.00                8.00
Lowest investment grade rating.........  BBB............................                8.00               18.00
One category below investment grade....  BB.............................               28.00               52.00
Two categories below investment grade..  B..............................              100.00              100.00
Three categories or more below           CCC............................              100.00              100.00
 investment grade.
----------------------------------------------------------------------------------------------------------------


[[Page 1903]]


   Table 3--Short-Term Credit Rating Specific Risk-Weighting Factors for Securitization and Re-Securitization
                                                    Positions
----------------------------------------------------------------------------------------------------------------
                                                                            Securitization
                                                                           exposure (that is
                                                                                 not a         Resecuritization
  Illustrative external rating description              Example            resecuritization     exposure risk-
                                                                            exposure) risk-    weighting factor
                                                                           weighting factor           (%)
                                                                                  (%)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating.............  A-1/P-1...................                1.60                3.20
Second-highest investment grade rating......  A-2/P-2...................                4.00                8.00
Third-highest investment grade rating.......  A-3/P-3...................                8.00               18.00
All other ratings...........................  N/A.......................              100.00              100.00
----------------------------------------------------------------------------------------------------------------

    As a result of the recent enactment in the United States of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act \19\ (the 
Act), the agencies may not reference or require reliance on credit 
ratings in the assessment of the creditworthiness of a security or 
money market instrument. The Act provides that each Federal agency, 
after a required review of its regulations, must remove from each of 
its regulations any reference to or requirement of reliance on credit 
ratings and substitute a standard of creditworthiness the agency 
determines is appropriate for the regulation.\20\
---------------------------------------------------------------------------

    \19\ See Public Law 111-203 (July 21, 2010).
    \20\ See section 939A of the Act.
---------------------------------------------------------------------------

    The 2005 and 2009 BCBS revisions include provisions that rely on 
credit ratings for determining the specific risk-weighting factors for 
debt, securitization, and re-securitization positions. These provisions 
would need to be revised when implemented in the U.S. in order to 
conform to the Act. The agencies acknowledge that the specific risk 
treatment for debt, securitization and re-securitization positions 
outlined in Tables 1 through 3 would provide a more risk-sensitive 
treatment for these positions than exists under the current rule; 
however, pending the agencies' development of appropriate standards of 
creditworthiness to replace use of credit ratings as required by the 
Act, the proposed rule retains as a placeholder the current rule's 
method for determining specific risk add-ons applicable to debt and 
securitization positions. More specifically, the ``government,'' 
``qualifying,'' and ``other'' categories as described in the current 
market risk capital rule and associated risk-weighting factors would 
continue to apply to a bank's debt and securitization positions until 
the agencies develop a substitute standard of creditworthiness to 
replace reliance on credit ratings. For completeness and to ensure 
uniformity of regulatory text across the agencies' rules, the proposed 
rule includes in section 10(b) the current standardized measurement 
method for these positions. The agencies acknowledge the shortcomings 
of the current treatment and recognize that it will have to be amended 
in accordance with the requirements of the Act. To the extent possible, 
the amended treatment would seek to establish comparable capital 
requirements for the affected positions in order to ensure 
international consistency and competitive equity. At the same time, the 
agencies believe it is important to move forward with the revisions to 
the market risk rules contained in this proposal.\21\
---------------------------------------------------------------------------

    \21\ The agencies also note that certain other provisions of the 
Act may affect the market risk capital rules. For example, the 
credit risk retention requirements of the Act may affect whether a 
securitization position retained by a bank pursuant to the 
requirements meets the definition of a trading position or a covered 
position.
---------------------------------------------------------------------------

    When the agencies determine a substitute standard of 
creditworthiness for external ratings as required by the Act, they 
intend to incorporate the new standard into their capital rules, 
including the market risk rule. The agencies are currently reviewing 
alternative approaches to the use of credit ratings across all of the 
agencies' regulations and requirements with the goal of establishing a 
uniform alternative credit-worthiness standard. The agencies have asked 
for public input on this process through an advance notice of proposed 
rulemaking (ANPR).\22\ The agencies noted in the ANPR that in 
evaluating any standard of creditworthiness for purpose of determining 
risk-based capital requirements, the agencies will, to the extent 
practicable and consistent with the other objectives, consider whether 
the standard would:
---------------------------------------------------------------------------

    \22\ 75 FR 52283 (August 25, 2010).
---------------------------------------------------------------------------

     Appropriately distinguish the credit risk associated with 
a particular exposure within an asset class;
     Be sufficiently transparent, unbiased, replicable, and 
defined to allow banking organizations of varying size and complexity 
to arrive at the same assessment of creditworthiness for similar 
exposures and to allow for appropriate supervisory review;
     Provide for the timely and accurate measurement of 
negative and positive changes in creditworthiness;
     Minimize opportunities for regulatory capital arbitrage;
     Be reasonably simple to implement and not add undue burden 
on banking organizations; and
     Foster prudent risk management.
    Question 7: What specific standards of creditworthiness that meet 
the agencies' suggested criteria for a creditworthiness standard 
outlined above should the agencies consider for these positions?
    Under the proposed rule, the total specific risk add-on for a 
portfolio of nth-to-default credit derivatives is the sum of the 
specific risk add-ons for individual nth-to-default credit derivatives, 
as computed therein. A bank must calculate a specific risk add-on for 
each nth-to-default credit derivative position regardless of whether 
the bank is a net protection buyer or net protection seller.
    For first-to-default credit derivatives, the specific risk add-on 
is the lesser of (i) the sum of the specific risk add-ons for the 
individual reference credit exposures in the group of reference 
exposures, and (ii) the maximum possible credit event payment under the 
credit derivative contract. Where a bank has a risk position in one of 
the reference credit exposures underlying a first-to-default credit 
derivative and this credit derivative hedges the bank's risk position, 
the bank is allowed to reduce both the specific risk add-on for the 
reference credit exposure and that part of the specific risk add-on for 
the credit derivative that relates to this particular reference credit 
exposure such that its specific risk add-on for the pair reflects the 
bank's net position in the reference credit exposure. Where a bank has 
multiple risk positions in reference credit exposures underlying a 
first-to-default credit derivative, this offset is allowed only for the 
underlying

[[Page 1904]]

reference credit exposure having the lowest specific risk add-on.
    For second-or-subsequent-to-default credit derivatives, the 
specific risk add-on is the lesser of: (i) The sum of the specific risk 
add-ons for the individual reference credit exposures in the group of 
reference exposures, but disregarding the (n-1) obligations with the 
lowest specific risk add-ons; or (ii) the maximum possible credit event 
payment under the credit derivative contract. For second-or-subsequent-
to-default credit derivatives, no offset of the specific risk add-on 
with an underlying reference credit exposure is allowed under the 
proposed rule.
    Equity Positions. Under the proposed rule, the total specific risk 
add-on for a portfolio of equity positions is the sum of the specific 
risk add-ons of the individual equity positions, which are determined 
by multiplying the absolute value of the current market value of each 
net long or short equity position by an appropriate risk-weighting 
factor.
    The proposed rule retains the specific risk add-ons applicable to 
equity positions under the current market risk capital rule, with one 
exception. Consistent with the 2009 revisions, the proposed rule 
eliminates the provision that allows a bank to apply a specific risk-
weighting factor of 4.0 to an equity position held in a portfolio that 
is both liquid and well-diversified. Instead, a bank must multiply the 
absolute value of the current market value of each net long or short 
equity position by a risk-weighting factor of 8.0 percent. For equity 
positions that are index contracts comprising a well-diversified 
portfolio of equity instruments, the absolute value of the current 
market value of each net long or short position is multiplied by a 
risk-weighting factor of 2.0 percent. A portfolio is well-diversified 
if it contains a large number of individual equity positions, with no 
single position representing a substantial portion of the portfolio's 
total market value.
    The proposed rule retains the specific risk treatment in the 
current market risk capital rule for equity positions arising from 
futures-related arbitrage strategies where long and short positions are 
in exactly the same index at different dates or in different market 
centers, or where long and short positions are in index contracts at 
the same date in different but similar indices. The proposed rule also 
retains the current treatment for futures contracts on main indices 
that are matched by offsetting positions in a basket of stocks 
comprising the index.
    Due Diligence Requirements for Securitization Positions. The 
proposed rule incorporates requirements from the 2009 revisions that 
banks perform due diligence on securitization positions. The due 
diligence requirements apply to all securitization positions and 
emphasize the need for banks to conduct their own due diligence of 
borrower creditworthiness, in addition to any use of third-party 
assessments, and not place undue reliance on external credit ratings.
    In order to meet the proposed due diligence requirements, a bank 
must be able to demonstrate, to the satisfaction of its primary Federal 
supervisor, a comprehensive understanding of the features of a 
securitization position that would materially affect the performance of 
the bank's securitization position. The bank's analysis must be 
commensurate with the complexity of the securitization position and the 
materiality of the position in relation to capital.
    To support the demonstration of its comprehensive understanding, 
for each securitization position, the bank must conduct and document an 
analysis of the risk characteristics of a securitization position prior 
to acquiring the position, considering: (i) Structural features of the 
securitization that would materially impact the performance of the 
position, for example, the contractual cash flow waterfall, waterfall-
related triggers, credit enhancements, liquidity enhancements, market 
value triggers, the performance of organizations that service the 
position, and deal-specific definitions of default; (ii) relevant 
information regarding the performance of the underlying credit 
exposure(s), for example, the percentage of loans 30, 60, and 90 days 
past due; default rates; prepayment rates; loans in foreclosure; 
property types; occupancy; average credit score or other measures of 
creditworthiness; average LTV ratio; and industry and geographic 
diversification data on the underlying exposure(s); (iii) relevant 
market data of the securitization, for example, bid-ask spreads, most 
recent sales price and historical price volatility, trading volume, 
implied market rating, and size, depth and concentration level of the 
market for the securitization; and (iii) for resecuritization 
positions, performance information on the underlying securitization 
exposures, for example, the issuer name and credit quality, and the 
characteristics and performance of the exposures underlying the 
securitization exposures. On an on-going basis, but no less frequently 
than quarterly, the bank must also evaluate, review, and update as 
appropriate the analysis required above for each securitization 
position.
    Question 8: What, if any, specific challenges are involved with 
meeting the proposed due diligence requirements and for what types of 
securitization positions? How might the agencies address these 
challenges while still ensuring that a bank conducts an appropriate 
level of due diligence commensurate with the risks of its covered 
positions? For example, would it be appropriate to scale the 
requirements according to a position's expected holding period? How 
would such scaling affect a bank's ability to demonstrate a 
comprehensive understanding of the risk characteristics of a 
securitization position? What are the benefits and drawbacks of 
requiring public disclosures regarding a bank's processes for 
performing due diligence on its securitization positions?
    The agencies are considering alternative methodologies to the 
standardized measurement method for determining the specific risk 
capital requirement for securitization positions to better recognize 
the risk reduction benefits of hedging. Conceptually, such a 
methodology could recognize some degree of offsetting between positions 
that reference the same pool of assets but have different levels of 
seniority, or between positions that reference similar but not 
identical assets. For example, it could use a formulaic approach to 
determine a degree of offset between securitization positions that are 
similar to an index. Inputs to the formula could include factors such 
as the attachment and detachment points of an individual securitization 
position, the aggregate capital requirement of its underlying 
exposures, and the percentage of underlying obligors common to the 
securitization exposure and the index.
    Question 9: What alternative non-models-based methodologies could 
the agencies use to determine the specific risk add-ons for 
securitization positions? Please provide specific details on the 
mechanics of and rationale for any suggested methodology. Please also 
describe how the methodology conservatively recognizes some degree of 
hedging benefits, yet captures the basis risk between non-identical 
positions. To what types of securitization positions would such a 
methodology apply and why?
11. Incremental Risk Capital Requirement
    Under section 8 of the proposed rule, a bank that measures the 
specific risk of a portfolio of debt positions using internal models 
must calculate an incremental risk measure for that portfolio using an 
internal model

[[Page 1905]]

(incremental risk model). Incremental risk consists of the default risk 
of a position (that is, the risk of loss on the position upon an event 
of default (for example, the failure of the obligor to make timely 
payments of principal or interest), including bankruptcy, insolvency, 
or similar proceeding) and the credit migration risk of a position 
(that is, price risk that arises from significant changes in the 
underlying credit quality of the position).
    With the prior approval of its primary Federal supervisor, a bank 
may also include portfolios of equity positions in its incremental risk 
model, provided that it consistently includes such equity positions in 
a manner that is consistent with how the bank internally measures and 
manages the incremental risk for such positions at the portfolio level. 
Default is deemed to occur with respect to any equity position that is 
included in the bank's incremental risk model upon the default of any 
debt of the issuer of the equity position. A bank may not include 
correlation trading positions or securitization positions in its 
incremental risk model.
    Under the proposed rule, a bank's model to measure the incremental 
risk of a portfolio of debt positions (and equity positions, if 
applicable) must meet certain requirements and be approved by the 
bank's primary Federal supervisor before the bank may use it to 
calculate its risk-based capital requirement. The model must measure 
incremental risk over a one-year time horizon and at a one-tail, 99.9 
percent confidence level, either under the assumption of a constant 
level of risk, or under the assumption of constant positions.
    The liquidity horizon of a position is the time that would be 
required for a bank to reduce its exposure to, or hedge all of the 
material risks of, the position(s) in a stressed market. The liquidity 
horizon for a position may not be less than the lower of three months 
or the contractual maturity of the position.
    A position's liquidity horizon is a key risk attribute for purposes 
of calculating the incremental risk measure because it puts a bank's 
overall risk exposure to an actively managed portfolio into context. 
Positions with longer (that is, less liquid) liquidity horizons are 
more difficult to hedge and result in more exposure to both default and 
credit migration risk over any fixed time horizon. In particular, two 
positions with differing liquidity horizons but exactly the same amount 
of default risk if held in a static portfolio over a one-year horizon 
may exhibit significantly different amounts of default risk if held in 
a dynamic portfolio in which hedging can occur in response to 
observable changes in credit quality. The position with the shorter 
liquidity horizon can be hedged more rapidly and with less cost in the 
event of a change in credit quality, which leads to a different 
exposure to default risk over a one-year horizon than the position with 
the longer liquidity horizon.
    A constant level of risk assumption assumes that the bank 
rebalances, or rolls over, its trading positions at the beginning of 
each liquidity horizon over a one-year horizon in a manner that 
maintains the bank's initial risk level. The bank must determine the 
frequency of rebalancing in a manner consistent with the liquidity 
horizons of the positions in the portfolio. A constant position 
assumption assumes that a bank maintains the same set of positions 
throughout the one-year horizon. If a bank uses this assumption, it 
must do so consistently across all portfolios for which it models 
incremental risk. A bank has flexibility in whether it chooses to use a 
constant risk or constant position assumption in its incremental risk 
model; however, the agencies expect that the assumption will remain 
fairly constant once selected. As with any material change to modeling 
assumptions, the proposed rule requires a bank must promptly notify its 
primary Federal supervisor if the bank changes from a constant risk to 
a constant position assumption or vice versa. Further, to the extent a 
bank estimates a comprehensive risk measure under section 9 of the 
proposed rule, the bank's selection of a constant position or a 
constant risk assumption must be consistent between the bank's 
incremental risk model and comprehensive risk model. Similarly, the 
bank's treatment of liquidity horizons must be consistent between a 
bank's incremental risk model and comprehensive risk model.
    The proposed rule requires a bank's incremental risk model to meet 
the conditions described below. The model must recognize the impact of 
correlations between default and credit migration events among 
obligors. In particular, the existence of an aggregate, economy-wide 
credit cycle implies some degree of correlation between the default and 
credit migration events across different issuers. The degree of 
correlation between default and credit migration events of different 
issuers may also depend on other issuer attributes such as industry 
sector or region of domicile. The model must also reflect the effect of 
issuer and market concentrations, as well as concentrations that can 
arise within and across product classes during stressed conditions.
    The bank's incremental risk model must reflect netting only of long 
and short positions that reference the same financial instrument and 
must also reflect any material mismatch between a position and its 
hedge. Examples of such mismatches include maturity mismatches as well 
as mismatches between an underlying position and its hedge, (for 
example, the use of an index position to hedge a single name security).
    The bank's incremental risk model must also recognize the effect 
that liquidity horizons have on hedging strategies. When a bank's 
hedging strategy requires continual rebalancing of the hedge position, 
the constraints on rebalancing imposed by the liquidity horizon of the 
hedge must be recognized. As an example, if a position is being hedged 
with an instrument with a liquidity horizon of three months, no 
rebalancing of the hedge can occur within a three month period. 
Accordingly, any divergence in the value of the position and its hedge 
that occurs because the hedge cannot be rebalanced within the three 
month liquidity horizon must be recognized. Moreover, in order to 
reflect the effect of hedging in the incremental risk measure, the bank 
must (i) Choose to model the rebalancing of the hedge consistently over 
the relevant set of trading positions; (ii) demonstrate that the 
inclusion of rebalancing results in a more appropriate risk 
measurement; (iii) demonstrate that the market for the hedge is 
sufficiently liquid to permit rebalancing during periods of stress; and 
(iv) capture in the incremental risk model any residual risks arising 
from such hedging strategies.
    The incremental risk model must reflect the nonlinear impact of 
options and other positions with material nonlinear behavior with 
respect to default and credit migration changes. In light of the one-
year horizon of the incremental risk measure and the extremely high 
confidence level required, it is important that nonlinearities be 
explicitly recognized. Price changes resulting from defaults or credit 
migrations can be large and the resulting nonlinear behavior of the 
position can be material. The bank's incremental risk model must also 
maintain consistency with the bank's internal risk management 
methodologies for identifying, measuring, and managing risk.
    A bank that calculates an incremental risk measure under section 8 
of the proposed rule must calculate its incremental risk capital 
requirement at

[[Page 1906]]

least weekly. This capital requirement is the greater of: (i) The 
average of the incremental risk measures over the previous 12 weeks; or 
(ii) the most recent incremental risk measure.
12. Comprehensive Risk Capital Requirement
    Under section 9 of the proposed rule, with its primary Federal 
supervisor's prior approval, a bank may measure all material price 
risks of one or more portfolios of correlation trading positions 
(comprehensive risk measure) using a model (comprehensive risk model). 
If the bank uses a comprehensive risk model for a portfolio of 
correlation trading positions, the bank must also measure the specific 
risk of that portfolio using internal models that meet the requirements 
in section 7(b) of the proposed rule. If the bank does not use a 
comprehensive risk model to calculate the price risk of a portfolio of 
correlation trading positions, it must calculate a specific risk add-on 
for the portfolio under section 7(c) of the proposed rule, determined 
using the standardized measurement method for specific risk described 
in section 10 of the proposed rule.
    A bank's comprehensive risk model must meet several requirements 
under the proposed rule. The model must measure comprehensive risk 
(that is, all price risk) consistent with a one-year time horizon and 
at a one-tail, 99.9 percent confidence level, under the assumption of 
either a constant level of risk or constant positions. As mentioned 
under the incremental risk measure discussion, while a bank has 
flexibility in whether it chooses to use a constant risk or constant 
position assumption, the agencies expect that the assumption will 
remain fairly constant once selected. The bank's selection of a 
constant position assumption or a constant risk assumption must be 
consistent between the bank's comprehensive risk model and its 
incremental risk model. Similarly, the bank's treatment of liquidity 
horizons must be consistent between the bank's comprehensive risk model 
and its incremental risk model.
    The proposed rule requires that a bank's comprehensive risk model 
capture all material price risk of included positions, including, but 
not limited to: (i) The risk associated with the contractual structure 
of cash flows of the position, its issuer, and its underlying exposures 
(for example, the risk arising from multiple defaults, including the 
ordering of defaults, in tranched products); (ii) credit spread risk, 
including nonlinear price risks; (iii) volatility of implied 
correlations, including nonlinear price risks such as the cross-effect 
between spreads and correlations; (iv) basis risks (for example, the 
basis between the spread of an index and the spread on its constituents 
and the basis between implied correlation of an index tranche and that 
of a bespoke tranche); (v) recovery rate volatility as it relates to 
the propensity for recovery rates to affect tranche prices; and (vi) to 
the extent the comprehensive risk measure incorporates benefits from 
dynamic hedging, the static nature of the hedge over the liquidity 
horizon.
    The risks above have been identified as risks that are particularly 
important for correlation trading positions; however, the comprehensive 
risk model is intended to capture all material price risks related to 
those correlation trading positions that are included in the 
comprehensive risk model. Accordingly, additional risks that are not 
explicitly discussed above but are a material source of price risk must 
be included in the comprehensive risk model.
    The proposed rule also requires that a bank have sufficient market 
data to ensure that it fully captures the material price risks of the 
correlation trading positions in its comprehensive risk measure. 
Moreover, the bank must be able to demonstrate that its model is an 
appropriate representation of comprehensive risk in light of the 
historical price variation of its correlation trading positions. The 
agencies will scrutinize the positions a bank identifies as correlation 
trading positions and will also review whether the correlation trading 
positions have sufficient market data available to support reliable 
modeling of material risks. If there is insufficient market data to 
support reliable modeling for certain positions (such as new products), 
the agencies may require the bank to exclude these positions from the 
comprehensive risk model and, instead, require the bank to calculate 
specific risk add-ons for these positions under the standardized 
measurement method for specific risk. Again, the proposed rule requires 
a bank to promptly notify its primary Federal supervisor if the bank 
plans to extend the use of a model that has been approved by the 
supervisor to an additional business line or product type.
    In addition to these requirements, a bank must at least weekly 
apply to its portfolio of correlation trading positions a set of 
specific, supervisory stress scenarios that capture changes in default 
rates, recovery rates, and credit spreads; correlations of underlying 
exposures; and correlations of a correlation trading position and its 
hedge. A bank must retain and make available to its primary supervisor 
the results of the supervisory stress testing, including comparisons 
with the capital requirements generated by the bank's comprehensive 
risk model. A bank also must promptly report to its primary Federal 
supervisor any instances where the stress tests indicate any material 
deficiencies in the comprehensive risk model.
    The agencies are evaluating the appropriate bases for supervisory 
stress scenarios to be applied to a bank's portfolio of correlation 
trading positions. There are inherent difficulties in prescribing 
stress scenarios that would be universally applicable and relevant 
across all banks and across all products contained in banks' 
correlation trading portfolios. The agencies believe a level of 
comparability is important for assessing the sufficiency and 
appropriateness of banks' comprehensive risk models, but also recognize 
that specific scenarios may not be relevant for certain products or for 
certain modeling approaches. The agencies are considering various 
options for stress scenarios, including an approach that would involve 
specifying stress scenarios based on credit spread shocks to certain 
correlation trading positions (for example, single-name CDSs, CDS 
indexes, index tranches), which may replicate historically observed 
spreads. Another approach would require a bank to calibrate its 
existing valuation model to certain specified stress periods by 
adjusting credit-related risk factors to reflect a given stress period. 
The credit-related risk factors, as adjusted, would then be used to 
revalue the bank's correlation trading portfolio under one or more 
stress scenarios.
    Question 10: What are the benefits and drawbacks of the supervisory 
stress scenario requirements described above and what other specific 
stress scenario approaches for the correlation trading portfolio should 
the agencies consider? For which products and model types are widely 
applicable stress scenarios most appropriate, and for which product and 
model types is a more tailored stress scenario most appropriate? What 
other stress scenario approaches could consistently reflect the risks 
of the entire portfolio of correlation trading positions?
    The agencies have identified prudential challenges associated with 
relying solely on banks' comprehensive risk models for determining 
risk-based capital requirements for correlation trading positions. For 
example, a bank's ability to perform robust validation of

[[Page 1907]]

its comprehensive risk model using standard backtesting methods is 
limited in light of the proposed requirements for the model to measure 
potential losses on correlation trading positions due to all price risk 
at a one-year time horizon and high-percentile confidence level. As a 
result, banks will need to use indirect model validation methods, such 
as stress tests, scenario analysis or other methods to assess their 
models. The agencies anticipate that banks' comprehensive risk model 
validation approaches will evolve over time; however, to address near-
term modeling challenges while still giving consideration to sound risk 
management practices, the agencies are proposing a floor on the modeled 
correlation trading position capital requirements in the form of a 
capital surcharge as described below.
    A bank approved to measure comprehensive risk for one or more 
portfolios of correlation trading positions must calculate at least 
weekly a comprehensive risk measure. The comprehensive risk measure 
equals the sum of the output from the bank's approved comprehensive 
risk model plus a surcharge on the bank's modeled correlation trading 
positions. The agencies propose setting the surcharge equal to 15.0 
percent of the total specific risk add-on that would apply to the 
bank's modeled correlation trading positions under the standardized 
measurement method for specific risk in section 10 of the proposed 
rule.
    The agencies propose that banks initially be required to calculate 
the comprehensive risk measure under the surcharge approach while banks 
and supervisors gain experience with the banks' comprehensive risk 
models. Over time, with approval from its primary Federal supervisor, a 
bank may be permitted to use a floor approach to calculate its 
comprehensive risk measure as the greater of: (1) The output from the 
bank's approved comprehensive risk model; or (2) 8.0 percent of the 
total specific risk add-on that would apply to the bank's modeled 
correlation trading positions under the standardized measurement method 
for specific risk, provided the bank has met the comprehensive risk 
modeling requirements in the proposed rule for a period of at least one 
year and can demonstrate the effectiveness of its comprehensive risk 
model through the results of ongoing validation efforts, including 
robust benchmarking. Such results may incorporate a comparison of the 
banks' internal model results to those from an alternative model for 
certain portfolios and other relevant data. The agencies may also 
consider a benchmarking approach that uses banks' internal models to 
determine capital requirements for a portfolio specified by the 
supervisors to allow for a relative assessment of models across banks. 
A bank's primary Federal supervisor will monitor the appropriateness of 
the floor approach on an ongoing basis and may rescind its approval of 
this approach if it determines that the bank's comprehensive risk model 
may not sufficiently reflect the risks of the bank's modeled 
correlation trading positions.
    The agencies believe the proposed approach provides a prudential 
backstop on modeled capital requirements as well as appropriate 
incentives for ongoing model improvement. Another potential approach 
would be a stress-test based floor that would, for instance, require a 
bank to value its correlation trading positions using prescribed 
instantaneous price and correlation shocks in the models it uses to 
price its correlation trading positions. For example, such a floor 
could require a bank's comprehensive risk capital requirement to be at 
least as great as the largest loss the bank would experience for its 
correlation trading positions under a scenario of instantaneous price 
changes for the underlying positions within a range of plus and minus 
15.0 percent combined with instantaneous correlation changes within a 
range of plus or minus 5.0 percent.
    Question 11: What, if any, specific challenges exist with respect 
to the proposed modeling requirements for correlation trading 
positions? What additional criteria and benchmarking methods should the 
agencies consider that would provide an objective basis for evaluating 
whether to allow a bank to apply a lower surcharge percentage in 
calculating its comprehensive risk measure? What are the advantages and 
disadvantages of the proposed floor approach and the other potential 
floor approaches described above? What other alternatives should the 
agencies consider to address the uncertainties identified above while 
ensuring safe and sound risk-based capital requirements for correlation 
trading positions?
    A bank that calculates a comprehensive risk measure under section 9 
of the proposed rule must calculate its comprehensive risk capital 
requirement at least weekly. This capital requirement is the greater of 
(i) the average of the comprehensive risk measures over the previous 12 
weeks; or (ii) the most recent comprehensive risk measure. Separate 
from the proposed requirements for calculating a comprehensive risk 
measure, as discussed previously, the proposed rule contains an 
explicit reservation of authority providing that a bank's primary 
Federal supervisor may require a bank to assign a different risk-based 
capital requirement than would otherwise apply to a covered position or 
portfolio of covered positions that better reflects the risk of the 
position or portfolio. For example, regardless of a modeled capital 
requirement, a primary Federal supervisor may require a bank to 
increase its risk-weighted asset amount for correlation trading 
positions to ensure that it reflects the risk to which the bank is 
exposed. Because banks' comprehensive risk models use many different 
methodologies, there is no uniform appropriate supervisory adjustment 
to risk-weighted assets. An adjustment may take the form of a 
multiplier, a floor, a fixed add-on, or another adjustment consistent 
with the risk of the portfolio and the bank's modeling practices.
13. Disclosure Requirements
    The proposed rule imposes disclosure requirements designed to 
increase transparency and improve market discipline on the top-tier 
consolidated legal entity that is subject to the market risk capital 
rule. The disclosure requirements, discussed further below, include a 
breakdown of certain components of a bank's market risk capital 
requirement, information on a bank's modeling approaches, and 
qualitative and quantitative disclosures relating to a bank's 
securitization activities.
    The agencies recognize the importance of market discipline in 
encouraging sound risk management practices and fostering financial 
stability. With enhanced information, market participants can better 
evaluate a bank's risk management performance, earnings potential, and 
financial strength. Many of the proposed disclosure requirements 
reflect information already disclosed publicly by the banking industry. 
A bank is encouraged, but not required, to make these disclosures in a 
central location on its web site.
    Consistent with the advanced approaches rules, the proposed rule 
requires a bank to comply with the disclosure requirements of section 
11 of the proposed rule unless it is a consolidated subsidiary of 
another depository institution or bank holding company that is subject 
to the disclosure requirements. A bank subject to section 11 is 
required to adopt a formal disclosure policy approved by its board of 
directors that addresses the bank's approach for determining the 
disclosures it makes. The policy must

[[Page 1908]]

address the associated internal controls and disclosure controls and 
procedures. The board of directors and senior management must ensure 
that appropriate verification of the bank's disclosures takes place and 
that effective internal controls and disclosure controls and procedures 
are maintained. One or more senior officers is required to attest that 
the disclosures meet the requirements of the proposed rule, and the 
board of directors and senior management are responsible for 
establishing and maintaining an effective internal control structure 
over financial reporting, including the information required under 
section 11 of the proposed rule.
    The proposed rule requires a bank, at least quarterly, to disclose 
publicly for each portfolio of covered positions (i) The high, low, 
median, and mean VaR-based measures over the reporting period and the 
VaR-based measure at period-end; (ii) the high, low, median, and mean 
stressed VaR-based measures over the reporting period and the stressed 
VaR-based measure at period-end; (iii) the high, low, median, and mean 
incremental risk capital requirements over the reporting period and the 
incremental risk capital requirement at period-end; (iv) the high, low, 
median, and mean comprehensive risk capital requirements over the 
reporting period and the comprehensive risk capital requirement at 
period-end; (v) separate measures for interest rate risk, credit spread 
risk, equity price risk, foreign exchange rate risk, and commodity 
price risk used to calculate the VaR-based measure; and (vi) a 
comparison of VaR-based measures with actual results and an analysis of 
important outliers. In addition, the bank must publicly disclose the 
following information at least quarterly: (i) The aggregate amount of 
on-balance sheet and off-balance sheet securitization positions by 
exposure type; and (ii) the aggregate amount of correlation trading 
positions.
    A bank is required to make qualitative disclosures at least 
annually, or more frequently in the event of material changes, of the 
following information for each portfolio of covered positions: (i) The 
composition of material portfolios of covered positions; (ii) the 
bank's valuation policies, procedures, and methodologies for covered 
positions including, for securitization positions, the methods and key 
assumptions used for valuing such positions, any significant changes 
since the last reporting period, and the impact of such change; (iii) 
the characteristics of its internal models, including, for the bank's 
incremental risk capital requirement and the comprehensive risk capital 
requirement, the approach used by the bank to determine liquidity 
horizons; the methodologies used to achieve a capital assessment that 
is consistent with the required soundness standard; and the specific 
approaches used in the validation of these models; (iv) a description 
of its approaches for validating the accuracy of its internal models 
and modeling processes; (v) a description of the stress tests applied 
to each market risk category; (vi) the results of a comparison of the 
bank's internal estimates with actual outcomes during a sample period 
not used in model development; (vii) the soundness standard on which 
its internal capital adequacy assessment is based, including a 
description of the methodologies used to achieve a capital adequacy 
assessment that is consistent with the soundness standard and the 
requirements of the market risk capital rule; and (viii) a description 
of the bank's processes for monitoring changes in the credit and market 
risk of securitization positions, including how those processes differ 
for resecuritization positions; and (ix) a description of the bank's 
policy governing the use of credit risk mitigation to mitigate the 
risks of securitization and resecuritization positions.
    Question 12: The agencies seek comment on the effectiveness of the 
proposed disclosure requirements. What, if any, changes to these 
requirements would make the proposed disclosures more effective in 
promoting market discipline?

III. Regulatory Flexibility Act Analysis

    The Regulatory Flexibility Act, 5 U.S.C. 601 et seq. (RFA), 
generally requires that, in connection with a notice of proposed 
rulemaking, an agency prepare and make available for public comment an 
initial regulatory flexibility analysis that describes the impact of a 
proposed rule on small entities.\23\ Under regulations issued by the 
Small Business Administration,\24\ a small entity includes a commercial 
bank or bank holding company with assets of $175 million or less (a 
small banking organization). As of June 30, 2010, there were 
approximately 2,561 small bank holding companies, 690 small national 
banks, 400 small state member banks, and 2,706 small state nonmember 
banks.
---------------------------------------------------------------------------

    \23\ See 5 U.S.C. 603(a).
    \24\ See 13 CFR 121.201.
---------------------------------------------------------------------------

    The proposed rule would apply only if the bank holding company or 
bank has aggregated trading assets and trading liabilities equal to 10 
percent or more of quarter-end total assets, or $1 billion or more. No 
small banking organizations satisfy these criteria. Therefore, no small 
entities would be subject to this rule.

IV. OCC Unfunded Mandates Reform Act of 1995 Determination

    The Unfunded Mandates Reform Act of 1995 (UMRA) requires Federal 
agencies to prepare a budgetary impact statement before promulgating a 
rule that 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 (adjusted annually for 
inflation) in any one year. The current inflation-adjusted expenditure 
threshold is $126.4 million. If a budgetary impact statement is 
required, section 205 of the UMRA also requires an agency to identify 
and consider a reasonable number of regulatory alternatives before 
promulgating a rule.
    In conducting the regulatory analysis, UMRA requires each Federal 
agency to provide:
     The text of the draft regulatory action, together with a 
reasonably detailed description of the need for the regulatory action 
and an explanation of how the regulatory action will meet that need;
     An assessment of the potential costs and benefits of the 
regulatory action, including an explanation of the manner in which the 
regulatory action is consistent with a statutory mandate and, to the 
extent permitted by law, promotes the President's priorities and avoids 
undue interference with State, local, and tribal governments in the 
exercise of their governmental functions;
     An assessment, including the underlying analysis, of 
benefits anticipated from the regulatory action (such as, but not 
limited to, the promotion of the efficient functioning of the economy 
and private markets, the enhancement of health and safety, the 
protection of the natural environment, and the elimination or reduction 
of discrimination or bias) together with, to the extent feasible, a 
quantification of those benefits;
     An assessment, including the underlying analysis, of costs 
anticipated from the regulatory action (such as, but not limited to, 
the direct cost both to the government in administering the regulation 
and to businesses and others in complying with the regulation, and any 
adverse effects on the efficient functioning of the economy, private 
markets (including productivity, employment, and competitiveness), 
health, safety, and the natural environment), together with, to the

[[Page 1909]]

extent feasible, a quantification of those costs; and
     An assessment, including the underlying analysis, of costs 
and benefits of potentially effective and reasonably feasible 
alternatives to the planned regulation, identified by the agencies or 
the public (including improving the current regulation and reasonably 
viable nonregulatory actions), and an explanation why the planned 
regulatory action is preferable to the identified potential 
alternatives.
     An estimate of any disproportionate budgetary effects of 
the Federal mandate upon any particular regions of the nation or 
particular State, local, or tribal governments, urban or rural or other 
types of communities, or particular segments of the private sector.
     An estimate of the effect the rulemaking action may have 
on the national economy, if the OCC determines that such estimates are 
reasonably feasible and that such effect is relevant and material.

A. The Need for the Regulatory Action

    The proposed rule would modify the current market risk capital rule 
by adjusting the minimum risk-based capital calculation and adding 
public disclosure requirements. The proposed rule would also (1) modify 
the definition of covered positions to include assets that are in the 
trading book and held with the intent to trade; (2) introduce new 
requirements for the identification of trading positions and the 
management of covered positions; and (3) require banks to have clearly 
defined policies and procedures for actively managing all covered 
positions, for the prudent valuation of covered positions and for 
specific internal model validation standards. The proposed rule will 
generally apply to any bank with aggregate trading assets and 
liabilities that are at least 10 percent of total assets or at least $1 
billion. These thresholds are the same as those currently used to 
determine applicability of the market risk rule.
    Under current rules, the measure for market risk is as follows: 
\25\
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    \25\ The following are the components of the current Market Risk 
Measure. Value-at-Risk (VaR) is an estimate of the maximum amount 
that the value of one or more positions could decline due to market 
price or rate movements during a fixed holding period within a 
stated confidence interval. Specific risk is the risk of loss on a 
position that could result from factors other than broad market 
movements and includes event risk, default risk, and idiosyncratic 
risk. There may also be a capital requirement for de minimis 
exposures, if any, that are not included in the bank's VaR models.

Market Risk Measure = (Value-at-Risk based capital requirement) + 
(Specific risk capital requirement) + (Capital requirement for de 
---------------------------------------------------------------------------
minimis exposures)

    Under the proposed rule, the new market risk measure would be as 
follows (new risk measure components are underlined):

New Market Risk Measure = (Value-at-Risk based capital requirement) + 
(Stressed Value-at-Risk based capital requirement) + (Specific risk 
capital charge) + (Incremental risk capital requirement) + 
(Comprehensive risk capital requirement) + (Capital charge for de 
minimis exposures)

    The Basel Committee and the Federal banking agencies designed the 
new components of the market risk measure to capture key risks 
overlooked by the current market risk measure.

B. Cost-Benefit Analysis of the Proposed Rule

1. Organizations Affected by the Proposed Rule \26\
---------------------------------------------------------------------------

    \26\ Unless otherwise noted, the population of banks used in 
this analysis consists of all FDIC-insured national banks and 
uninsured national bank and trust companies. Banking organizations 
are aggregated to the top holding company level.
---------------------------------------------------------------------------

    According to September 30, 2010, Call Report data, 16 national 
banking organizations \27\ had trading assets and liabilities that are 
at least 10 percent of total assets or at least $1 billion.
---------------------------------------------------------------------------

    \27\ A national banking organization is any bank holding company 
with a subsidiary national bank.
---------------------------------------------------------------------------

2. Impact of the Proposed Rule
    The key benefits of the proposed rule are the following qualitative 
benefits:
     Enhances sensitivity to market risk,
     Enhances modeling requirements consistent with advances in 
risk management,
     Better captures trading positions for which market risk 
capital treatment is appropriate,
     Increases transparency through enhanced market 
disclosures.
     Increased market risk capital should lower the probability 
of catastrophic losses to the bank occurring because of market risk.
     Modified requirements should reduce the procyclicality of 
market risk capital.
    We derive our estimates of the proposed rule's effect on the market 
risk measure from the third trading book impact study conducted by the 
Basel Committee on Banking Supervision in 2009 and additional estimates 
of the capital requirement for standardized securitization exposures 
and correlation trading positions.\28\ Based on these two assessments, 
we estimate that the market risk measure will increase 300 percent on 
average. The market risk measure itself acts as an estimate of the 
minimum regulatory capital requirement for an adequately capitalized 
bank. Thus, quadrupling the market risk measure suggests that minimum 
required capital will increase by approximately $50.7 billion under the 
proposed rule. These new capital requirements would lead banks to 
deleverage and lose the tax advantage of debt. We estimate that the 
loss of these tax benefits would be approximately $334 million per 
year.
---------------------------------------------------------------------------

    \28\ The report, ``Analysis of the third trading book impact 
study'', is available at http://www.bis.org/publ/bcbs163.htm. The 
study gathered data from 43 banks in 10 countries, including six 
banks from the United States.
---------------------------------------------------------------------------

    We estimate that new disclosure requirements and the implementation 
of calculations for the new market risk measures may involve some 
additional system costs, but because the proposed rule will only affect 
institutions already subject to the current market risk rule we expect 
these additional system costs to be de minimis. We do not anticipate 
that the proposed rule will create significant additional 
administrative costs for the OCC. Based on our assessment of the 
capital costs of the proposed rule; we estimate that the total cost of 
the proposed rule will be approximately $334 million in 2010 dollars 
over one year.

C. Comparison Between Proposed Rule and Baseline

    Under the baseline scenario, the current market risk rule would 
continue to apply. Thus, in the baseline scenario, required market risk 
capital would remain at current levels and there would be no additional 
cost associated with adding capital. However, the benefits of increased 
sensitivity to market risk, increased transparency, the improved 
targeting of trading positions, reduced procyclicality of market risk 
capital, and the protective advantages of additional capital would be 
lost under the baseline scenario.

D. Comparison Between Proposed Rule and Alternatives

    The Unfunded Mandates Reform Act of 1995 (UMRA) requires a 
comparison between the proposed rule and reasonable alternatives. In 
this regulatory impact analysis, we compare the proposed rule with two 
alternatives that modify the size thresholds for the rule.
Assessment of Alternative A
    Under Alternative A, we consider a rule that has the same 
provisions as the

[[Page 1910]]

proposed rule, but we alter the rule's trading book size threshold. 
Because trading assets and liabilities are concentrated in six or seven 
institutions, modest changes in the size thresholds have little impact 
on the dollar volume of trading assets affected by the market risk rule 
and thus little impact on the estimated cost of the rule. Changing the 
size threshold does affect the number of institutions affected by the 
rule, which suggests that the banking agencies' systemic concerns could 
play a role in determining the appropriate size threshold for 
applicability of the market risk rule.
Assessment of Alternative B
    Under Alternative B, we consider a rule that has the same 
provisions as the proposed rule, but we change the condition of the 
size thresholds from ``or'' to ``and''. With this change, the proposed 
rule would apply to institutions that have $1 billion or more in 
trading assets and liabilities and a trading book to asset ratio of at 
least 10 percent. Making the applicability of the market risk rule 
contingent on meeting both size thresholds would reduce the number of 
banks affected by the rule to four using the current thresholds of $1 
billion and 10 percent. In order for the alternative B rule to apply to 
the same number of institutions as the current rule, the alternative's 
joint condition would have to be comparable to thresholds of between 
$500 million and $1 billion in the trading book and a 1 percent 
trading-book-to-assets ratio. However, under this alternative the list 
of the 16 institutions subject to the rule would change slightly. Not 
surprisingly, as this joint threshold alternative could excuse some 
institutions with larger trading books, the estimated cost of the 
alternative rule does decrease with the number of institutions affected 
by the rule.

E. Overall Impact of Proposed Rule, Baseline and Alternatives

    Under our baseline scenario, which reflects the current application 
of the market risk rule, a market risk capital charge of approximately 
$16.9 billion applies to 16 national banks. Under the proposed rule, 
this capital charge would continue to apply to the same 16 banks but 
the capital charge would likely quadruple. We estimate that the cost of 
this additional capital would be approximately $334 million per year in 
2010 dollars.
    Our alternatives examine the impact of a market risk rule that uses 
different size thresholds in order to determine which institutions are 
subject to the rule. With alternative A we consider altering the $1 
billion trading book threshold used currently and maintained under the 
proposed rule. Although varying the size threshold changed the number 
of institutions affected by the rule, the overall capital cost of the 
rule did not significantly change. This reflects the high concentration 
of trading assets and liabilities in seven banks with over $15 billion 
in their trading books as of September 30, 2010. As long as the 
proposed rule applies to these seven institutions, the additional 
required capital and its corresponding cost will not change 
considerably.
    Alternative B did affect both the number of institutions subject to 
the proposed rule and the cost of the proposed rule by limiting the 
market risk rule to institutions that meet both size criteria, i.e., a 
$1 billion trading book and a trading-book-to-assets ratio of at least 
10 percent. Only four national banks currently meet both of these 
criteria, and applying the proposed rule to these institutions would 
require an additional $36.0 billion in market risk capital at a cost of 
approximately $237 million. Clearly, the estimated cost of the proposed 
rule would fall if the size thresholds determining applicability of the 
market risk rule were to increase. However, the current size 
thresholds, which continue to apply under the proposed rule, capture 
those institutions that the regulatory agencies believe should be 
subject to market risk capital rules. The proposed rule changes covered 
positions, disclosure requirements, and methods relating to calculating 
the market risk measure. These changes achieve the important objectives 
of enhancing the banking system's sensitivity to market risk, increases 
transparency of the trading book and market risk, and better captures 
trading positions for which market risk capital treatment is 
appropriate. The proposed rule carries over the current thresholds used 
to determine the applicability of the market risk rule. The banking 
agencies have determined that these size thresholds capture the 
appropriate institutions; those most exposed to market risk.
    The large increase in required market risk capital, which we 
estimate to be approximately $51 billion under the proposed rule, will 
provide a considerable buttress to the capital position of institutions 
subject to the market risk rule. This additional capital should 
dramatically lower the likelihood of catastrophic losses from market 
risk occurring at these institutions, which will enhance the safety and 
soundness of these institutions, the banking system, and world 
financial markets. Although there is some concern regarding the burden 
of the proposed increase in market risk capital and the effect this 
could have on bank lending, in the OCC's opinion, the proposed rule 
offers a better balance between costs and benefits than either the 
baseline or the alternatives.
    The OCC does not expect the revised risk-based capital guidelines 
to have any disproportionate budgetary effect on any particular regions 
of the nation or particular State, local, or tribal governments, urban 
or rural or other types of communities, or particular segments of the 
private sector.

V. Paperwork Reduction Act

A. Request for Comment on Proposed Information Collection

    In accordance with the requirements of the Paperwork Reduction Act 
of 1995 (44 U.S.C. 3501-3521), the agencies may not conduct or sponsor, 
and the 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 information collection 
requirements contained in this joint notice of proposed rulemaking have 
been submitted by the OCC and FDIC to OMB for review and approval under 
section 3506 of the PRA and section 1320.11 of OMB's implementing 
regulations (5 CFR part 1320). The Board reviewed the proposed rule 
under the authority delegated to the Board by OMB.
    Comments are invited on:
    (a) Whether the collection of information is necessary for the 
proper performance of the agencies' functions, including whether the 
information has practical utility;
    (b) The accuracy of the estimates of the burden of the information 
collection, including the validity of the methodology and assumptions 
used;
    (c) Ways to enhance the quality, utility, and clarity of the 
information to be collected;
    (d) Ways to minimize the burden of the information collection on 
respondents, including through the use of automated collection 
techniques or other forms of information technology; and
    (e) Estimates of capital or start up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    Comments should be addressed to:
    OCC: Communications Division, Office of the Comptroller of the 
Currency, Public Information Room, Mail stop 1-5, Attention: 1557-NEW,

[[Page 1911]]

250 E Street, SW., Washington, DC 20219. In addition, comments may be 
sent by fax to 202-874-5274, or by electronic mail to 
regs.comments@occ.treas.gov. You can inspect and photocopy the comments 
at the OCC's Public Information Room, 250 E Street, SW., Washington, DC 
20219. For security reasons, OCC requires that visitors make an 
appointment to inspect the comments. You may do so by calling 202-874-
4700. Upon arrival, visitors will be required to present valid 
government-issued photo identification and submit to security screening 
in order to inspect and photocopy comments.
    Board: You may submit comments, identified by the Docket number, by 
any of the following methods:
     Agency Web Site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments on the http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: regs.comments@federalreserve.gov. Include docket 
number in the subject line of the message.
     FAX: 202-452-3819 or 202-452-3102.
     Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information. Public comments may also be viewed electronically or in 
paper form in Room MP-500 of the Board's Martin Building (20th and C 
Streets, NW) between 9 a.m. and 5 p.m. on weekdays.
    FDIC: You may submit written comments, which should refer to 3064-
--------, by any of the following methods:
     Agency Web Site: http://www.fdic.gov/regulations/laws/
federal/propose.html. Follow the instructions for submitting comments 
on the FDIC Web site.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     E-mail: Comments@FDIC.gov. Include RIN on the subject line 
of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, FDIC, 550 17th Street, NW., Washington, DC 20429.
     Hand Delivery/Courier: Guard station at the rear of the 
550 17th Street Building (located on F Street) on business days between 
7 a.m. and 5 p.m.
    Public Inspection: All comments received will be posted without 
change to http://www.fdic.gov/regulations/laws/federal/propose/html 
including any personal information provided. Comments may be inspected 
at the FDIC Public Information Center, Room 100, 801 17th Street, NW., 
Washington, DC, between 9 a.m. and 4:30 p.m. on business days.
    A copy of the comments may also be submitted to the OMB desk 
officer for the agencies: By mail to U.S. Office of Management and 
Budget, 725 17th Street, NW., 10235, Washington, DC 20503 or 
by facsimile to 202-395-6974, Attention: Federal Banking Agency Desk 
Officer.

B. Proposed Information Collection

    Title of Information Collection: Risk-Based Capital Standards: 
Market Risk
    Frequency of Response: Varied--some requirements are done at least 
quarterly and some at least annually.
    Affected Public:
    OCC: National banks and Federal branches and agencies of foreign 
banks.
    Board: State member banks and bank holding companies.
    FDIC: Insured non-member banks, insured state branches of foreign 
banks, and certain subsidiaries of these entities.
    Abstract: The information collection requirements are found in 
sections 3, 4, 5, 6, 7, 8, 9, 10, and 11 of the proposed rule. They 
will enhance risk sensitivity and introduce requirements for public 
disclosure of certain qualitative and quantitative information about a 
bank's or bank holding companies' market risk. The collection of 
information is necessary to ensure capital adequacy according to the 
level of market risk.
Section-by-Section Analysis
    Section 3 sets forth the requirements for applying the market risk 
framework. Section 3(a)(1) requires clearly defined policies and 
procedures for determining which trading assets and trading liabilities 
are trading positions, which of its trading positions are correlation 
trading positions, and specifies what must be taken into account. 
Section 3(a)(2) requires a clearly defined trading and hedging strategy 
for trading positions approved by senior management and specifies what 
each strategy must articulate. Section 3(b)(1) requires clearly defined 
policies and procedures for actively managing all covered positions and 
specifies the minimum that they must require. Sections 3(c)(4) through 
3(c)(10) require the annual review of internal models and include 
certain requirements that the models must meet. Section 3(d)(4) 
requires an annual report to the board of directors on the 
effectiveness of controls supporting market risk measurement systems.
    Section 4(b) requires quarterly backtesting. Section 5(a)(5) 
requires institutions to demonstrate to the agencies the 
appropriateness of proxies used to capture risks within value-at- risk 
models. Section 5(c) requires institutions to retain value-at-risk and 
profit and loss information on subportfolios for two years. Section 
6(b)(3) requires policies and procedures for stressed value-at-risk 
models and prior approvals on determining periods of significant 
financial stress.
    Section 7(b)(1) specifies what internal models for specific risk 
must include and address. Section 8(a) requires prior written approval 
for incremental risk. Section 9(a) requires prior approval for 
comprehensive risk models. Section 9(c)(2) requires retaining and 
making available the results of supervisory stress testing on a 
quarterly basis. Section 10(d) requires documentation quarterly for 
analysis of risk characteristics of each securitization position it 
holds. Section 11 requires quarterly quantitative disclosures, annual 
qualitative disclosures, and a formal disclosure policy approved by the 
board of directors that addresses the bank's approach for determining 
the market risk disclosures it makes.
Estimated Burden
    The burden associated with this collection of information may be 
summarized as follows:
OCC
    Number of Respondents: 15.
    Estimated Burden Per Respondent: 1,964 hours.
    Total Estimated Annual Burden: 29,460 hours.
Board
    Number of Respondents: 26.
    Estimated Burden Per Respondent: 2,204 hours.
    Total Estimated Annual Burden: 51,064 hours.
FDIC
    Number of Respondents: 2.
    Estimated Burden Per Respondent: 1,964.
    Total Estimated Annual Burden: 3,928.

[[Page 1912]]

VI. Plain Language

    Section 722 of the GLBA required the agencies to use plain language 
in all proposed and final rules published after January 1, 2000. The 
agencies invite comment on how to make this proposed rule easier to 
understand. For example:
     Have the agencies organized the material to suit your 
needs? If not, how could they present the rule more clearly?
     Are the requirements in the rule clearly stated? If not, 
how could the rule be more clearly stated?
     Do the regulations contain technical language or jargon 
that is not clear? If so, which language requires clarification?
     Would a different format (grouping and order of sections, 
use of headings, paragraphing) make the regulation easier to 
understand? If so, what changes would achieve that?
     Is this section format adequate? If not, which of the 
sections should be changed and how?
     What other changes can the agencies incorporate to make 
the regulation easier to understand?

Text of the Proposed Common Rules (All Agencies)

    The text of the proposed common rules appears below:

Appendix ---- to Part ------Risk-Based Capital Guidelines; Market Risk 
Adjustment

Section 1 Purpose, Applicability, and Reservation of Authority
Section 2 Definitions
Section 3 Requirements for Application of the Market Risk Capital 
Rule
Section 4 Adjustments to the Risk-Based Capital Ratio Calculations
Section 5 VaR-based Measure
Section 6 Stressed VaR-Based Measure
Section 7 Specific Risk
Section 8 Incremental Risk
Section 9 Comprehensive Risk
Section 10 Standardized Measurement Method for Specific Risk
Section 11 Market Risk Disclosures

Section 1. Purpose, Applicability, and Reservation of Authority

    (a) Purpose. This appendix establishes risk-based capital 
requirements for [banking organizations] with significant exposure 
to market risk and provides methods for these [banking 
organizations] to calculate their risk-based capital requirements 
for market risk. This appendix supplements and adjusts the risk-
based capital calculations under [the general risk-based capital 
rules] and [the advanced capital adequacy framework] and establishes 
public disclosure requirements.
    (b) Applicability--(1) This appendix applies to any [banking 
organization] with aggregate trading assets and trading liabilities 
(as reported in the [banking organization]'s most recent quarterly 
[regulatory report]), equal to:
    (i) 10 percent or more of quarter-end total assets as reported 
on the most recent quarterly [Call Report or FR Y-9C]; or
    (ii) $1 billion or more.
    (2) The [Agency] may apply this appendix to any [banking 
organization] if the [Agency] deems it necessary or appropriate 
because of the level of market risk of the [banking organization] or 
to ensure safe and sound banking practices.
    (3) The [Agency] may exclude a [banking organization] that meets 
the criteria of paragraph (b)(1) of this appendix from application 
of this appendix if the [Agency] determines that the exclusion is 
appropriate based on the level of market risk of the [banking 
organization] and is consistent with safe and sound banking 
practices.
    (c) Reservation of authority--(1) The [Agency] may require a 
[banking organization] to hold an amount of capital greater than 
otherwise required under this appendix if the [Agency] determines 
that the [banking organization]'s capital requirement for market 
risk as calculated under this appendix is not commensurate with the 
market risk of the [banking organization]'s covered positions. In 
making determinations under this paragraph, the [Agency] will apply 
notice and response procedures generally in the same manner as the 
notice and response procedures described in [12 CFR 3.12, 12 CFR 
263.202, 12 CFR 325.6(c), 12 CFR 567.3(d)].
    (2) If the [Agency] determines that the risk-based capital 
requirement calculated under this appendix by the [banking 
organization] for one or more covered positions or portfolios of 
covered positions is not commensurate with the risks associated with 
those positions or portfolios, the [Agency] may require the [banking 
organization] to assign a different risk-based capital requirement 
to the positions or portfolios that more accurately reflects the 
risk of the positions or portfolios.
    (3) The [Agency] may also require a [banking organization] to 
calculate risk-based capital requirements for specific positions or 
portfolios under this appendix, or under [the advanced capital 
adequacy framework] or [the general risk-based capital rules], as 
appropriate, to more accurately reflect the risks of the positions.
    (4) Nothing in this appendix limits the authority of the 
[Agency] under any other provision of law or regulation to take 
supervisory or enforcement action, including action to address 
unsafe or unsound practices or conditions, deficient capital levels, 
or violations of law.

Section 2. Definitions

    For purposes of this appendix, the following definitions apply:
    Backtesting means the comparison of a [banking organization]'s 
internal estimates with actual outcomes during a sample period not 
used in model development. For purposes of this appendix, 
backtesting is one form of out-of-sample testing.
    Bank holding company is defined in section 2(a) of the Bank 
Holding Company Act of 1956 (12 U.S.C. 1841(a)).
    Commodity position means a position for which price risk arises 
from changes in the price of a commodity.
    Company means a corporation, partnership, limited liability 
company, depository institution, business trust, special purpose 
entity, association, or similar organization.
    Correlation trading position means:
    (1) A securitization position for which all or substantially all 
of the value of the underlying exposures is based on the credit 
quality of a single company for which a two-way market exists, or on 
commonly traded indices based on such exposures for which a two-way 
market exists on the indices; or
    (2) A position that is not a securitization position and that 
hedges a position described in paragraph (1) of this definition; and
    (3) A correlation trading position does not include:
    (i) A resecuritization position;
    (ii) A derivative of a securitization position that does not 
provide a pro rata share in the proceeds of a securitization 
tranche; or
    (iii) A securitization position for which the underlying assets 
or reference exposures are retail exposures, residential mortgage 
exposures, or commercial mortgage exposures.
    Covered position means the following positions:
    (1) A trading asset or trading liability (whether on- or off-
balance sheet),\1\ as reported on Schedule RC-D of the Call Report 
or Schedule HC-D of the FR Y-9C, that meets the following 
conditions:
---------------------------------------------------------------------------

    \1\ Securities subject to repurchase and lending agreements are 
included as if they are still owned by the lender.
---------------------------------------------------------------------------

    (i) The position is a trading position or hedges another covered 
position \2\ and
---------------------------------------------------------------------------

    \2\ A position that hedges a trading position must be within the 
scope of the bank's hedging strategy as described in paragraph 
(a)(2) of section (3) of this appendix.
---------------------------------------------------------------------------

    (ii) The position is free of any restrictive covenants on its 
tradability or the [banking organization] is able to hedge the 
material risk elements of the position in a two-way market.
    (2) A foreign exchange or commodity position, regardless of 
whether the position is a trading asset or trading liability 
(excluding any structural foreign currency positions that the 
[banking organization] chooses to exclude with prior supervisory 
approval).
    (3) Notwithstanding paragraphs (1) and (2) of this definition, a 
covered position does not include:
    (i) An intangible asset, including any servicing asset;
    (ii) Any hedge of a trading position that the [Agency] 
determines to be outside the scope of the [banking organization]'s 
hedging strategy required in paragraph (a)(2) of section 3 of this 
appendix;
    (iii) Any position that, in form or substance, acts as a 
liquidity facility that provides support to asset-backed commercial 
paper;
    (iv) A credit derivative the [banking organization] recognizes 
as a guarantee for risk-weighted asset amount calculation purposes 
under [the advanced capital adequacy framework] or [the general 
risk-based capital rules];

[[Page 1913]]

    (v) Any equity position that is not publicly traded other than a 
derivative that references a publicly traded equity;
    (vi) Any position a [banking organization] holds with the intent 
to securitize; or
    (vii) Any direct real estate holding.
    Credit derivative means a financial contract executed under 
standard industry documentation that allows one party (the 
protection purchaser) to transfer the credit risk of one or more 
exposures (reference exposure(s)) to another party (the protection 
provider).
    Debt position means a covered position that is not a 
securitization position or a correlation trading position and that 
has a value that reacts primarily to changes in interest rates or 
credit spreads.
    Depository institution is defined in section 3 of the Federal 
Deposit Insurance Act (12 U.S.C. 1813).
    Equity position means a covered position that is not a 
securitization position or a correlation trading position and that 
has a value that reacts primarily to changes in equity prices.
    Event risk means the risk of loss on a position that could 
result from sudden and unexpected large changes in market prices or 
specific events other than default and credit migration of the 
issuer.
    Financial firm means a depository institution, a bank holding 
company, a savings and loan holding company (as defined in section 
10(a)(1)(D) of the Home Owners' Loan Act (12 U.S.C. 1467a(a)(1)(D)), 
a securities broker or dealer registered with the SEC, or a banking 
or securities firm that the [banking organization] has determined is 
subject to consolidated supervision and regulation comparable to 
that imposed on U.S. [banking organizations] or securities broker-
dealers.
    Foreign exchange position means a position for which price risk 
arises from changes in foreign exchange rates.
    General market risk means the risk of loss that could result 
from broad market movements, such as changes in the general level of 
interest rates, credit spreads, equity prices, foreign exchange 
rates, or commodity prices.
    Hedge means a position or positions that offset all, or 
substantially all, of one or more material risk factors of another 
position.
    Idiosyncratic risk means the risk of loss in the value of a 
position that arises from changes in risk factors unique to that 
position.
    Incremental risk means the default risk and credit migration 
risk of a position. Default risk means the risk of loss on a 
position that could result from the failure of an obligor to make 
timely payments of principal or interest on its debt obligation, and 
the risk of loss that could result from bankruptcy, insolvency, or 
similar proceeding. Credit migration risk means the price risk that 
arises from significant changes in the underlying credit quality of 
the position.
    Investing bank means, with respect to a securitization, a 
[banking organization] that assumes the credit risk of a 
securitization exposure (other than an originating bank of the 
securitization).
    Market risk means the risk of loss on a position that could 
result from movements in market prices.
    Nth-to-default credit derivative means a credit derivative that 
provides credit protection only for the nth-defaulting reference 
exposure in a group of reference exposures.
    Originating bank, with respect to a securitization, means a 
[banking organization] that:
    (1) Directly or indirectly originated or securitized the 
underlying exposures included in the securitization; or
    (2) Serves as an asset-backed commercial paper (ABCP) program 
sponsor to the securitization.
    Over-the-counter (OTC) derivative means a derivative contract 
that is not traded on an exchange that requires the daily receipt 
and payment of cash-variation margin.
    Publicly traded means traded on:
    (1) Any exchange registered with the SEC as a national 
securities exchange under section 6 of the Securities Exchange Act 
of 1934 (15 U.S.C. 78f); or
    (2) Any non-U.S.-based securities exchange that:
    (i) Is registered with, or approved by, a national securities 
regulatory authority; and
    (ii) Provides a liquid, two-way market for the instrument in 
question.
    Qualifying securities borrowing transaction means a cash-
collateralized securities borrowing transaction that meets the 
following conditions:
    (1) The transaction is based on liquid and readily marketable 
securities;
    (2) The transaction is marked-to-market daily;
    (3) The transaction is subject to daily margin maintenance 
requirements; and
    (4)(i) The transaction is a securities contract for the purposes 
of section 555 of the Bankruptcy Code (11 U.S.C. 555), a qualified 
financial contract for the purposes of section 11(e)(8) of the 
Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting 
contract between or among financial institutions for the purposes of 
sections 401-407 of the Federal Deposit Insurance Corporation 
Improvement Act of 1991 (12 U.S.C. 4401-4407), or the Board's 
Regulation EE (12 CFR part 231); or
    (ii) If the transaction does not meet the criteria in paragraph 
(4)(i) of this definition, either:
    (A) The [banking organization] has conducted sufficient legal 
review to reach a well-founded conclusion that:
    (1) The securities borrowing agreement executed in connection 
with the transaction provides the [banking organization] the right 
to accelerate, terminate, and close-out on a net basis all 
transactions under the agreement and to liquidate or set off 
collateral promptly upon an event of counterparty default, including 
in a bankruptcy, insolvency, or other similar proceeding of the 
counterparty; and
    (2) Under applicable law of the relevant jurisdiction, its 
rights under the agreement are legal, valid, binding, and 
enforceable and any exercise of rights under the agreement will not 
be stayed or avoided; or
    (B) The transaction is either overnight or unconditionally 
cancelable at any time by the [banking organization], and the 
[banking organization] has conducted sufficient legal review to 
reach a well-founded conclusion that:
    (1) The securities borrowing agreement executed in connection 
with the transaction provides the [banking organization] the right 
to accelerate, terminate, and close-out on a net basis all 
transactions under the agreement and to liquidate or set off 
collateral promptly upon an event of counterparty default; and
    (2) Under the law governing the agreement, its rights under the 
agreement are legal, valid, binding, and enforceable.
    Resecuritization means a securitization in which one or more of 
the underlying exposures is a securitization position.
    Resecuritization position means:
    (1) An on- or off-balance sheet exposure to a resecuritization; 
or
    (2) An exposure that directly or indirectly references a 
resecuritization exposure in paragraph (1) of this definition.
    SEC means the U.S. Securities and Exchange Commission.
    Securitization means a transaction in which:
    (1) All or a portion of the credit risk of one or more 
underlying exposures is transferred to one or more third parties;
    (2) The credit risk associated with the underlying exposures has 
been separated into at least two tranches that reflect different 
levels of seniority;
    (3) Performance of the securitization exposures depends upon the 
performance of the underlying exposures;
    (4) All or substantially all of the underlying exposures are 
financial exposures (such as loans, commitments, credit derivatives, 
guarantees, receivables, asset-backed securities, mortgage-backed 
securities, other debt securities, or equity securities);
    (5) For non-synthetic securitizations, the underlying exposures 
are not owned by an operating company;
    (6) The underlying exposures are not owned by a small business 
investment company described in section 302 of the Small Business 
Investment Act of 1958 (15 U.S.C. 682); and
    (7) The underlying exposures are not owned by a firm an 
investment in which qualifies as a community development investment 
under 12 U.S.C. 24(Eleventh).
    (8) The [Agency] may determine that a transaction in which the 
underlying exposures are owned by an investment firm that exercises 
substantially unfettered control over the size and composition of 
its assets, liabilities, and off-balance sheet exposures is not a 
securitization based on the transaction's leverage, risk profile, or 
economic substance.
    (9) The [Agency] may deem an exposure to a transaction that 
meets the definition of a securitization, notwithstanding paragraph 
(5), (6), or (7) of this definition, to be a securitization based on 
the transaction's leverage, risk profile, or economic substance.
    Securitization position means a covered position that is:
    (1) An on-balance sheet or off-balance sheet credit exposure 
(including credit-enhancing representations and warranties) that 
arises from a securitization (including a resecuritization); or

[[Page 1914]]

    (2) An exposure that directly or indirectly references a 
securitization exposure described in paragraph (1) of this 
definition.
    Sovereign entity means a central government (including the U.S. 
government) or an agency, department, ministry, or central bank of a 
central government.
    Specific risk means the risk of loss on a position that could 
result from factors other than broad market movements and includes 
event risk, default risk, and idiosyncratic risk.
    Structural position in a foreign currency means a position that 
is not a trading position and that is:
    (1) Subordinated debt, equity, or minority interest in a 
consolidated subsidiary that is denominated in a foreign currency;
    (2) Capital assigned to foreign branches that is denominated in 
a foreign currency;
    (3) A position related to an unconsolidated subsidiary or 
another item that is denominated in a foreign currency and that is 
deducted from the [banking organization]'s tier 1 and tier 2 
capital, or
    (4) A position designed to hedge a [banking organization]'s 
capital ratios or earnings against the effect on paragraphs (1), 
(2), or (3) of this definition of adverse exchange rate movements.
    Term repo-style transaction means a repurchase or reverse 
repurchase transaction, or a securities borrowing or securities 
lending transaction, including a transaction in which the [banking 
organization] acts as agent for a customer and indemnifies the 
customer against loss, that has an original maturity in excess of 
one business day, provided that:
    (1) The transaction is based solely on liquid and readily 
marketable securities or cash;
    (2) The transaction is marked-to-market daily and subject to 
daily margin maintenance requirements;
    (3) The transaction is executed under an agreement that provides 
the [banking organization] the right to accelerate, terminate, and 
close-out the transaction on a net basis and to liquidate or set off 
collateral promptly upon an event of default (including bankruptcy, 
insolvency, or similar proceeding) of the counterparty, provided 
that, in any such case, any exercise of rights under the agreement 
will not be stayed or avoided under applicable law in the relevant 
jurisdictions; \3\ and
---------------------------------------------------------------------------

    \3\ This requirement is met where all transactions under the 
agreement are (i) executed under U.S. law and (ii) constitute 
``securities contracts'' or ``repurchase agreements'' under section 
555 or 559, respectively, of the Bankruptcy Code (11 U.S.C. 555 or 
559), qualified financial contracts under section 11(e)(8) of the 
Federal Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or netting 
contracts between or among financial institutions under sections 
401-407 of the Federal Deposit Insurance Corporation Improvement Act 
of 1991 (12 U.S.C. 4407), or the Federal Reserve Board's Regulation 
EE (12 CFR part 231).
---------------------------------------------------------------------------

    (4) The [banking organization] has conducted and documented 
sufficient legal review to conclude with a well-founded basis that 
the agreement meets the requirements of paragraph (3) of this 
definition and is legal, valid, binding, and enforceable under 
applicable law in the relevant jurisdictions.
    Tier 1 capital is defined in [the general risk-based capital 
rules] or [the advanced capital adequacy framework], as applicable.
    Tier 2 capital is defined in [the general risk-based capital 
rules] or [the advanced capital adequacy framework], as applicable.
    Trading position means a position that is held by the [banking 
organization] for the purpose of short-term resale or with the 
intent of benefiting from actual or expected short-term price 
movements, or to lock in arbitrage profits.
    Two-way market means a market where there are independent bona 
fide offers to buy and sell so that a price reasonably related to 
the last sales price or current bona fide competitive bid and offer 
quotations can be determined within one day and settled at that 
price within five business days.
    Value-at-Risk (VaR) means the estimate of the maximum amount 
that the value of one or more positions could decline due to market 
price or rate movements during a fixed holding period within a 
stated confidence interval.

Section 3. Requirements for Application of the Market Risk Capital Rule

    (a) Trading positions--(1) Identification of trading positions. 
A [banking organization] must have clearly defined policies and 
procedures for determining which of its trading assets and trading 
liabilities are trading positions and which of its trading positions 
are correlation trading positions. These policies and procedures 
must take into account:
    (i) The extent to which a position, or a hedge of its material 
risks, can be marked-to-market daily by reference to a two-way 
market; and
    (ii) Possible impairments to the liquidity of a position or its 
hedge.
    (2) Trading and hedging strategies. A [banking organization] 
must have clearly defined trading and hedging strategies for its 
trading positions that are approved by senior management of the 
[banking organization].
    (i) The trading strategy must articulate the expected holding 
period of, and the market risk associated with, each portfolio of 
trading positions.
    (ii) The hedging strategy must articulate for each portfolio of 
trading positions the level of market risk the [banking 
organization] is willing to accept and must detail the instruments, 
techniques, and strategies the [banking organization] will use to 
hedge the risk of the portfolio.
    (b) Management of covered positions-- (1) Active management. A 
[banking organization] must have clearly defined policies and 
procedures for actively managing all covered positions. At a 
minimum, these policies and procedures must require:
    (i) Marking positions to market or to model on a daily basis;
    (ii) Daily assessment of the [banking organization]'s ability to 
hedge position and portfolio risks, and of the extent of market 
liquidity;
    (iii) Establishment and daily monitoring of limits on positions 
by a risk control unit independent of the trading business unit;
    (iv) Daily monitoring by senior management of information 
described in paragraphs (b)(1)(i) through (b)(1)(iii) of this 
section;
    (v) At least annual reassessment of established limits on 
positions by senior management; and
    (vi) At least annual assessments by qualified personnel of the 
quality of market inputs to the valuation process, the soundness of 
key assumptions, the reliability of parameter estimation in pricing 
models, and the stability and accuracy of model calibration under 
alternative market scenarios.
    (2) Valuation of covered positions. The [banking organization] 
must have a process for prudent valuation of its covered positions 
that includes policies and procedures on the valuation of positions, 
marking positions to market or to model, independent price 
verification, and valuation adjustments or reserves. The valuation 
process must consider, as appropriate, unearned credit spreads, 
close-out costs, early termination costs, investing and funding 
costs, future administrative costs, liquidity, and model risk.
    (c) Requirements for internal models. (1) A [banking 
organization] must obtain the prior written approval of the [Agency] 
before using any internal model to calculate its risk-based capital 
requirement under this appendix.
    (2) A [banking organization] must meet all of the requirements 
of this section on an ongoing basis. The [banking organization] must 
promptly notify the [Agency] when:
    (i) The [banking organization] plans to extend the use of a 
model that the [Agency] has approved under this appendix to an 
additional business line or product type;
    (ii) The [banking organization] makes any change to any internal 
model approved by the [Agency] under this appendix that would result 
in a material change in the [banking organization]'s risk-weighted 
asset amount for a portfolio of covered positions; or
    (iii) The [banking organization] makes any material change to 
its modeling assumptions.
    (3) The [Agency] may rescind its approval of the use of any 
internal model (in whole or in part) or of the surcharge applicable 
to a [banking organization]'s modeled correlation trading positions 
as determined under section 9(d)(2) of this appendix, and determine 
an appropriate capital requirement for the covered positions to 
which the model would apply, if the [Agency] determines that the 
model no longer complies with this appendix or fails to reflect 
accurately the risks of the [banking organization]'s covered 
positions.
    (4) The [banking organization] must periodically, but no less 
frequently than annually, review its internal models in light of 
developments in financial markets and modeling technologies, and 
enhance those models as appropriate to ensure that they continue to 
meet the [Agency]'s standards for model approval and employ risk 
measurement methodologies that are most appropriate for the [banking 
organization]'s covered positions.
    (5) The [banking organization] must incorporate its internal 
models into its risk management process and integrate the internal 
models used for calculating its VaR-based measure into its daily 
risk management process.

[[Page 1915]]

    (6) The level of sophistication of a [banking organization]'s 
internal models must be commensurate with the complexity and amount 
of its covered positions. A [banking organization]'s internal models 
may use any of the generally accepted approaches, including but not 
limited to variance-covariance models, historical simulations, or 
Monte Carlo simulations, to measure market risk.
    (7) The [banking organization]'s internal models must properly 
measure all of the material risks in the covered positions to which 
they are applied.
    (8) The [banking organization]'s internal models must 
conservatively assess the risks arising from less liquid positions 
and positions with limited price transparency under realistic market 
scenarios.
    (9) The [banking organization] must have a rigorous and well-
defined process for reestimating, reevaluating, and updating its 
internal models to ensure continued applicability and relevance.
    (10) If a [banking organization] uses internal models to measure 
specific risk, the internal models must also satisfy the 
requirements in paragraph (b)(1) of section 7 of this appendix.
    (d) Control, oversight, and validation mechanisms. (1) The 
[banking organization] must have a risk control unit that reports 
directly to senior management and is independent from the business 
trading units.
    (2) The [banking organization] must validate its internal models 
initially and on an ongoing basis. The [banking organization]'s 
validation process must be independent of the internal models' 
development, implementation, and operation, or the validation 
process must be subjected to an independent review of its adequacy 
and effectiveness. Validation must include:
    (i) An evaluation of the conceptual soundness of (including 
developmental evidence supporting) the internal models;
    (ii) An ongoing monitoring process that includes verification of 
processes and the comparison of the [banking organization]'s model 
outputs with relevant internal and external data sources or 
estimation techniques; and
    (iii) An outcomes analysis process that includes backtesting. 
For internal models used to calculate the VaR-based measure, this 
process must include a comparison of the changes in the [banking 
organization]'s portfolio value that would have occurred were end-
of-day positions to remain unchanged (therefore, excluding fees, 
commissions, reserves, net interest income, and intraday trading) 
with VaR-based measures during a sample period not used in model 
development.
    (3) The [banking organization] must stress-test the market risk 
of its covered positions at a frequency appropriate to each 
portfolio, and in no case less frequently than quarterly. The stress 
tests must take into account concentration risk (including but not 
limited to concentrations in single issuers, industries, sectors, or 
markets), illiquidity under stressed market conditions, and risks 
arising from the [banking organization]'s trading activities that 
may not be adequately captured in its internal models.
    (4) The [banking organization] must have an internal audit 
function independent of business-line management that at least 
annually assesses the effectiveness of the controls supporting the 
[banking organization]'s market risk measurement systems, including 
the activities of the business trading units and independent risk 
control unit, compliance with policies and procedures, and 
calculation of the [banking organization]'s measure for market risk 
under this appendix. At least annually, the internal audit function 
must report its findings to the [banking organization]'s board of 
directors (or a committee thereof).
    (e) Internal assessment of capital adequacy. The [banking 
organization] must have a rigorous process for assessing its overall 
capital adequacy in relation to its market risk. The assessment must 
take into account risks that may not be captured fully in the VaR-
based measure, including concentration and liquidity risk under 
stressed market conditions.
    (f) Documentation. The [banking organization] must adequately 
document all material aspects of its internal models, management and 
valuation of covered positions, control, oversight, validation and 
review processes and results, and internal assessment of capital 
adequacy.

Section 4. Adjustments to the Risk-Based Capital Ratio Calculations

    (a) Risk-based capital ratio denominator. The [banking 
organization] must calculate its risk-based capital ratio 
denominator as follows:
    (1) Adjusted risk-weighted assets. The [banking organization] 
must calculate adjusted risk-weighted assets, which equal risk-
weighted assets (as determined in accordance with [the advanced 
capital adequacy framework] or [the general risk-based capital 
rules], as applicable), with the following adjustments:
    (i) The [banking organization] must exclude the risk-weighted 
asset amounts of all covered positions (except foreign exchange 
positions that are not trading positions and over-the-counter 
derivative positions).
    (ii) A [banking organization] subject to [the general risk-based 
capital rules] may exclude receivables that arise from the posting 
of cash collateral and are associated with qualifying securities 
borrowing transactions to the extent the receivable is 
collateralized by the market value of the borrowed securities;
    (2) Measure for market risk. The [banking organization] must 
calculate the measure for market risk, which equals the sum of the 
VaR-based capital requirement, stressed VaR-based capital 
requirement, any specific risk add-ons, any incremental risk capital 
requirement, any comprehensive risk capital requirement, and any 
capital requirement for de minimis exposures as defined under this 
paragraph.
    (i) VaR-based capital requirement. The VaR-based capital 
requirement equals the greater of:
    (A) The previous day's VaR-based measure as calculated under 
section 5 of this appendix; or
    (B) The average of the daily VaR-based measures as calculated 
under section 5 of this appendix for each of the preceding 60 
business days multiplied by three, except as provided in paragraph 
(b) of this section.
    (ii) Stressed VaR-based capital requirement. The stressed VaR-
based capital requirement equals the greater of:
    (A) The most recent stressed VaR-based measure as calculated 
under section 6 of this appendix; or
    (B) The average of the stressed VaR-based measures as calculated 
under section 6 of this rule for each of the preceding 60 business 
days multiplied by three, except as provided in paragraph (b) of 
this section.
    (iii) Any specific risk add-ons. Any specific risk add-ons that 
are required under section 7 and are calculated in accordance with 
section 10 of this appendix.
    (iv) Any incremental risk capital requirement. Any incremental 
risk capital requirement as calculated under section 8 of this 
appendix.
    (v) Any comprehensive risk capital requirement. Any 
comprehensive risk capital requirement as calculated under section 9 
of this appendix.
    (vi) Any capital requirement for de minimis exposures. The 
[banking organization] must add to its measure for market risk the 
absolute value of the market value of those de minimis exposures 
that are not captured in the [banking organization]'s VaR-based 
measure unless the [banking organization] has obtained prior written 
approval from the [Agency] to calculate a capital requirement for de 
minimis exposures using alternative techniques that appropriately 
measure the market risk associated with those exposures.
    (3) Market risk equivalent assets. The [banking organization] 
must calculate market risk equivalent assets as the measure for 
market risk (as calculated in paragraph (a)(2) of this section) 
multiplied by 12.5.
    (4) Denominator calculation. The [banking organization] must add 
market risk equivalent assets (as calculated in paragraph (a)(3) of 
this section) to adjusted risk-weighted assets (as calculated in 
paragraph (a)(1) of this section). The resulting sum is the [banking 
organization]'s risk-based capital ratio denominator.
    (b) Backtesting. A [banking organization] must compare each of 
its most recent 250 business days' trading losses (excluding fees, 
commissions, reserves, intra-day trading, and net interest income) 
with the corresponding daily VaR-based measures calibrated to a one-
day holding period and at a one-tail, 99.0 percent confidence level.
    (1) Once each quarter, the [banking organization] must identify 
the number of exceptions (that is, the number of business days for 
which the actual daily net trading loss, if any, exceeds the 
corresponding daily VaR-based measure) that have occurred over the 
preceding 250 business days.
    (2) A [banking organization] must use the multiplication factor 
in Table 1 of this appendix that corresponds to the number of 
exceptions identified in paragraph (b)(1) of this section to 
determine its VaR-based capital requirement for market risk under 
paragraph (a)(2)(i) of this section and to determine its stressed 
VaR-based capital requirement for market risk under paragraph

[[Page 1916]]

(a)(2)(ii) of this section until it obtains the next quarter's 
backtesting results, unless the [Agency] notifies the [banking 
organization] in writing that a different adjustment or other action 
is appropriate.

     Table 1--Multiplication Factors Based on Results of Backtesting
------------------------------------------------------------------------
                                                          Multiplication
                  Number of exceptions                        factor
------------------------------------------------------------------------
4 or fewer..............................................           3.00
5.......................................................           3.40
6.......................................................           3.50
7.......................................................           3.65
8.......................................................           3.75
9.......................................................           3.85
10 or more..............................................           4.00
------------------------------------------------------------------------

Section 5. VaR-Based Measure

    (a) General requirement. A [banking organization] must use one 
or more internal models to calculate daily a VaR-based measure of 
the general market risk of all covered positions. The daily VaR-
based measure also may reflect the [banking organization]'s specific 
risk for one or more portfolios of debt and equity positions, if the 
internal models meet the requirements of paragraph (b)(1) of section 
7. The daily VaR-based measure must also reflect the [banking 
organization]'s specific risk for any portfolio of correlation 
trading positions that is modeled under section 9 of this appendix. 
A [banking organization] may elect to include term repo-style 
transactions in its VaR-based measure, provided that the [banking 
organization] includes all such term repo-style transactions 
consistently over time.
    (1) The [banking organization]'s internal models for calculating 
its VaR-based measure must use risk factors sufficient to measure 
the market risk inherent in all covered positions. The market risk 
categories must include, as appropriate, interest rate risk, credit 
spread risk, equity price risk, foreign exchange risk, and commodity 
price risk. For material positions in the major currencies and 
markets, modeling techniques must incorporate enough segments of the 
yield curve--in no case less than six--to capture differences in 
volatility and less than perfect correlation of rates along the 
yield curve.
    (2) The VaR-based measure may incorporate empirical correlations 
within and across risk categories, provided the [banking 
organization] validates and demonstrates the reasonableness of its 
process for measuring correlations. If the VaR-based measure does 
not incorporate empirical correlations across risk categories, the 
[banking organization] must add the separate measures from its 
internal models used to calculate the VaR-based measure for the 
appropriate market risk categories (interest rate risk, credit 
spread risk, equity price risk, foreign exchange rate risk, and/or 
commodity price risk) to determine its aggregate VaR-based measure.
    (3) The VaR-based measure must include the risks arising from 
the nonlinear price characteristics of options positions or 
positions with embedded optionality and the sensitivity of the 
market value of the positions to changes in the volatility of the 
underlying rates, prices, or other material risk factors. A [banking 
organization] with a large or complex options portfolio must measure 
the volatility of options positions or positions with embedded 
optionality by different maturities and/or strike prices, where 
material.
    (4) The [banking organization] must be able to justify to the 
satisfaction of the [Agency] the omission of any risk factors from 
the calculation of its VaR-based measure that the [banking 
organization] uses in its pricing models.
    (5) The [banking organization] must demonstrate to the 
satisfaction of the [Agency] the appropriateness of any proxies used 
to capture the risks of the [banking organization]'s actual 
positions for which such proxies are used.
    (b) Quantitative requirements for VaR-based measure. (1) The 
VaR-based measure must be calculated on a daily basis using a one-
tail, 99.0 percent confidence level, and a holding period equivalent 
to a 10-business-day movement in underlying risk factors, such as 
rates, spreads, and prices. To calculate VaR-based measures using a 
10-business-day holding period, the [banking organization] may 
calculate 10-business-day measures directly or may convert VaR-based 
measures using holding periods other than 10 business days to the 
equivalent of a 10-business-day holding period. A [banking 
organization] that converts its VaR-based measure in such a manner 
must be able to justify the reasonableness of its approach to the 
satisfaction of the [Agency].
    (2) The VaR-based measure must be based on a historical 
observation period of at least one year. Data used to determine the 
VaR-based measure must be relevant to the [banking organization]'s 
actual exposures and of sufficient quality to support the 
calculation of risk-based capital requirements. The [banking 
organization] must update data sets at least monthly or more 
frequently as changes in market conditions or portfolio composition 
warrant. For a [banking organization] that uses a weighting scheme 
or other method for the historical observation period, the [banking 
organization] must either:
    (i) Use an effective observation period of at least one year in 
which the average time lag of the observations is at least six 
months; or
    (ii) Demonstrate to the [Agency] that its weighting scheme is 
more effective than a weighting scheme with an average time lag of 
at least six months at representing the volatility of the [banking 
organization]'s trading portfolio over a full business cycle. A 
[banking organization] using this option must update its data more 
frequently than monthly and in a manner appropriate for the type of 
weighting scheme.
    (c) A [banking organization] must divide its portfolio into a 
number of significant subportfolios approved by the [Agency] for 
subportfolio backtesting purposes. These subportfolios must be 
sufficient to allow the [banking organization] and the [Agency] to 
assess the adequacy of the VaR model at the risk factor level; the 
[Agency] will evaluate the appropriateness of these subportfolios 
relative to the value and composition of the [banking 
organization]'s covered positions. The [banking organization] must 
retain and make available to the [Agency] the following information 
for each subportfolio for each business day over the previous two 
years (500 business days), with no more than a 60 day lag:
    (1) A daily VaR-based measure for the subportfolio calibrated to 
a one-tail, 99.0 percent confidence level;
    (2) The daily profit or loss for the subportfolio (that is, the 
net change in price of the positions held in the portfolio at the 
end of the previous business day); and
    (3) The p-value of the profit or loss on each day (that is, the 
probability of observing a profit that is less than, or a loss that 
is greater than, the amount reported for purposes of paragraph 
(c)(2) of this section based on the model used to calculate the VaR-
based measure described in paragraph (c)(1) of this section).

Section 6. Stressed VaR-Based Measure

    (a) General requirement. At least weekly, a [banking 
organization] must use the same internal model(s) used to calculate 
its VaR-based measure to calculate a stressed VaR-based measure.
    (b) Quantitative requirements for stressed VaR-based measure. 
(1) A [banking organization] must calculate a stressed VaR-based 
measure for its covered positions using the same model(s) used to 
calculate the VaR-based measure, subject to the same confidence 
level and holding period applicable to the VaR-based measure under 
section 5, but with model inputs calibrated to historical data from 
a continuous 12-month period that reflects a period of significant 
financial stress appropriate to the [banking organization]'s current 
portfolio.
    (2) The stressed VaR-based measure must be calculated at least 
weekly and be no less than the [banking organization]'s VaR-based 
measure.
    (3) A [banking organization] must have policies and procedures 
that describe how it determines the period of significant financial 
stress used to calculate the [banking organization]'s stressed VaR-
based measure under this section and must be able to provide 
empirical support for the period used. The [banking organization] 
must obtain the prior approval of the [Agency] for, and notify the 
[Agency] if the [banking organization] makes any material changes 
to, these policies and procedures. The policies and procedures must 
address:
    (i) How the [banking organization] links the period of 
significant financial stress used to calculate the stressed VaR-
based measure to the composition and directional bias of its current 
portfolio; and
    (ii) The [banking organization]'s process for selecting, 
reviewing, and updating the period of significant financial stress 
used to calculate the stressed VaR-based measure and for monitoring 
the appropriateness of the period to the [banking organization]'s 
current portfolio.
    (4) Nothing in this section prevents the [Agency] from requiring 
a [banking organization] to use a different period of significant 
financial stress in the calculation of the stressed VaR-based 
measure.

[[Page 1917]]

Section 7. Specific Risk

    (a) General requirement. A [banking organization] must use one 
of the methods in this section to measure the specific risk for each 
of its debt, equity, and securitization positions with specific 
risk.
    (b) Modeled specific risk. A [banking organization] may use 
models to measure the specific risk of covered positions as provided 
in paragraph (a) of section 5 (therefore, excluding securitization 
positions that are not modeled under section 9 of this appendix). A 
[banking organization] must use models to measure the specific risk 
of correlation trading positions that are modeled under section 9 of 
this appendix.
    (1) Requirements for specific risk modeling. (i) If a [banking 
organization] uses internal models to measure the specific risk of a 
portfolio, the internal models must:
    (A) Explain the historical price variation in the portfolio;
    (B) Be responsive to changes in market conditions;
    (C) Be robust to an adverse environment, including signaling 
rising risk in an adverse environment; and
    (D) Capture all material components of specific risk for the 
debt and equity positions in the portfolio. Specifically, the 
internal models must:
    (1) Capture event risk and idiosyncratic risk;
    (2) Capture and demonstrate sensitivity to material differences 
between positions that are similar but not identical; and
    (3) Capture and demonstrate sensitivity to changes in portfolio 
composition and concentrations.
    (ii) If a [banking organization] calculates an incremental risk 
measure for a portfolio of debt or equity positions under section 8 
of this appendix, the [banking organization] is not required to 
capture default and credit migration risks in its internal models 
used to measure the specific risk of those portfolios.
    (2) Specific risk fully modeled for one or more portfolios. If 
the [banking organization]'s VaR-based measure captures all material 
aspects of specific risk for one or more of its portfolios of debt, 
equity, or correlation trading positions, the [banking organization] 
has no specific risk add-on for those portfolios for purposes of 
paragraph (a)(2)(iii) of section 4 of this appendix.
    (c) Specific risk not modeled. (1) If the [banking 
organization]'s VaR-based measure does not capture all material 
aspects of specific risk for a portfolio of debt, equity, or 
correlation trading positions, the [banking organization] must 
calculate a specific-risk add-on for the portfolio under the 
standardized measurement method as described in section 10 of this 
appendix.
    (2) A [banking organization] must calculate a specific risk add-
on under the standardized measurement method as described in section 
10 of this appendixfor all of its securitization positions that are 
not modeled under section 9 of this appendix.

Section 8. Incremental Risk

    (a) General requirement. A [banking organization] that measures 
the specific risk of a portfolio of debt positions under section 
7(b) using internal models must calculate at least weekly an 
incremental risk measure for that portfolio according to the 
requirements in this section. The incremental risk measure is the 
[banking organization]'s measure of potential losses due to 
incremental risk over a one-year time horizon at a one-tail, 99.9 
percent confidence level, either under the assumption of a constant 
level of risk, or under the assumption of constant positions. With 
the prior approval of the [Agency], a [banking organization] may 
choose to include portfolios of equity positions in its incremental 
risk model, provided that it consistently includes such equity 
positions in a manner that is consistent with how the [banking 
organization] internally measures and manages the incremental risk 
of such positions at the portfolio level. If equity positions are 
included in the model, for modeling purposes default is considered 
to have occurred upon the default of any debt of the issuer of the 
equity position. A [banking organization] may not include 
correlation trading positions or securitization positions in its 
incremental risk measure.
    (b) Requirements for incremental risk modeling. For purposes of 
calculating the incremental risk measure, the incremental risk model 
must:
    (1) Measure incremental risk over a one-year time horizon and at 
a one-tail, 99.9 percent confidence level, either under the 
assumption of a constant level of risk, or under the assumption of 
constant positions.
    (i) A constant level of risk assumption means that the [banking 
organization] rebalances, or rolls over, its trading positions at 
the beginning of each liquidity horizon over the one-year horizon in 
a manner that maintains the [banking organization]'s initial risk 
level. The [banking organization] must determine the frequency of 
rebalancing in a manner consistent with the liquidity horizons of 
the positions in the portfolio. The liquidity horizon of a position 
or set of positions is the time required for a [banking 
organization] to reduce its exposure to, or hedge all of its 
material risks of, the position(s) in a stressed market. The 
liquidity horizon for a position or set of positions may not be less 
than the lower of three months or the contractual maturity of the 
position.
    (ii) A constant position assumption means that the [banking 
organization] maintains the same set of positions throughout the 
one-year horizon. If a [banking organization] uses this assumption, 
it must do so consistently across all portfolios.
    (iii) A [banking organization]'s selection of a constant 
position or a constant risk assumption must be consistent between 
the [banking organization]'s incremental risk model and its 
comprehensive risk model described in section 9, if applicable.
    (iv) A [banking organization]'s treatment of liquidity horizons 
must be consistent between the [banking organization]'s incremental 
risk model and its comprehensive risk model described in section 9, 
if applicable.
    (2) Recognize the impact of correlations between default and 
migration events among obligors.
    (3) Reflect the effect of issuer and market concentrations, as 
well as concentrations that can arise within and across product 
classes during stressed conditions.
    (4) Reflect netting only of long and short positions that 
reference the same financial instrument.
    (5) Reflect any material mismatch between a position and its 
hedge.
    (6) Recognize the effect that liquidity horizons have on dynamic 
hedging strategies. In such cases, a [banking organization] must:
    (i) Choose to model the rebalancing of the hedge consistently 
over the relevant set of trading positions;
    (ii) Demonstrate that the inclusion of rebalancing results in a 
more appropriate risk measurement;
    (iii) Demonstrate that the market for the hedge is sufficiently 
liquid to permit rebalancing during periods of stress; and
    (iv) Capture in the incremental risk model any residual risks 
arising from such hedging strategies.
    (7) Reflect the nonlinear impact of options and other positions 
with material nonlinear behavior with respect to default and 
migration changes.
    (8) Maintain consistency with the [banking organization]'s 
internal risk management methodologies for identifying, measuring, 
and managing risk.
    (c) Calculation of incremental risk capital requirement. The 
incremental risk capital requirement is the greater of:
    (1) The average of the incremental risk measures over the 
previous 12 weeks; or
    (2) The most recent incremental risk measure.

Section 9. Comprehensive Risk

    (a) General requirement. (1) Subject to the prior approval of 
the [Agency], a [banking organization] may use the method in this 
section to measure comprehensive risk, that is, all price risk, for 
one or more portfolios of correlation trading positions.
    (2) A [banking organization] that measures the price risk of a 
portfolio of correlation trading positions using internal models 
must calculate at least weekly a comprehensive risk measure that 
captures all price risk according to the requirements of this 
section. The comprehensive risk measure is either:
    (i) The sum of:
    (A) The [banking organization]'s modeled measure of all price 
risk determined according to the requirements in paragraph (b) of 
this section; and
    (B) A surcharge for the [banking organization]'s modeled 
correlation trading positions equal to the total specific risk add-
on for such positions as calculated under section 10 of this 
appendix multiplied by 15.0 percent; or
    (ii) With approval of the [Agency] and provided the [banking 
organization] has met the requirements of this section for a period 
of at least one year and can demonstrate the effectiveness of the 
model through the results of ongoing model validation efforts 
including robust benchmarking, the greater of:
    (A) The [banking organization]'s modeled measure of all price 
risk determined according to the requirements in paragraph (b) of 
this section; or
    (B) The total specific risk add-on that would apply to the 
bank's modeled correlation trading positions as calculated under 
section 10 of this appendix multiplied by 8.0 percent.

[[Page 1918]]

    (b) Requirements for modeling all price risk. If a [banking 
organization] uses an internal model to measure the price risk of a 
portfolio of correlation trading positions:
    (1) The internal model must measure comprehensive risk over a 
one-year time horizon at a one-tail, 99.9 percent confidence level, 
either under the assumption of a constant level of risk, or under 
the assumption of constant positions.
    (2) The model must capture all material price risk, including 
but not limited to the following:
    (i) The risks associated with the contractual structure of cash 
flows of the position, its issuer, and its underlying exposures;
    (ii) Credit spread risk, including nonlinear price risks;
    (iii) The volatility of implied correlations, including 
nonlinear price risks such as the cross-effect between spreads and 
correlations;
    (iv) Basis risk;
    (v) Recovery rate volatility as it relates to the propensity for 
recovery rates to affect tranche prices; and
    (vi) To the extent the comprehensive risk measure incorporates 
the benefits of dynamic hedging, the static nature of the hedge over 
the liquidity horizon must be recognized. In such cases, a [banking 
organization] must:
    (A) Choose to model the rebalancing of the hedge consistently 
over the relevant set of trading positions;
    (B) Demonstrate that the inclusion of rebalancing results in a 
more appropriate risk measurement;
    (C) Demonstrate that the market for the hedge is sufficiently 
liquid to permit rebalancing during periods of stress; and
    (D) Capture in the comprehensive risk model any residual risks 
arising from such hedging strategies;
    (3) The [banking organization] must use market data that are 
relevant in representing the risk profile of the [banking 
organization]'s correlation trading positions in order to ensure 
that the [banking organization] fully captures the material risks of 
the correlation trading positions in its comprehensive risk measure 
in accordance with this section; and
    (4) The [banking organization] must be able to demonstrate that 
its model is an appropriate representation of comprehensive risk in 
light of the historical price variation of its correlation trading 
positions.
    (c) Requirements for stress testing.
    (1) A [banking organization] must at least weekly apply 
specific, supervisory stress scenarios to its portfolio of 
correlation trading positions that capture changes in:
    (i) Default rates;
    (ii) Recovery rates;
    (iii) Credit spreads;
    (iv) Correlations of underlying exposures; and
    (v) Correlations of a correlation trading position and its 
hedge.
    (2) Other requirements. (i) A [banking organization] must retain 
and make available to the [Agency] the results of the supervisory 
stress testing, including comparisons with the capital requirements 
generated by the [banking organization]'s comprehensive risk model.
    (ii) A [banking organization] must report to the [Agency] 
promptly any instances where the stress tests indicate any material 
deficiencies in the comprehensive risk model.
    (d) Calculation of comprehensive risk capital requirement. The 
comprehensive risk capital requirement is the greater of:
    (1) The average of the comprehensive risk measures over the 
previous 12 weeks; or
    (2) The most recent comprehensive risk measure.

Section 10. Standardized Measurement Method for Specific Risk

    (a) General requirement. A [banking organization] must calculate 
a total specific risk add-on for each portfolio of debt and equity 
positions for which the [banking organization]'s VaR-based measure 
does not capture all material aspects of specific risk and for all 
securitization positions that are not modeled under section 9 of 
this appendix. A [banking organization] must calculate each specific 
risk add-on in accordance with the requirements of this section.
    (1) The specific risk add-on for an individual debt or 
securitization position that represents purchased credit protection 
is capped at the market value of the protection.
    (2) For debt, equity, or securitization positions that are 
derivatives with linear payoffs, a [banking organization] must risk 
weight the market value of the effective notional amount of the 
underlying instrument or index portfolio. A swap must be included as 
an effective notional position in the underlying instrument or 
portfolio, with the receiving side treated as a long position and 
the paying side treated as a short position. For debt, equity, or 
securitization positions that are derivatives with nonlinear 
payoffs, a [banking organization] must risk weight the market value 
of the effective notional amount of the underlying instrument or 
portfolio multiplied by the derivative's delta.
    (3) For debt, equity, or securitization positions, a [banking 
organization] may net long and short positions (including 
derivatives) in identical issues or identical indices. A [banking 
organization] may also net positions in depositary receipts against 
an opposite position in an identical equity in different markets, 
provided that the [banking organization] includes the costs of 
conversion.
    (4) A set of transactions consisting of either a debt position 
and its credit derivative hedge or a securitization position and its 
credit derivative hedge has a specific risk add-on of zero if the 
debt or securitization position is fully hedged by a total return 
swap (or similar instrument where there is a matching of payments 
and changes in market value of the position) and there is an exact 
match between the reference obligation of the swap and the debt or 
securitization position, the maturity of the swap and the debt or 
securitization position, and the currency of the swap and the debt 
or securitization position.
    (5) The specific risk add-on for a set of transactions 
consisting of either a debt position and its credit derivative hedge 
or a securitization position and its credit derivative hedge that 
does not meet the criteria of paragraph (a)(4) of this section is 
equal to 20.0 percent of the capital requirement for the side of the 
transaction with the higher capital requirement when the credit risk 
of the position is fully hedged by a credit default swap or similar 
instrument and there is an exact match between the reference 
obligation of the credit derivative hedge and the debt or 
securitization position, the maturity of the credit derivative hedge 
and the debt or securitization position, and the currency of the 
credit derivative hedge and the debt or securitization position.
    (6) The specific risk add-on for a set of transactions 
consisting of either a debt position and its credit derivative hedge 
or a securitization position and its credit derivative hedge that 
does not meet the criteria of either paragraph (a)(4) or (a)(5) of 
this section, but in which all or substantially all of the price 
risk has been hedged, is equal to the specific risk add-on for the 
side of the transaction with the higher specific risk add-on.
    (b) Debt and securitization positions. (1) Unless otherwise 
provided in paragraph (b)(2) of this section, the total specific 
risk add-on for a portfolio of debt or securitization positions is 
the sum of the specific risk add-ons for individual debt or 
securitization positions, as computed under this section. To 
determine the specific risk add-on for individual debt or 
securitization positions, a [banking organization] must multiply the 
absolute value of the current market value of each net long or net 
short debt or securitization position in the portfolio by the 
appropriate risk-weighting factor in Table 2. The following 
definitions apply to this paragraph, including Table 2:

  Table 2--Specific Risk Weighting Factors for Debt and Securitization
                                Positions
------------------------------------------------------------------------
                                                          Risk-weighting
            Category                Remaining maturity      factor (in
                                      (contractual)          percent)
------------------------------------------------------------------------
Government.....................  N/A....................            0.00
Qualifying.....................  6 months or less.......            0.25
                                 Over 6 months to 24                1.00
                                  months.
                                 Over 24 months.........            1.60

[[Page 1919]]

 
Other..........................  N/A....................            8.00
------------------------------------------------------------------------

     (i) The government category includes all debt instruments of 
central governments of OECD-based countries \4\ including bonds, 
Treasury bills, and other short-term instruments, as well as local 
currency instruments of non-OECD central governments to the extent 
the bank has liabilities booked in that currency.
---------------------------------------------------------------------------

    \4\ Organization for Economic Cooperation and Development 
(OECD)-based countries is defined in [the general risk-based capital 
rules].
---------------------------------------------------------------------------

    (ii) The qualifying category includes debt instruments of U.S. 
government-sponsored agencies, general obligation debt instruments 
issued by states and other political subdivisions of OECD-based 
countries, multilateral development banks, and debt instruments 
issued by U.S. depository institutions or OECD-banks that do not 
qualify as capital of the issuing institution.\5\ This category also 
includes other debt instruments, including corporate debt and 
revenue instruments issued by states and other political 
subdivisions of OECD countries, that are:
---------------------------------------------------------------------------

    \5\ U.S. government-sponsored agencies, multilateral development 
banks, and OECD banks are defined in [the general risk-based capital 
rules].
---------------------------------------------------------------------------

    (A) Rated investment-grade by at least two nationally recognized 
credit rating services;
    (B) Rated investment-grade by one nationally recognized credit 
rating agency and not rated less than investment-grade by any other 
credit rating agency; or
    (C) Unrated, but deemed to be of comparable investment quality 
by the reporting bank and the issuer has instruments listed on a 
recognized stock exchange, subject to review by the [Agency].
    (iii) The other category includes debt instruments that are not 
included in the government or qualifying categories.
    (2) Nth-to-default credit derivatives. The total 
specific risk add-on for a portfolio of nth-to-default 
credit derivatives is the sum of the specific risk add-ons for 
individual nth-to-default credit derivatives, as computed 
under this paragraph. The specific risk add-on for each 
nth-to-default credit derivative position applies 
irrespective of whether a [banking organization] is a net protection 
buyer or net protection seller. A [banking organization] must 
calculate the specific risk add-on for each nth-to-
default credit derivative as follows:
    (i) First-to-default credit derivatives.
    (A) The specific risk add-on for a first-to-default credit 
derivative is the lesser of:
    (1) The sum of the specific risk add-ons for the individual 
reference credit exposures in the group of reference exposures; or
    (2) The maximum possible credit event payment under the credit 
derivative contract.
    (B) Where a [banking organization] has a risk position in one of 
the reference credit exposures underlying a first-to-default credit 
derivative and this credit derivative hedges the [banking 
organization]'s risk position, the [banking organization] is allowed 
to reduce both the specific risk add-on for the reference credit 
exposure and that part of the specific risk add-on for the credit 
derivative that relates to this particular reference credit exposure 
such that its specific risk add-on for the pair reflects the bank's 
net position in the reference credit exposure. Where a [banking 
organization] has multiple risk positions in reference credit 
exposures underlying a first-to-default credit derivative, this 
offset is allowed only for the underlying reference credit exposure 
having the lowest specific risk add-on.
    (ii) Second-or-subsequent-to-default credit derivatives.
    (A) The specific risk add-on for a second-or-subsequent-to-
default credit derivative is the lesser of:
    (1) The sum of the specific risk add-ons for the individual 
reference credit exposures in the group of reference exposures, but 
disregarding the (n-1) obligations with the lowest specific risk 
add-ons; or
    (2) The maximum possible credit event payment under the credit 
derivative contract.
    (B) For second-or-subsequent-to-default credit derivatives, no 
offset of the specific risk add-on with an underlying reference 
credit exposure is allowed.
    (c) Equity positions. The total specific risk add-on for a 
portfolio of equity positions is the sum of the specific risk add-
ons of the individual equity positions, as computed under this 
section. To determine the specific risk add-on of individual equity 
positions, a [banking organization] must multiply the absolute value 
of the current market value of each net long or net short equity 
position by the appropriate risk-weighting factor as determined 
under this paragraph.
    (1) The [banking organization] must multiply the absolute value 
of the current market value of each net long or net short equity 
position by a risk-weighting factor of 8.0 percent. For equity 
positions that are index contracts comprising a well-diversified 
portfolio of equity instruments, the absolute value of the current 
market value of each net long or net short position is multiplied by 
a risk-weighting factor of 2.0 percent.\6\
---------------------------------------------------------------------------

    \6\ A portfolio is well-diversified if it contains a large 
number of individual equity positions, with no single position 
representing a substantial portion of the portfolio's total market 
value.
---------------------------------------------------------------------------

    (2) For equity positions arising from the following futures-
related arbitrage strategies, a [banking organization] may apply a 
2.0 percent risk-weighting factor to one side (long or short) of 
each position with the opposite side exempt from an additional 
capital requirement:
    (i) Long and short positions in exactly the same index at 
different dates or in different market centers; or
    (ii) Long and short positions in index contracts at the same 
date in different, but similar indices.
    (3) For futures contracts on main indices that are matched by 
offsetting positions in a basket of stocks comprising the index, a 
[banking organization] may apply a 2.0 percent risk-weighting factor 
to the futures and stock basket positions (long and short), provided 
that such trades are deliberately entered into and separately 
controlled, and that the basket of stocks is comprised of stocks 
representing at least 90.0 percent of the capitalization of the 
index. A main index refers to the Standard & Poor's 500 Index, the 
FTSE All-World Index, and any other index for which the [banking 
organization] can demonstrate to the satisfaction of the [AGENCY] 
that the equities represented in the index have liquidity, depth of 
market, and size of bid-ask spreads comparable to equities in the 
Standard & Poor's 500 Index and FTSE All-World Index.
    (d)(1) A [banking organization] must be able to demonstrate to 
the satisfaction of the [Agency] a comprehensive understanding of 
the features of a securitization position that would materially 
affect the performance of the position. The [banking organization]'s 
analysis must be commensurate with the complexity of the 
securitization position and the materiality of the position in 
relation to capital.
    (2) To support the demonstration of its comprehensive 
understanding, for each securitization position a [banking 
organization] must:
    (i) Conduct and document an analysis of the risk characteristics 
of a securitization position prior to acquiring the position, 
considering:
    (A) Structural features of the securitization that would 
materially impact the performance of the position, for example, the 
contractual cash flow waterfall, waterfall-related triggers, credit 
enhancements, liquidity enhancements, market value triggers, the 
performance of organizations that service the position, and deal-
specific definitions of default;
    (B) Relevant information regarding the performance of the 
underlying credit exposure(s), for example, the percentage of loans 
30, 60, and 90 days past due; default rates; prepayment rates; loans 
in foreclosure; property types; occupancy; average credit score or 
other measures of creditworthiness; average LTV ratio; and industry 
and geographic diversification data on the underlying exposure(s);
    (C) Relevant market data of the securitization, for example, 
bid-ask spreads, most recent sales price and historical price 
volatility, trading volume, implied market

[[Page 1920]]

rating, and size, depth and concentration level of the market for 
the securitization; and
    (D) For resecuritization positions, performance information on 
the underlying securitization exposures, for example, the issuer 
name and credit quality, and the characteristics and performance of 
the exposures underlying the securitization exposures; and
    (ii) On an on-going basis (no less frequently than quarterly), 
evaluate, review, and update as appropriate the analysis required 
under paragraph (d)(1) of this section for each securitization 
position.

Section 11. Market Risk Disclosures

    (a) Scope. A [banking organization] must comply with this 
section unless it is a consolidated subsidiary of a bank holding 
company or a depository institution that is subject to these 
requirements or of a non-U.S. banking organization that is subject 
to comparable public disclosure requirements in its home 
jurisdiction. Quantitative disclosures must be made publicly each 
calendar quarter. If a significant change occurs, such that the most 
recent reporting amounts are no longer reflective of the [banking 
organization]'s capital adequacy and risk profile, then a brief 
discussion of this change and its likely impact must be provided as 
soon as practicable thereafter. Qualitative disclosures that 
typically do not change each quarter may be disclosed annually, 
provided any significant changes are disclosed in the interim. If a 
[banking organization] believes that disclosure of specific 
commercial or financial information would prejudice seriously its 
position by making public certain information that is either 
proprietary or confidential in nature, the [banking organization] 
need not disclose these specific items, but must disclose more 
general information about the subject matter of the requirement, 
together with the fact that, and the reason why, the specific items 
of information have not been disclosed.
    (b) Disclosure policy. The [banking organization] must have a 
formal disclosure policy approved by the board of directors that 
addresses the [banking organization]'s approach for determining the 
market risk disclosures it makes. The policy must address the 
associated internal controls and disclosure controls and procedures. 
The board of directors and senior management must ensure that 
appropriate verification of the disclosures takes place and that 
effective internal controls and disclosure controls and procedures 
are maintained. One or more senior officers of the [banking 
organization] must attest that the disclosures meet the requirements 
of this appendix, and the board of directors and senior management 
are responsible for establishing and maintaining an effective 
internal control structure over financial reporting, including the 
disclosures required by this section.
    (c) Quantitative disclosures.
    (1) For each portfolio of covered positions, the [banking 
organization] must publicly disclose the following information at 
least quarterly:
    (i) The high, low, median, and mean VaR-based measures over the 
reporting period and the VaR-based measure at period-end;
    (ii) The high, low, median, and mean stressed VaR-based measures 
over the reporting period and the stressed VaR-based measure at 
period-end;
    (iii) The high, low, median, and mean incremental risk capital 
requirements over the reporting period and the incremental risk 
capital requirement at period-end;
    (iv) The high, low, median, and mean comprehensive risk capital 
requirements over the reporting period and the comprehensive risk 
capital requirement at period-end, with the period-end requirement 
broken down into appropriate risk classifications (for example, 
default risk, migration risk, correlation risk);
    (v) Separate measures for interest rate risk, credit spread 
risk, equity price risk, foreign exchange risk, and commodity price 
risk used to calculate the VaR-based measure; and
    (vi) A comparison of VaR-based estimates with actual gains or 
losses experienced by the [banking organization], with an analysis 
of important outliers.
    (2) In addition, the [banking organization] must publicly 
disclose the following information at least quarterly:
    (i) The aggregate amount of on-balance sheet and off-balance 
sheet securitization positions by exposure type; and
    (ii) The aggregate amount of correlation trading positions.
    (d) Qualitative disclosures.
    (1) For each portfolio of covered positions, the [banking 
organization] must publicly disclose the following information at 
least annually, or more frequently in the event of material changes 
for each portfolio:
    (i) The composition of material portfolios of covered positions;
    (ii) The [banking organization]'s valuation policies, 
procedures, and methodologies for covered positions including, for 
securitization positions, the methods and key assumptions used for 
valuing such positions, any significant changes since the last 
reporting period, and the impact of such change;
    (iii) The characteristics of the internal models used for 
purposes of this appendix. For the incremental risk capital 
requirement and the comprehensive risk capital requirement, this 
must include:
    (A) The approach used by the [banking organization] to determine 
liquidity horizons;
    (B) The methodologies used to achieve a capital assessment that 
is consistent with the required soundness standard; and
    (C) The specific approaches used in the validation of these 
models;
    (iv) A description of the approaches used for validating and 
evaluating the accuracy of internal models and modeling processes 
for purposes of this appendix;
    (v) For each market risk category (that is, interest rate risk, 
credit spread risk, equity price risk, foreign exchange risk, and 
commodity price risk), a description of the stress tests applied to 
the positions subject to the factor;
    (vi) The results of the comparison of the [banking 
organization]'s internal estimates for purposes of this appendix 
with actual outcomes during a sample period not used in model 
development;
    (vii) The soundness standard on which the [banking 
organization]'s internal capital adequacy assessment under this 
appendix is based, including a description of the methodologies used 
to achieve a capital adequacy assessment that is consistent with the 
soundness standard;
    (2) A description of the [banking organization]'s processes for 
monitoring changes in the credit and market risk of securitization 
positions, including how those processes differ for resecuritization 
positions; and
    (3) A description of the [banking organization]'s policy 
governing the use of credit risk mitigation to mitigate the risks of 
securitization and resecuritization positions.

    [End of Common Text]

List of Subjects

12 CFR Part 3

    Administrative practices and procedure, Capital, National banks, 
Reporting and recordkeeping requirements, Risk.

12 CFR Part 208

    Confidential business information, Crime, Currency, Federal Reserve 
System, Mortgages, reporting and recordkeeping requirements, 
Securities.

12 CFR Part 225

    Administrative practice and procedure, Banks, banking, Federal 
Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Securities.

12 CFR Part 325

    Administrative practice and procedure, Banks, banking, Capital 
Adequacy, Reporting and recordkeeping requirements, Savings 
associations, State non-member banks.

Adoption of Proposed Common Rule

    The adoption of the proposed common rules by the agencies, as 
modified by agency-specific text, is set forth below:

Department of the Treasury

Office of the Comptroller of the Currency

12 CFR Chapter I

Authority and Issuance

    For the reasons set forth in the common preamble, part 3 of chapter 
I of title 12 of the Code of Federal Regulations is proposed to be 
amended as follows:

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

    1. The authority citation for part 3 continues to read as follows:

    Authority:  12 U.S.C. 93a, 161, 1818, 3907 and 3909.


[[Page 1921]]


    2. Appendix B to part 3 is revised to read as set forth at the end 
of the common preamble.

Appendix B to Part 3--Risk-Based Capital Guidelines; Market Risk 
Adjustment

    3. Appendix B to part 3 is further amended by:
    a. Removing ``[the advanced capital adequacy framework]'' wherever 
it appears and adding in its place ``Appendix C to this part'';
    b. Removing ``[Agency]'' wherever it appears and adding in its 
place ``OCC'';
    c. Removing ``[Agency's]'' wherever it appears and adding in its 
place ``OCC's'';
    d. Removing ``[banking organization]'' wherever it appears and 
adding in its place ``bank'';
    e. Removing ``[banking organizations]'' wherever it appears and 
adding in its place ``banks'';
    f. Removing ``[Call Report or FR Y-9C]'' wherever it appears and 
adding in its place ``Call Report'';
    g. Removing ``[regulatory report]'' wherever it appears and adding 
in its place ``Consolidated Reports of Condition and Income (Call 
Report)'';
    h. Removing ``[the general risk-based capital rules]'' wherever it 
appears and adding in its place ``Appendix A to this part''.

Board of Governors of the Federal Reserve System

12 CFR Chapter II

Authority and Issuance

    For the reasons set forth in the common preamble, parts 208 and 225 
of chapter II of title 12 of the Code of Federal Regulations are 
proposed to be amended as follows:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)

    4. The authority citation for part 208 continues to read as 
follows:

    Authority:  12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-
338a, 371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 
1833(j), 1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1831w, 1831x, 
1835a, 1882, 2901-2907, 3105, 3310, 3331-3351, and 3905-3909; 15 
U.S.C. 78b, 78I(b), 78l(i), 780-4(c)(5), 78q, 78q-1, and 78w, 1681s, 
1681w, 6801, and 6805; 31 U.S.C. 5318; 42 U.S.C. 4012a, 4104a, 
4104b, 4106 and 4128.

    5. Appendix E to part 208 is revised to read as set forth at the 
end of the common preamble.

Appendix E to Part 208--Capital Adequacy Guidelines for State Member 
Banks: Market Risk Measure

    6. Appendix E to part 208 is amended by:
    a. Removing ``[the advanced capital adequacy framework]'' wherever 
it appears and adding in its place ``Appendix F to this part'';
    b. Removing ``[Agency]'' wherever it appears and adding in its 
place ``Board'';
    c. Removing ``[Agency's]'' wherever it appears and adding in its 
place ``Board's'';
    d. Removing ``[banking organization]'' wherever it appears and 
adding in its place ``bank'';
    e. Removing ``[banking organizations]'' wherever it appears and 
adding in its place ``banks'';
    f. Removing ``[Call Report or FR Y-9C]'' wherever it appears and 
adding in its place ``Call Report'';
    g. Removing ``[regulatory report]'' wherever it appears and adding 
in its place ``Consolidated Reports of Condition and Income (Call 
Report)'';
    h. Removing ``[the general risk-based capital rules]'' wherever it 
appears and adding in its place ``Appendix A to this part''.

PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL 
(REGULATION Y)

    7. The authority citation for part 225 continues to read as 
follows:

    Authority:  12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-
1, 1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, 
and 3909; 15 U.S.C. 1681s, 1681w, 6801 and 6805.

    8. Appendix E to part 225 is revised to read as set forth at the 
end of the common preamble.

Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies: Market Risk Measure

    9. Appendix E is amended by:
    a. Removing ``[the advanced capital adequacy framework]'' wherever 
it appears and adding in its place ``Appendix G to this part'';
    b. Removing ``[Agency]'' wherever it appears and adding in its 
place ``Board'';
    c. Removing ``[Agency's]'' wherever it appears and adding in its 
place ``Board's'';
    d. Removing ``[banking organization]'' wherever it appears and 
adding in its place ``bank holding company'';
    e. Removing ``[banking organizations]'' wherever it appears and 
adding in its place ``bank holding companies'';
    f. Removing ``[Call Report or FR Y-9C]'' wherever it appears and 
adding in its place ``FR Y-9C'';
    g. Removing ``[regulatory report]'' wherever it appears and adding 
in its place ``Consolidated Financial Statements for Bank Holding 
Companies (FR Y-9C)''; and
    h. Removing ``[the general risk-based capital rules]'' wherever it 
appears and adding in its place ``Appendix A to this part''.

Federal Deposit Insurance Corporation

12 CFR Chapter III

Authority and Issuance

    For the reasons set forth in the common preamble, part 325 of 
chapter III of title 12 of the Code of Federal Regulations is proposed 
to be amended as follows:

PART 325--CAPITAL MAINTENANCE

    10. The authority citation for part 325 continues to read as 
follows:

    Authority:  12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat. 
2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160, 2233 (12 
U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386, as amended 
by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note).

    11. Appendix C to part 325 is revised to read as set forth at the 
end of the common preamble.

Appendix C to Part 325--Risk-Based Capital for State Nonmember Banks: 
Market Risk

    12. Appendix C is further amended by:
    a. Removing ``[Agency]'' wherever it appears and adding in its 
place ``FDIC'';
    b. Removing ``[Agency's]'' wherever it appears and adding in its 
place ``FDIC's'';
    c. Removing ``[banking organization]'' wherever it appears and 
adding in its place ``bank'';
    d. Removing ``[banking organizations]'' wherever it appears and 
adding in its place ``banks'';
    e. Removing [Call Report or FR Y-9C] wherever it appears and adding 
in its place ``Call Report'';
    f. Removing ``[the advanced capital adequacy framework]'' wherever 
it appears and adding in its place ``Appendix D to this part'';
    g. Removing ``[regulatory report]'' wherever it appears and adding 
in its place ``Consolidated Reports of Condition and Income (Call 
Report)'';
    h. Removing ``[the general risk-based capital rules]'' wherever it 
appears and adding in its place ``Appendix A to this part''.


[[Page 1922]]


    Dated: December 15, 2010.
John Walsh,
Acting Comptroller of the Currency.
    By order of the Board of Governors of the Federal Reserve 
System, December 14, 2010.
Robert deV. Frierson,
Deputy Secretary of the Board.
    Dated at Washington, DC, this 14th of December 2010. By order of 
the Board of Directors. Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2010-32189 Filed 1-10-11; 8:45 am]
BILLING CODE 4810-33-P; 6210-01-P; 6714-01-P; 6720-01-P