[Federal Register Volume 77, Number 169 (Thursday, August 30, 2012)]
[Rules and Regulations]
[Pages 53059-53115]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-16759]



[[Page 53059]]

Vol. 77

Thursday,

No. 169

August 30, 2012

Part V





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

12 CFR Parts 208 and 225





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Federal Deposit Insurance Corporation

12 CFR Part 325





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Risk-Based Capital Guidelines: Market Risk; Rule

Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / 
Rules and Regulations

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket ID: OCC-2012-0002]
RIN 1557-AC99

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-1401]
RIN 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: Joint final rule.

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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 revising their market risk capital 
rules to better capture positions for which the market risk capital 
rules are appropriate; reduce procyclicality; enhance the rules' 
sensitivity to risks that are not adequately captured under current 
methodologies; and increase transparency through enhanced disclosures. 
The final rule does not include all of the methodologies adopted by the 
Basel Committee on Banking Supervision for calculating the standardized 
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 of 2010. Instead, the final rule includes alternative 
methodologies for calculating standardized specific risk capital 
requirements for debt and securitization positions.

DATES: The final rule is effective January 1, 2013.

FOR FURTHER INFORMATION CONTACT: OCC: Roger Tufts, Senior Economic 
Advisor, Capital Policy Division, (202) 874-4925, or Ron Shimabukuro, 
Senior Counsel, or Carl Kaminski, Senior 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, Assistant Director, (202) 530-6260, Connie 
Horsley, Manager, (202) 452-5239, Tom Boemio, Manager, (202) 452-2982, 
Dwight Smith, Senior Supervisory Financial Analyst, (202) 452-2773, or 
Jennifer Judge, Supervisory Financial Analyst, (202) 452-3089, Capital 
and Regulatory Policy, Division of Banking Supervision and Regulation; 
or Benjamin W. McDonough, Senior Counsel, (202) 452-2036, or April C. 
Snyder, Senior Counsel, (202) 452-3099, Legal Division. For the hearing 
impaired only, Telecommunication Device for the Deaf (TDD), (202) 263-
4869.
    FDIC: Karl Reitz, Chief, Capital Markets Strategies Section, 
kreitz@fdic.gov; Bobby R. Bean, Associate Director, bbean@fdic.gov; 
Ryan Billingsley, Chief, Capital Policy Section, rbillingsley@fdic.gov; 
David Riley, Senior Policy Analyst, dariley@fdic.gov, Capital Markets 
Branch, Division of Risk Management Supervision, (202) 898-6888; or 
Mark Handzlik, Counsel, mhandzlik@fdic.gov, Michael Phillips, Counsel, 
mphillips@fdic.gov, Greg Feder, Counsel, gfeder@fdic.gov, or Ryan 
Clougherty, Senior Attorney, rclougherty@fdic.gov; Supervision Branch, 
Legal Division, Federal Deposit Insurance Corporation, 550 17th Street 
NW., Washington, DC 20429.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
II. Overview of Comments
    1. Comments on the January 2011 Proposal
    2. Comments on the December 2011 Amendment
III. Description of the Final Market Risk Capital Rule
    1. Scope
    2. Reservation of Authority
    3. 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. Modeling Standards for Specific Risk
    10. Standardized Specific Risk Capital Requirement
    Debt and Securitization Positions
    Treatment Under the Standardized Measurement Method for Specific 
Risk for
    Modeled Correlation Trading Positions and Non-modeled 
Securitization Positions
    Equity Positions
    Due Diligence Requirements for Securitization Positions
    11. Incremental Risk Capital Requirement
    12. Comprehensive Risk Capital Requirement
    13. Disclosure Requirements
IV. Regulatory Flexibility Act Analysis
V. OCC Unfunded Mandates Reform Act of 1995 Determination
VI. Paperwork Reduction Act
VII. Plain Language

I. Introduction

    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 central bank 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

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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 final rule uses the term ``bank'' to include banks 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 and 12 CFR part 167 (OCC); 12 CFR parts 208 and 
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 requirement under the 
internal models approach (see http://www.bis.org/press/p970918a.htm).
    \5\ 61 FR 47358 (September 6, 1996). In 1996, the Office of 
Thrift Supervision did not implement the market risk framework for 
savings associations and savings and loan holding companies. 
However, also included in today's Federal Register, the agencies are 
proposing to expand the scope of their market risk capital rules to 
apply to Federal and state savings associations as well as savings 
and loan holding companies. Therefore, the market risk rule would 
not apply to savings associations or savings and loan holding 
companies until such times as the agencies' were to finalize their 
proposal to expand the scope of their market risk capital rules. The 
agencies' market risk capital rules are at 12 CFR part 3, appendix B 
(OCC); 12 CFR parts 208 and 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 (Basel II), which was intended for use by individual 
countries as the basis for national consultation and implementation. 
Basel II sets forth a ``three-pillar'' framework that includes (1) 
Risk-based capital requirements for credit risk, market risk, and 
operational risk (Pillar 1); (2) supervisory review of capital adequacy 
(Pillar 2); and (3) market discipline through enhanced public 
disclosures (Pillar 3).
    Basel II 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) jointly published The Application of Basel II to Trading 
Activities and the Treatment of Double Default Effects (the 2005 
revisions). The BCBS incorporated the 2005 revisions into the June 2006 
comprehensive version of Basel II and followed its ``three-pillar'' 
structure. Specifically, the Pillar 1 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. 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.
    The BCBS began work on significant changes to the market risk 
framework in 2007 and developed reforms aimed at addressing issues 
highlighted by the financial crisis. These changes were published in 
the BCBS's 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).
    The 2009 revisions 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 a 
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' existing general VaR-based capital requirement. 
In June 2010, the BCBS published additional revisions to the market 
risk framework including a floor on the risk-based capital requirement 
for modeled correlation trading positions (2010 revisions).\6\
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    \6\ The June 2010 revisions can be found in their entirety at 
http://bis.org/press/p100618/annex.pdf.
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    Both the 2005 and 2009 revisions include provisions that reference 
credit ratings. The 2005 revisions also expanded the ``government'' 
category of debt positions to include all sovereign debt and changed 
the standardized specific risk-weighting factor for sovereign debt from 
zero percent to a range of zero to 12.0 percent based on the credit 
rating of the obligor and the remaining contractual maturity of the 
debt position.\7\
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    \7\ In the context of the market risk capital rules, the 
specific risk-weighting factor is a scaled measure that is similar 
to the ``risk weights'' used in the general risk-based capital rules 
(e.g., the zero, 20 percent, 50 percent, and 100 percent risk 
weights) for determining risk-weighted assets. The measure for 
market risk is multiplied by 12.5 to convert it to market risk 
equivalent assets, which are then added to the denominator of the 
risk-based capital ratios.
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    The 2009 revisions include changes to the specific risk-weighting 
factors for rated and unrated securitization positions. For rated 
securitization positions, the revisions assign a specific risk-
weighting factor based on the credit rating of a position, and whether 
such rating represents a long-term credit rating or a short-term credit 
rating. In addition, the 2009 revisions provide for the application of 
higher specific risk-weighting factors to rated resecuritization 
positions relative to similarly-rated securitization exposures. Under 
the 2009 revisions, unrated securitization positions were to be 
deducted from total capital, except when the unrated position was held 
by a bank that had approval and ability to use the supervisory formula 
approach (SFA) to determine the specific risk add-on for the unrated 
position. Finally, under Basel III: A Global Regulatory Framework for 
More Resilient Banks and Banking Systems (Basel III), published by the 
BCBS in December 2010, and revised in June 2011, certain items, 
including certain securitization positions, that had been deducted from 
total capital are assigned a risk weight of 1,250 percent.
    On January 11, 2011, the agencies issued a joint notice of proposed 
rulemaking (January 2011 proposal) that sought public comment on 
revisions to the agencies' market risk capital rules to implement the 
2005, 2009, and 2010 revisions.\8\ The key objectives of the proposal 
were to enhance the rule's sensitivity to risks not adequately 
captured, including default and credit migration; enhance modeling 
requirements in a manner that is consistent with advances in risk 
management since the agencies' initial implementation of the MRA; 
modify the definition of ``covered position'' to better capture 
positions for which treatment under the rule is appropriate; address 
shortcomings in the modeling of certain risks; address procyclicality; 
and increase transparency through enhanced disclosures. The objective 
of enhancing the risk sensitivity of the market risk capital rule is 
particularly important because of banks' increased exposures to traded 
credit and other structured products, such as credit default swaps 
(CDSs) and asset-backed securities, and exposures to less liquid 
products. Generally, the risks of these products have not been fully 
captured by VaR models that rely on a 10-business-day, one-tail, 99.0 
percent confidence level soundness standard.
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    \8\ 76 FR 1890 (January 11, 2011).
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    When publishing the January 2011 proposal, the agencies did not 
propose to implement those aspects of the 2005 and 2009 revisions that 
rely on the use of credit ratings due to certain provisions of the 
Dodd-Frank Wall

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Street Reform and Consumer Protection Act (the Dodd-Frank Act).\9\ The 
January 2011 proposal did not include new specific risk add-ons but 
included as an interim solution the treatment under the agencies' 
current market risk capital rules. Subsequently, after developing and 
considering alternative standards of creditworthiness, the agencies 
issued in December 2011 a joint notice of proposed rulemaking (NPR) 
that amended the January 2011 proposal (December 2011 amendment) to 
include alternative methodologies for calculating the specific risk 
capital requirements for covered debt and securitization positions 
under the market risk capital rules, consistent with section 939A of 
the Dodd-Frank Act. The agencies are now adopting a final rule, which 
incorporates comments received on both the January 2011 proposal and 
December 2011 amendment and includes aspects of the BCBS's 2005, 2009, 
and 2010 revisions (collectively, the MRA revisions) to the market risk 
framework.
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    \9\ Public Law 111-203, 124 Stat. 1376 (July 21, 2010). Section 
939A(a) of the Dodd-Frank Act provides that not later than 1 year 
after the date of enactment, each Federal agency shall: (1) Review 
any regulation issued by such agency that requires the use of an 
assessment of the credit-worthiness of a security or money market 
instrument; and (2) any references to or requirements in such 
regulations regarding credit ratings. Section 939A further provides 
that each such agency ``shall modify any such regulations identified 
by the review under subsection (a) to remove any reference to or 
requirement of reliance on credit ratings and to substitute in such 
regulations such standard of credit-worthiness as each respective 
agency shall determine as appropriate for such regulations.'' See 15 
U.S.C. 78o-7 note.
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II. Overview of Comments

    The agencies received six comment letters on the January 2011 
proposal and 30 comment letters on the December 2011 amendment from 
banking organizations, trade associations representing the banking or 
financial services industry, and other interested parties. This section 
of the preamble highlights commenters' main concerns and briefly 
describes how the agencies have responded to comments received in the 
final rule. A more detailed discussion of comments on specific 
provisions of the final rule is provided in section III of this 
preamble.

1. Comments on the January 2011 Proposal

    While commenters expressed general support for the proposed 
revisions to the agencies' market risk capital rules, many noted that 
the BCBS's market risk framework required further improvement in 
certain areas. For example, some commenters expressed concern about 
certain duplications in the capital requirements, such as the 
requirement for both a VaR-based measure and a stressed VaR-based 
measure, because such redundancies would result in excessive capital 
requirements and distortions in risk management. A different commenter 
noted that the use of numerous risk measures with different time 
horizons and conceptual approaches may encourage excessive risk taking.
    Although commenters characterized the conceptual overlap of certain 
provisions of the January 2011 proposal as resulting in duplicative 
capital requirements, the agencies believe that these provisions 
provide a prudent level of conservatism in the market risk capital 
rule.
    One commenter noted that the rule's VaR-based measure has notable 
shortcomings because it may encourage procyclical behavior and 
regulatory arbitrage. This commenter also asserted that because marked-
to-market assets can experience significant price volatility, the 
proposal's required capital levels may not be sufficient to address 
this volatility. The agencies are concerned about these issues but 
believe that the January 2011 proposal addressed these concerns, for 
example, through the addition of a stressed VaR-based measure.
    Commenters generally encouraged the agencies to continue work on 
the fundamental review of the market risk framework recently published 
as a consultative document through the BCBS, and one asserted that the 
agencies should wait until this work is completed before revising the 
agencies' market risk capital rules.\10\ While the agencies are 
committed to continued improvement of the market risk framework, they 
believe that the proposed modifications to the market risk capital 
rules are necessary to address current significant shortcomings in 
banks' measurement and capitalization of market risk.
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    \10\ The consultative document is available at http://www.bis.org/publ/bcbs219.htm.
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    Commenters also expressed concern that the January 2011 proposal 
differs from the 2005 and 2009 revisions in some respects, such as 
excluding from the definition of covered position a hedge that is not 
within the scope of the bank's hedging strategy, providing a more 
restrictive definition of two-way market, and establishing a surcharge 
for correlation trading position equal to 15 percent of the specific 
risk capital requirements for such positions. Commenters expressed 
concern that such differences could place U.S. banks at a competitive 
disadvantage to certain foreign banking organizations. In response to 
commenters' concerns, the agencies have revised the definition of two-
way market and adjusted the surcharge as discussed more fully in 
sections II.3 and II.12, respectively, of this preamble.

2. Comments on the December 2011 Amendment

    While many commenters responding to the December 2011 amendment 
commended the agencies' efforts to develop viable alternatives to 
credit ratings, most commenters indicated that the amendment did not 
strike a reasonable balance between accurate measurement of risk and 
implementation burden. Commenters' general concerns with the December 
2011 amendment include its overall lack of risk sensitivity and its 
complexity. The agencies have incorporated a number of changes into the 
final rule based on feedback received from commenters, including 
modifications to the approaches for determining capital requirements 
for corporate debt positions and securitization positions proposed in 
the December 2011 amendment. These changes are intended to increase the 
risk sensitivity of the approaches as well as simplify and reduce the 
difficulty of implementing the approaches.
    A few commenters asserted that the proposal exceeded the intent of 
the Dodd-Frank Act because the Dodd-Frank Act was limited to the 
replacement of credit ratings and did not include provisions that, in 
their estimation, would significantly increase capital requirements and 
thus negatively affect the economy. While the agencies acknowledge that 
capital requirements may generally increase under the final rule, the 
agencies also believe that the approach provides a prudent level of 
conservatism to address factors such as modeling uncertainties and that 
changes to the current rules are necessary to address significant 
shortcomings in the measurement and capitalization of market risk.
    One commenter suggested that the agencies allow banks a transition 
period of at least one year to implement the market risk capital rule 
after incorporation of alternatives to credit ratings. The agencies 
believe that a one-year transition period is not necessary for banks to 
implement the credit ratings alternatives in the final rule. The 
agencies have determined based on comments and discussions with 
commenters that the information required for calculation of capital 
requirements under the final rule will

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be available to banks. Other commenters indicated that the proposal 
would be burdensome for community banks if the agencies used the 
proposed approaches to address the use of credit ratings in the general 
risk-based capital rules. The agencies believe that it is important to 
align the methodologies for calculating specific risk-weighting factors 
for debt positions and securitization positions in the market risk 
capital rules with methodologies for assigning risk weights under the 
agencies' other capital rules. Such alignment reduces the potential for 
regulatory arbitrage between rules. The agencies are proposing similar 
credit rating alternatives in the three notices of proposed rulemaking 
for the risk-based capital requirements that are published elsewhere in 
today's Federal Register.
    Several commenters requested extensions of the comment period 
citing the complexity of the December 2011 amendment and resulting 
difficulty of assessing its impact in the time period given as well as 
the considerable burden faced by banks in evaluating various 
regulations related to the Dodd-Frank Act within similar time periods. 
The agencies considered these requests but believe that sufficient time 
was provided between the agencies' announcement of the proposed 
amendment on December 7, 2011, and the close of the comment period on 
February 3, 2012, to allow for adequate analysis of the proposal. The 
agencies also met with a number of industry participants during the 
comment period and thereafter in order to clarify the intent of the 
comments. Accordingly, the agencies chose not to extend the comment 
period on the December 2011 amendment.

III. Description of the Final Market Risk Capital Rule

1. Scope

    The 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) \11\ by requiring any bank subject to the market risk capital 
rule to adjust its risk-based capital ratios to reflect the market risk 
in its trading activities. The agencies did not propose to amend the 
scope of application of the market risk capital rule, which applies to 
any bank with aggregate trading assets and trading liabilities equal to 
10 percent or more of total assets or $1 billion or more. One commenter 
stated that the $1 billion threshold for the application of the market 
risk capital rule is not a particularly risk-sensitive means for 
determining the applicability of the rule. This commenter also 
expressed concern that the proposed threshold is too low, and 
recommended an adjustment to recognize the relative risk of exposures, 
calculated by offsetting trading assets and liabilities. The agencies 
believe that the current scope of application of the market risk 
requirements reasonably identifies banks with significant levels of 
trading activity and therefore have retained the existing threshold 
criteria. While the agencies are concerned about placing undue burden 
on banks, the agencies believe that the thresholds provided in the 
final rule are reasonable given the risk profile of banks identified by 
the current scope of application.
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    \11\ 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 include operational risk capital 
requirements), as applicable to the bank using the market risk 
capital rule.
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    Consistent with the January 2011 proposal, under the final rule, 
the primary federal supervisor of a bank that does not meet the 
threshold criteria would be still be able to apply the market risk 
capital rule to a bank. Conversely, the primary federal supervisor may 
exclude a bank from application of the rule if the supervisor were to 
deem it necessary or appropriate given the level of market risk of the 
bank or to ensure safe and sound banking practices.

2. Reservation of Authority

    The January 2011 proposal contained a reservation of authority that 
affirmed 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 that supervisor 
determined that the bank's capital requirement for market risk under 
the rule was not commensurate with the market risk of the bank's 
covered positions. In addition, the agencies anticipated that there may 
be instances when the January 2011 proposal 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 circumstances, a bank's primary 
federal supervisor could require the bank to assign a different risk-
based capital requirement to the covered position or portfolio of 
covered positions that more accurately reflects the risk of the 
position or portfolio. The January 2011 proposal also provided 
authority for a bank's primary federal supervisor to require the bank 
to calculate capital requirements for specific positions or portfolios 
using either the market risk capital rule or the credit risk capital 
rules, depending on which outcome more appropriately reflected the 
risks of the positions. The agencies did not receive any comment on the 
proposed reservation of authority and have adopted it without change in 
the final rule.

3. Definition of Covered Position

    The January 2011 proposal modified the definition of a covered 
position to include trading assets or 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. The January 2011 proposal defined a trading position 
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. Therefore, the 
characterization of an asset or liability as ``trading'' for purposes 
of U.S. Generally Accepted Accounting Principles (U.S. GAAP) would not 
on its own determine whether the asset or liability is a ``trading 
position'' for purposes of the January 2011 proposal. That is, being 
reported as a trading asset or trading liability on the regulatory 
reporting schedules is a necessary, but not sufficient, condition for 
meeting this aspect of the covered position definition under the 
January 2011 proposal. Such a position would also need to be either a 
trading position or hedge another covered position. 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 the 
material risk elements of the position in a two-way market.
    One commenter was concerned that this and other references to a 
two-way market in the January 2011 proposal could be construed to 
require that there be a two-way market for every covered position. The 
January 2011 proposal did not require that there be a two-way market 
for every covered position but did use that standard for defining some 
covered positions, such as certain correlation trading positions. 
Rather, in identifying its trading positions, a bank's policies and 
procedures must take into account 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.

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    The January 2011 proposal defined a two-way market as 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. Commenters 
expressed concern about the proposed definition of a two-way market 
including a requirement for settlement within five business days 
because it would automatically exclude a number of markets where 
settlement periods are longer than this time frame. In light of 
commenters' concerns, the agencies have modified this aspect of the 
definition in the final rule to require settlement within a 
``relatively short time frame conforming to trade custom.''
    Another commenter requested clarification regarding whether 
securities held as available for sale under U.S. GAAP may be treated as 
covered positions under the rule. This commenter also indicated that a 
narrow reading of the definitions of trading position and covered 
position could be interpreted to require banks to move positions 
between treatment under the market risk and the credit risk capital 
rules during periods of market stress. In particular, the commenter 
expressed concern about changes in capital treatment due to changes in 
a bank's short-term trading intent or the lack of a two-way market 
during periods of market stress that might be temporary. The commenter 
suggested that a bank should be able to continue to treat a position as 
a covered position if it met the definitional requirements when the 
position was established, notwithstanding changes in markets that led 
to a longer than expected time horizon for sale or hedging.
    The agencies note that under section 3 of the final rule, as under 
the proposed rule, a bank must have clearly defined policies and 
procedures that determine which of its positions are trading positions. 
With respect to the frequency of movement of positions, consistent with 
the requirements under U.S. GAAP, the agencies generally would expect 
re-designations of positions as trading or non-trading to be rare. 
Thus, in general, the agencies would not expect temporary market 
movements as described by the commenter to result in re-designations. 
In those limited circumstances where a bank re-designates a covered 
position, the bank should document the reasons for such action.
    Commenters suggested allowing a bank to treat as a covered position 
any hedge that is outside of the bank's hedging strategy. The proposed 
definition of covered position included hedges that offset the risk of 
trading positions. The agencies are concerned that a bank could craft 
its hedging strategies to recognize as covered positions certain non-
trading positions that are more appropriately treated under the credit 
risk capital rules. For example, mortgage-backed securities that are 
not held with the intent to trade, but are hedged with interest rate 
swaps, would not be covered positions. The agencies will review a 
bank's hedging strategies to ensure that they are not being manipulated 
in an inappropriate manner. Consistent with the concerns raised above, 
the agencies continue to believe that a position that hedges a trading 
position must be within the scope of a bank's hedging strategy as 
described in the rule. Thus, the final rule retains the treatment that 
hedges outside of a bank's hedging strategy as described in the final 
rule are not covered positions.
    Other commenters sought clarification as to whether an internal 
hedge (between a banking unit and a trading unit of the same bank) 
could be treated as a covered position if it materially or completely 
offset the risk of a non-covered position or set of positions, provided 
the hedge meets the definition of a covered position. The agencies note 
that internal hedges are not recognized for regulatory capital purposes 
because they are eliminated in consolidation.
    Commenters inquired as to whether the phrase ``restrictive 
covenants on its tradability,'' in the covered position definition, 
applies to securities transferable only to qualified institutional 
buyers as required under Rule 144A of the Securities Act of 1933. The 
agencies do not believe an instrument's designation as a 144A security 
in and of itself would preclude the instrument from meeting the 
definition of covered position. Another commenter asked whether level 3 
securities could be treated as covered positions.\12\ The agencies note 
that there is no explicit exclusion of level 3 securities from being 
designated as covered positions, as long as they meet the requirements 
of the covered position definition.
---------------------------------------------------------------------------

    \12\ See Financial Accounting Standards Board Statement 157. 
This statement defines fair value, establishes a framework for 
measuring fair value in U.S. GAAP and expands disclosures about fair 
value measurement. The fair value hierarchy gives the highest 
priority to quoted prices (unadjusted) in active markets for 
identical assets or liabilities (Level 1) and the lowest priority to 
unobservable inputs (Level 3). Level 3 securities are those for 
which inputs are unobservable in the market.
---------------------------------------------------------------------------

    One commenter requested clarification as to whether the rule would 
permit a bank to determine at the portfolio level whether a set of 
positions satisfies the definition of covered position, provided the 
bank is able to demonstrate a sufficiently robust process for making 
this determination. Another commenter found it confusing and 
operationally challenging that the definition of covered position had 
requirements both at the position level, for example, specific 
exclusions, and at the portfolio level, in regard to hedging 
strategies. The commenter felt that many of the definitional 
requirements are better suited to assessment at a portfolio level based 
on robust policies and procedures. The agencies require that the 
covered position determination be made at the individual position 
level. The requirements for policies and procedures for identifying 
trading positions, defining hedging strategies, and management of 
covered positions are requirements for application of the market risk 
capital rule broadly.
    The January 2011 proposal included within the definition of a 
covered position any foreign exchange or commodity position, regardless 
of whether it is a trading asset or trading liability. With prior 
supervisory approval, a bank could exclude from its covered positions 
any structural position in a foreign currency, which was defined as 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 a foreign 
branch 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 bank's 
tier 1 and tier 2 capital; or (4) a position designed to hedge a bank's 
capital ratios or earnings against the effect of adverse exchange rate 
movements on (1), (2), or (3).
    Also, the proposed definition of covered position had several 
explicit exclusions. It explicitly excluded any position that, in form 
or substance, acts as a liquidity facility that provides support to 
asset-backed commercial paper, as well as all intangible assets, 
including servicing assets. Intangible assets were excluded because 
their risks are explicitly addressed in the credit risk capital rules, 
often through a deduction from capital. The agencies received no 
comment on these exclusions and have incorporated them into the final 
rule.
    The definition of covered positions also excluded any hedge of a 
trading

[[Page 53065]]

position that the bank's primary federal supervisor determines is 
outside the scope of a bank's hedging strategy. One commenter objected 
to that exclusion; however, the agencies believe that sound risk 
management should be guided by explicit strategies subject to 
appropriate oversight by bank management and, therefore, have retained 
this provision in the final rule.
    Under the final rule and as proposed, the 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 
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 respect to such real estate holdings, 
the determination of marketability and liquidity can be difficult or 
even impractical because 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 to be a covered position. One 
commenter sought clarification that indirect real estate holdings (such 
as an exposure to a real estate investment trust) could qualify as a 
covered position. The agencies note that such an indirect investment 
may qualify, provided the position otherwise meets the definition of a 
covered position.
    Commenters requested clarification regarding whether hedge fund 
exposures that hedge a covered position are within the scope of a 
bank's hedging strategy qualify for inclusion in the definition of a 
covered position. Generally, hedge fund exposures are not covered 
positions because they typically are equity positions (as defined under 
the final rule) that are not publicly traded. The fact that a bank has 
a hedging strategy for excluded equity positions would not alone 
qualify such positions to be treated as covered positions under the 
rule.
    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 the positions excluded from the covered 
position definition have significant constraints in terms of a bank's 
ability to liquidate them readily and value them reliably on a daily 
basis.
    The covered position definition also excludes a credit derivative 
that a bank recognizes as a guarantee for purposes of calculating its 
risk-weighted assets under the agencies' credit risk capital rules if 
the credit derivative 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 treatment 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 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 because 
only one side of the transaction would be reflected in that measure. 
Accordingly, the final rule adopts this aspect of the proposed 
definition of covered position without change.
    Under the January 2011 proposal, in addition to commodities and 
foreign exchange positions, a covered position includes debt positions, 
equity positions, and securitization positions. Consistent with the 
January 2011 proposal, the final rule 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 final rule 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 final rule as under the January 2011 proposal, a 
securitization is defined as 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; \13\ (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).
---------------------------------------------------------------------------

    \13\ 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.
---------------------------------------------------------------------------

    Under the final rule, 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.
    Based on a particular transaction's leverage, risk profile, or 
economic substance, a bank's primary federal supervisor may also deem 
an exposure to a transaction to be a securitization exposure, even if 
the exposure does not meet the criteria in provisions (5), (6), or (7) 
above. A securitization position is 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 (2) an exposure that 
directly or indirectly references a

[[Page 53066]]

securitization exposure described in (1) above.
    Under the final rule as under the January 2011 proposal, a 
securitization position includes nth-to-default credit derivatives and 
resecuritization positions. The rule 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, a resecuritization is defined as a 
securitization in which one or more of the underlying exposures is a 
securitization exposure. A resecuritization position is (1) an on- or 
off-balance sheet exposure to a resecuritization or (2) an exposure 
that directly or indirectly references a resecuritization exposure 
described in (1).
    Some commenters expressed the desire to align the proposed 
definition of securitization in the market risk capital rule with the 
Basel II definition. For instance, one commenter suggested excluding 
from the definition of a securitization exposures that do not resemble 
what is customarily thought of as a securitization. The agencies note 
that the proposed definition is consistent with the definition 
contained in the agencies' advanced approaches rules and believe that 
remaining consistent is important in order to reduce regulatory capital 
arbitrage opportunities across the rules.
    The January 2011 proposal and the final rule define a correlation 
trading position as (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 (1) 
above. Under this 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 may include collateralized debt 
obligation (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. The agencies are adopting 
the definition of a debt, equity, securitization, and correlation 
trading position in the final rule as proposed.
    The agencies note that certain aspects of the final rule, including 
the definition of ``covered position,'' are substantially similar to 
the definitions of similar terms used in the agencies' proposed rule 
that would implement section 619 of the Dodd-Frank Act, familiarly 
referred to as the ``Volcker rule.'' The agencies intend to promote 
consistency across regulations employing similar concepts to increase 
regulatory effectiveness and reduce unnecessary burden.
    Section 619 of the Dodd-Frank Act contains certain prohibitions and 
restrictions on the ability of a bank (or nonbank financial company 
supervised by the Board under Title I of the Dodd-Frank Act) to engage 
in proprietary trading and have certain interests in, or relationships 
with, a covered fund as defined under section 619 of the Dodd-Frank Act 
and applicable regulations or private equity fund. Section 619 defines 
proprietary trading to mean engaging as a principal for the trading 
account, as defined under section 619(h)(6), of a bank (or relevant 
nonbank) in the purchase or sale of securities and other financial 
instruments.
    In November 2011, the agencies, together with the SEC sought 
comment on an NPR that would implement section 619 of the Dodd-Frank 
Act (the Volcker NPR). The Volcker NPR includes in the definition of 
``trading account'' all exposures of a bank subject to the market risk 
capital rule that fall within the definition of ``covered position,'' 
except for certain foreign exchange and commodity positions, unless 
they otherwise are in an account that meets the other prongs of the 
Volcker NPR ``trading account'' definition. Those prongs focus on 
determining whether a banking entity subject to section 619 of the 
Dodd-Frank Act is acquiring or taking a position in securities or other 
covered instruments principally for the purpose of short-term trading. 
Specifically, the definition of ``trading account'' under the Volcker 
NPR would include any account that is used by a bank to acquire or take 
one or more covered financial positions for the purpose of (1) Short-
term resale, (2) benefitting from actual or expected short-term price 
movements, (3) realizing short-term arbitrage profits, or (4) hedging 
one or more such positions.
    These standards correspond with the definition of ``trading 
position'' under the final market risk capital rule and are generally 
the type of positions to which the proprietary trading restrictions of 
section 13 of the BHC Act, which implements section 619 of the Dodd-
Frank Act, were intended to apply. Thus, the Volcker NPR would cover 
all positions of a bank that receive trading position treatment under 
the final market risk capital rule because they meet a nearly identical 
standard regarding short-term trading intent, thereby eliminating the 
potential for inconsistency or regulatory arbitrage in which a bank 
might characterize a position as ``trading'' for regulatory capital 
purposes but not for purposes of the Volcker NPR.
    Covered positions generally would be subject to the Volcker NPR 
unless they are foreign exchange or commodity positions that would not 
otherwise fall into the definition of ``trading account'' under the 
Volcker NPR or would otherwise be eligible for one of the exemptions to 
the prohibitions under the Volcker NPR and section 619 of the Dodd-
Frank Act.

4. Requirements for the Identification of Trading Positions and 
Management of Covered Positions

    Section 3 of the January 2011 proposal introduced new requirements 
for the identification of trading positions and the management of 
covered positions. These new requirements would enhance prudent capital 
management to address the issues that arise when banks include more 
credit risk-related, less liquid, and less actively traded products in 
their 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.
    Consistent with the January 2011 proposal, the final 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 (1) 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 (2) possible impairments to the liquidity of a 
position or its hedge.
    In addition, a bank must have clearly defined trading and hedging 
strategies. The bank's trading and hedging strategies for its trading 
positions must

[[Page 53067]]

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).
    Also consistent with the January 2011 proposal, the final 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 (1) Marking positions to market or model on a daily basis; 
(2) assessing on a daily basis the bank's ability to hedge position and 
portfolio risks and the extent of market liquidity; (3) establishment 
and daily monitoring of limits on positions by a risk control unit 
independent of the trading business unit; (4) daily monitoring by 
senior management of the information described in (1) through (3) 
above; (5) at least annual reassessment by senior management of 
established limits on positions; and (6) 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 January 2011 proposal introduced new requirements for the 
prudent valuation of covered positions, including maintaining policies 
and procedures for valuation, marking positions to market or to model, 
independent price verification, and valuation adjustments or reserves. 
Under the proposal, a bank's valuation of covered positions would be 
required to consider, as appropriate, unearned credit spreads, close-
out costs, early termination costs, investing and funding costs, future 
administrative costs, liquidity, and model risk. These valuation 
requirements reflect the agencies' concerns about deficiencies in 
banks' valuation of less liquid trading positions, especially in light 
of the prior 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 
proven at times to be inadequate in reflecting the full extent of the 
market risk of less liquid positions.
    Several commenters expressed concern about including consideration 
of future administrative costs in the valuation process because they 
believe calculation of this estimate would be difficult and arbitrary 
and would result in only a minor increase in total costs. In response 
to commenters' concern, the agencies removed this requirement from the 
final rule. In all other respects, the agencies are adopting the 
proposed requirements for the valuation of covered positions.

5. General Requirements for Internal Models

    Model Approval and Ongoing Use Requirements. The January 2011 
proposal would have required a bank to receive the prior written 
approval of its primary federal supervisor before using any internal 
model to calculate its market risk capital requirement. Also, a bank 
would be required to 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 agencies consider these requirements to be 
appropriate and are adopting them in the final rule.
    One commenter on the January 2011 proposal inquired as to whether 
models used by the bank, but developed by parties outside of the bank 
(commonly referred to as vendor models), are permissible for 
calculating market risk capital requirements given approval from the 
bank's primary federal supervisor. The agencies believe that a vendor 
model may be acceptable for purposes of calculating a bank's risk-based 
capital requirements if it otherwise meets the requirements of the rule 
and is properly understood and implemented by the bank.
    The final rule, consistent with the January 2011 proposal, requires 
a bank to notify its primary federal supervisor promptly if it makes 
any change to an internal model that would result in a material change 
in the 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 an 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. In the final rule, 
the agencies made minor modifications to this provision in section 
3(c)(3) to improve clarity and correct a cross-reference.
    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 effective as the risks of covered 
positions evolve and as the industry develops more sophisticated 
modeling techniques that better capture material risks. Therefore, 
under the final rule, as under the January 2011 proposal, a bank must 
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, in the bank's judgment, 
most appropriate for the bank's covered positions. It is essential that 
a bank continually review, and as appropriate, make adjustments to its 
models to help ensure that its market risk capital requirement reflects 
the risk of the bank's covered positions. A bank's primary federal 
supervisor will closely review the bank's model review practices as a 
matter of safety and soundness. The agencies are adopting these 
requirements in the final rule.
    Risks Reflected in Models. The final rule requires a bank to 
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 its 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. Consistent with the January 2011 
proposal, the final rule requires that risks arising from less liquid 
positions and positions with limited price transparency be modeled

[[Page 53068]]

conservatively under realistic market scenarios. The January 2011 
proposal also would require a bank to have a rigorous process for re-
estimating, re-evaluating, and updating its models to ensure continued 
applicability and relevance. The final rule retains these proposed 
requirements for internal models.
    Control, Oversight, and Validation Mechanisms. The final rule, 
consistent with the January 2011 proposal, requires a bank to have a 
risk control unit that reports directly to senior management and that 
is independent of its business trading units. In addition, the final 
rule provides specific model validation standards similar to those in 
the advanced approaches rules. Specifically, the final rule 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.
    Also consistent with the January 2011 proposal, the final rule 
requires validation to include an evaluation of the conceptual 
soundness of the internal models. This should include an 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.
    Validation also must include an ongoing monitoring process that 
includes a review of all model processes and verification that these 
processes are functioning as intended 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 January 2011 proposal required 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 final rule, consistent with the January 2011 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 large price 
movements, 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 adversely affecting the 
market. A bank's primary federal supervisor will evaluate the 
robustness and appropriateness of any bank stress tests required under 
the final rule through the supervisory review process.
    One commenter advocated an exemption from the proposed backtesting 
requirements for vendor models, and stated that banks using the same 
vendor model would be duplicating their efforts. The agencies believe 
that each bank must be responsible for ensuring that its market risk 
capital requirement reflects the risks of its covered positions. Each 
bank generally customizes some aspects of a vendor model and has a 
unique trading profile. Therefore, effective backtesting of either a 
vendor-provided or internally-developed model requires reference to a 
bank's experience with its own positions, which is consistent with 
guidance issued by the OCC and the Board with respect to the use of 
internal and third-party models.\14\
---------------------------------------------------------------------------

    \14\ See Supervisory Guidance on Model Risk Management, issued 
by the OCC and Federal Reserve (April 4, 2011).
---------------------------------------------------------------------------

    Consistent with the January 2011 proposal, the final 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). The final rule adopts the January 
2011 proposal's requirements pertaining to control, oversight, and 
validation mechanisms.
    Internal Assessment of Capital Adequacy. The final rule, consistent 
with the January 2011 proposal, requires a bank to have a rigorous 
process for assessing its overall capital adequacy in relation to its 
market risk. This 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. The final rule also adopts as proposed the 
requirement that a bank 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 will 
facilitate the supervisory review process as well as the bank's 
internal audit or other review procedures.

6. Capital Requirement for Market Risk

    Consistent with the January 2011 proposal, the final 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. 
However, the agencies are making changes to this calculation

[[Page 53069]]

in the final rule for banks subject to the advanced approaches rules 
(as amended in June 2011 to implement certain provisions in section 171 
of the Dodd-Frank Act).\15\ Under the advanced approaches rules, a bank 
is required to calculate its risk-based capital requirements under the 
general risk-based capital rules and the advanced approaches rules for 
purposes of determining compliance with minimum regulatory capital 
requirements. Thus, a bank subject to the advanced approaches rules is 
required to calculate both a general risk-based capital ratio 
denominator based on the general risk-based capital rules and an 
advanced risk-based capital ratio denominator based on the advanced 
approaches rules, each supplemented by the market risk capital rules as 
appropriate.\16\ Consequently, a bank subject to the advanced 
approaches rules and the market risk capital rules is also required to 
calculate both general adjusted risk-weighted assets and advanced 
adjusted risk-weighted assets under the market risk capital rules as 
the starting point to determine its risk-based capital ratio 
denominators. The agencies have revised the mechanics of section 4 of 
the final rule to be consistent with the risk-based capital ratio 
calculation requirements under the advanced approaches rules.
---------------------------------------------------------------------------

    \15\ 76 FR 37620 (June 28, 2011).
    \16\ Section 171 of the Dodd-Frank Act (12 U.S.C. 5371) requires 
the agencies to establish consolidated minimum risk-based capital 
requirements for depository institutions, bank holding companies, 
savings and loan holding companies, and nonbank financial companies 
supervised by the Board that are not less than the capital 
requirements the agencies establish under section 38 of the Federal 
Deposit Insurance Act to apply to insured depository institutions, 
regardless of total asset size or foreign financial exposure 
(generally applicable risk-based capital requirements). Currently, 
the general risk-based capital rules (supplemented by the market 
risk capital rule) are the generally applicable risk-based capital 
rules for purposes of section 171 of the Dodd-Frank Act. 12 U.S.C. 
5371.
---------------------------------------------------------------------------

    To calculate general market risk equivalent assets, a bank must 
multiply its general measure for market risk by 12.5. A bank subject to 
the advanced approaches rules also must calculate its advanced market 
risk equivalent assets by multiplying its advanced measure for market 
risk by 12.5. The final rule requires a bank's general and advanced 
measures for market risk to equal the sum of its VaR-based capital 
requirement, its stressed VaR-based capital requirement, specific risk 
add-ons, incremental risk capital requirement, comprehensive risk 
capital requirement, and capital requirement for de minimis exposures, 
each calculated according to defined applicable requirements. The 
components of the two measures for market risk described above are the 
same except for a potential difference stemming from the specific risk 
add-ons component. This difference arises because a bank may not use 
the SFA (discussed further below) to calculate its general measure for 
market risk for securitization positions while it must use the SFA, 
provided the bank has sufficient information, to calculate its advanced 
measure for market risk for the same positions. Consistent with the 
proposal, under the final rule, no adjustments are permitted to address 
potential double counting among any of the components of a bank's 
measure(s) for market risk.
    The final rule requires a bank to include in its measure for market 
risk any specific risk add-on as required under section 7 of the rule, 
determined using the standardized measurement methods described in 
section 10 of the rule. For a bank subject to the advanced approaches 
rules, these standardized measurement methods may include the SFA for 
securitization positions as discussed further below, where both the 
securitization position and the bank would meet the requirements to use 
the SFA. Such a bank must use the SFA in all instances where possible 
to calculate specific risk add-ons for its securitization positions. 
The agencies expect banks to use the SFA rather than the simplified 
supervisory formula approach (SSFA) in all instances where the data to 
calculate the SFA is available. The agencies expect a bank to apply the 
SFA on a consistent basis for a given position. For instance, if a bank 
is able to calculate a specific risk add-on for a securitization 
position using the SFA, the agencies would expect the bank to continue 
to have access to the information needed to perform this calculation on 
an ongoing basis for that position. If the bank were to change the 
methodology it used for calculating the specific risk add-on for such a 
securitization position, it should be able to explain and justify the 
change in approach (e.g., based on data availability) to its primary 
federal supervisor.
    As described above, a bank subject to the advanced approaches rules 
must calculate two market risk equivalent asset amounts: a general 
measure for market risk and an advanced measure for market risk. A bank 
subject to the advanced approaches rules may not use the SFA to 
calculate its general measure for market risk, because this methodology 
is not available under the general risk-based capital rules.
    The final rule requires a bank to include in both its general 
measure for market risk and its advanced measure for market risk its 
capital requirement for de minimis exposures. Specifically, a bank must 
add to its general and advanced measures 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. The agencies have made conforming changes to the 
proposed requirements for a bank to calculate its risk-based capital 
ratio denominator under the final rule. With regard to a bank's total 
risk-based capital numerator, the final rule, like the January 2011 
proposal, eliminates tier 3 capital and the associated allocation 
methodologies.
    As proposed, the final rule requires a bank's VaR-based capital 
requirement to equal the greater of (1) the previous day's VaR-based 
measure, or (2) 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 rule and as discussed further below. 
Similarly, the final rule requires a bank's stressed VaR-based capital 
requirement to equal the greater of (1) the most recent stressed VaR-
based measure; or (2) the average of the weekly stressed 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 rule. The 
multiplication factor applicable to the stressed-VaR based measure for 
purposes of this calculation is based on the backtesting results for 
the bank's 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.
    Determination of the Multiplication Factor. Consistent with the 
January 2011 proposal, the final rule requires a bank, each quarter, to 
compare each of its most recent 250 business days of trading losses 
(excluding fees, commissions, reserves, net interest income, and 
intraday trading) 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

[[Page 53070]]

are usually 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.
    The agencies sought comment on any challenges banks may face in 
formulating the proposed measure of trading loss, particularly whether 
any excluded components described above would present difficulties and 
the nature of those difficulties. Commenters expressed concern about 
challenges in calculating trading loss net of the above excluded 
components, noting that many banks only have trading gain and loss data 
which includes these components. According to commenters, because 
historical data are not always available for the components excluded 
from trading losses, it would be difficult to immediately create 
historical trading gains and losses that exclude these components. 
Commenters also indicated that banks will need to make changes to their 
systems to support this requirement. Because of these concerns, 
commenters requested additional time to come into compliance with the 
new requirement.
    The agencies acknowledge these implementation concerns and 
recognize that banks may not be able to immediately implement the new 
backtesting requirements. Therefore, the agencies have specified in the 
final rule that banks will be allowed up to one year after the later of 
either January 1, 2013, or the date on which a bank becomes subject to 
the rule, to begin backtesting as required under the final rule. In the 
interim, consistent with safety and soundness principles, a bank 
subject to the rule as of January 1, 2013, should continue to follow 
their current regulatory backtesting procedures, in accordance with its 
primary federal supervisor's expectations.
    One commenter expressed concern with the proposed backtesting 
requirements. In particular, the commenter described the frequency of 
calculations required for determining the number of exceptions as 
burdensome and unnecessary. The agencies believe that the comparison of 
daily trading loss to the corresponding daily VaR-based measure is a 
critical part of a bank's ongoing risk management. Such comparisons 
improve a bank's ability to make prompt adjustment to its market risk 
management to address factors such as changing market conditions and 
model deficiencies. A high number of exceptions could indicate modeling 
issues and warrants an increase in capital requirements by a higher 
multiplication factor. Accordingly, the agencies believe the 
multiplication factor and associated backtesting requirements provide 
appropriate incentives for banks to regularly update their VaR-based 
models and have adopted the proposed approach for determining the 
number of daily backtesting exceptions. With the exception of the 
timing consideration discussed above for calculating daily trading 
losses, the final rule retains the proposed backtesting requirements.

7. VaR-Based Capital Requirement

    Consistent with the January 2011 proposal, section 5 of the final 
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 
rule. The rule defines general market risk as 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. Specific risk is the risk of loss 
on a position that could result from factors other than broad market 
movements and includes event and default risk as well as idiosyncratic 
risk.\17\ Like the January 2011 proposal, the final rule also 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.
---------------------------------------------------------------------------

    \17\ 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 name or exposure(s). Idiosyncratic risk is the risk of 
loss in the value of a position that arises from changes in risk 
factors unique to that position.
---------------------------------------------------------------------------

    Under the final rule, a term repo-style transaction is defined as 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, U.S. 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 under the credit risk 
capital rules for calculating capital requirements for counterparty 
credit risk.
---------------------------------------------------------------------------

    \18\ See section 2 of the final rule for a complete definition 
of a term repo-style transaction.
---------------------------------------------------------------------------

    As in the January 2011 proposal, the final rule adds credit spread 
risk to the list of risk categories 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 its models and justifies 
the reasonableness of its process for measuring correlations. If the 
VaR-based measure does not incorporate empirical correlations across 
market risk categories, the bank must add the separate measures from 
its internal models used to calculate the VaR-based measure to 
determine the bank's aggregate VaR-based measure. The final rule, as 
proposed, requires models to include risks arising from the nonlinear 
price characteristics of option positions or positions with embedded 
optionality.
    Consistent with the 2009 revisions and the proposed rule, the final 
rule requires a bank to 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 used to capture the risks of the actual positions for which 
such proxies are used.
    Quantitative Requirements for VaR-based Measure. Like the January 
2011 proposal, the final rule does not change the existing quantitative 
requirements for the daily VaR-based measure. These include a 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

[[Page 53071]]

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.\19\
---------------------------------------------------------------------------

    \19\ Using the square root of time assumes that daily portfolio 
returns are independent and identically distributed. When this 
assumption is violated, the square root of time approximation is not 
appropriate.
---------------------------------------------------------------------------

    Consistent with the January 2011 proposal, the final 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 its risk-based capital requirements. The bank must update its 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 to identify the appropriate historical 
observation period, the bank must either (1) 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 (2) demonstrate to its 
primary federal supervisor that the method used is more effective than 
that described in (1) 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 for a bank to include these observations in its VaR-based 
measure.
    Also consistent with the January 2011 proposal, the final 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-based model 
to reflect risk factors appropriately. A bank's primary federal 
supervisor must approve the number of significant subportfolios the 
bank uses for subportfolio backtesting. While the final rule does not 
prescribe the basis for determining significant subportfolios, the 
primary federal supervisor may consider the bank's evaluation of 
factors such as trading volume, product types and number of distinct 
traded products, business lines, and number of traders or trading 
desks.
    The final rule, consistent with the January 2011 proposal, requires 
a bank to retain and make available to its primary federal supervisor, 
with no more than a 60-day lag, information for each subportfolio for 
each business day over the previous two years (500 business days) that 
includes (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 less than or a loss greater than 
reported in (2) above, based on the model used to calculate the VaR-
based measure described in (1) above).
    Daily information on the probability of observing a loss greater 
than that which occurred on any given 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 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 many 
times over a long interval provides information about the adequacy of 
the VaR model's ability to characterize the entire 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 does not adequately measure risk.
    The agencies solicited comment on whether the proposed subportfolio 
backtesting requirements would present any challenges and, if so, the 
specific nature of such challenges. In addition, the agencies sought 
comment on how to determine an appropriate number of subportfolios for 
purposes of these requirements. The agencies also requested comment on 
whether the p-value is a useful statistic for evaluating the efficacy 
of the VaR model in gauging market risk, as well as whether the 
agencies should consider other statistics and, if so, why.
    Several commenters urged the agencies to provide discretion and 
flexibility in identifying significant subportfolios. In particular, 
the commenters asked the agencies to allow banks to identify 
subportfolios based on the internal management structure of the bank. 
Notwithstanding these comments, the agencies believe the final rule, 
like the January 2011 proposal, provides an appropriate level of 
flexibility, as it does not prescribe a specific basis or parameters 
for determining significant subportfolios. Some commenters urged the 
agencies to be sensitive to the operational challenges associated with 
meeting subportfolio backtesting requirements that would be caused by 
organizational changes and model enhancements. The agencies recognize 
the operational challenges involved in meeting these requirements and 
will consider them as part of the ongoing evaluation of a bank's 
compliance with the backtesting requirements. Some commenters stated 
that the p-value statistic does not add sufficient explanatory power to 
warrant the calculation effort, and instead recommended the use of 
``band breaks'' to detect VaR model deficiencies.
    The agencies believe that the p-value statistic adds significant 
explanatory power and will facilitate a more appropriate evaluation of 
the VaR models by both banks and supervisors. The agencies believe that 
the so-called band-break methodology generally fails to recognize 
modeling deficiencies comprehensively and view the p-value as an 
improvement over this methodology. VaR models and the break-band 
methodology evaluate only one statistic at the tail of the profit and 
loss distribution while the p-values provide information to banks and 
supervisors regarding the appropriateness of the entire profit and loss 
distribution. The agencies have thus decided to adopt the proposed 
subportfolio backtesting requirements in the final rule as proposed.

8. Stressed VaR-Based Capital Requirement

    Like the January 2011 proposal, section 6 of the final rule 
requires a bank to 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

[[Page 53072]]

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, the final rule, consistent 
with the January 2011 proposal, requires a bank to 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.
    One commenter pointed out that one interpretation of the January 
2011 proposal could be inconsistent with a BCBS interpretation, which 
appears to indicate that a weighting scheme should not be used for the 
stressed VaR-based measure. The final rule requires a bank to use the 
same internal model for its VaR-based measure and its stressed VaR-
based measure. In general, if a bank chooses to use a weighting scheme 
for its VaR-based measure, the agencies expect this weighting scheme to 
also be used for its stressed VaR-based measure. Where there is not 
consistent use of weighting schemes across both measures, the bank 
should document and be able to explain its approach to its primary 
federal supervisor.
    The final rule also 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 (1) 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 (2) 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 these policies and procedures and must notify 
its primary federal supervisor if the bank makes any material changes 
to them. 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. The final rule retains the 
proposed quantitative requirements for the stressed VaR-based measure.

9. Modeling Standards for Specific Risk

    Consistent with the January 2011 proposal, the final rule allows a 
bank to use one or more internal models to measure the specific risk of 
a portfolio of debt or equity positions with specific risk. A bank is 
required to 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 final rule. However, a bank is 
not permitted to model the specific risk of securitization positions 
that are not modeled under section 9 of the rule. This treatment 
addresses regulatory arbitrage concerns 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 final rule and consistent with the January 2011 proposal, 
the internal models for specific risk are required to 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 debt and equity positions. 
Specifically, the final rule requires 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 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.
    Commenters asked for guidance or examples regarding the types of 
events captured by the definition of ``event risk.'' In response, the 
agencies have clarified the definition of event risk in the final rule 
as the risk of loss on equity or hybrid equity positions as a result of 
a financial event, such as the announcement or occurrence of a company 
merger, acquisition, spin-off or dissolution.
    The January 2011 proposal required a bank that does not have an 
approved internal model that captures all material aspects of specific 
risk for a particular portfolio of debt, equity, or correlation trading 
positions to use the standardized measurement method to calculate a 
specific risk add-on for that portfolio. This requirement was intended 
to provide banks with incentive to model specific risk more robustly. 
However, due to concerns about the ability of a bank to model the 
specific risk of certain securitization positions, the January 2011 
proposal required a bank to calculate a specific risk add-on using 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 (for example, certain interest rate swaps) 
have specific risk. Therefore, there would be 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 January 2011 proposal continued 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 VaR-based models for both general market risk and specific 
risk. A bank's use of a combination of approaches is 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. Except for the revision to the definition of event risk 
described above, the final rule retains the proposed requirements 
pertaining to modeling standards for specific risk.

10. Standardized Specific Risk Capital Requirement

    The final rule, like the January 2011 proposal, 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 all of its 
securitization positions that is not modeled under section 9 of the 
rule. The final rule requires a bank to calculate each specific risk 
add-on in accordance with the requirements of the final rule and add 
the total specific risk add-on for each portfolio to the applicable 
measure(s) for market risk.
    Some commenters asserted that the capital requirement for a given 
covered position should not exceed the maximum loss a bank could incur 
on

[[Page 53073]]

that position and requested that the agencies revise the rule 
accordingly to clarify this limitation. The agencies agree with the 
principle of limiting a bank's capital requirement for a covered 
position to its maximum possible loss. For long positions, this amount 
is the loss of all remaining value of the instrument, assuming no 
recovery. For short debt and securitization positions, this amount is 
the loss associated with the position becoming risk free. In some 
contexts (for example, equity positions), the maximum loss may be 
unbounded and not constrain the amount of capital to be held. The 
agencies have clarified in the final rule that the specific risk add-on 
for an individual debt or securitization position that represents 
purchased credit protection is capped at the current market value of 
the transaction, plus the absolute value of the present value of all 
remaining payments to the protection seller under the transaction where 
the sum is equal to the value of the protection leg of the transaction. 
The agencies have also clarified in the final rule that the specific 
risk add-on for an individual debt or securitization position that 
represents sold credit protection is capped at the effective notional 
amount of the credit derivative contract.
    For debt, equity, and securitization positions that are derivatives 
with linear payoffs (for example, futures and equity swaps), the final 
rule, consistent with the January 2011 proposal, requires a bank to 
apply a specific risk-weighting factor that is included in the 
calculation of a specific risk add-on to the market value of the 
effective notional amount of the underlying instrument or index 
portfolio (except where a bank would instead directly calculate a 
specific risk add-on for the position using the SFA). For debt, equity, 
and securitization positions that are derivatives with nonlinear 
payoffs (for example, options, interest rate caps, tranched positions), 
a bank must risk-weight the market value of the effective notional 
amount of the underlying instrument or instruments multiplied by the 
derivative's delta (that is, the change of the derivative's value 
relative to changes in the price of the underlying instrument or 
instruments). 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. A bank may net long and short positions 
(including derivatives) in identical issues or identical indices. A 
bank may also net positions in depository receipts against an opposite 
position in an identical equity in different markets, provided that the 
bank includes the costs of conversion.
    Like the January 2011 proposal, the final rule expands the 
recognition of credit derivative 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 swap 
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.
    The agencies are clarifying in the final rule that in cases where a 
total return swap references a portfolio of positions with different 
maturity dates, the total return swap maturity date must match the 
maturity date of the underlying asset in that portfolio that has the 
latest maturity date.
    The January 2011 proposal also specified that 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 described 
above, 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: (1) 
The credit risk of the position is fully hedged by a credit default 
swap (or similar instrument); (2) there is an exact match between the 
reference obligation and currency of the credit derivative hedge and 
the debt or securitization position; and (3) there is an exact match 
between the maturity date of the credit derivative hedge and the 
maturity date of the debt or securitization position.
    A commenter noted that credit derivatives are traded on market 
conventions based on standard maturity dates, whereas debt or 
securitization instruments may not have standard maturity dates. In 
response, in the final rule the agencies provide clarification 
regarding the circumstances under which a bank could consider a credit 
derivative hedge with a standard maturity date and the debt or 
securitization position that the credit derivative hedges to have 
matched maturity dates. In particular, the maturity date of the credit 
derivative hedge must be within 30 business days of the maturity date 
of the debt or securitization position in the case of sold credit 
protection. In the case of purchased credit protection, the maturity 
date of the credit derivative hedge must be later than the maturity 
date of the debt or securitization position, but no later than the 
standard maturity date for that instrument that immediately follows the 
maturity date of the debt or securitization position. In this case, the 
maturity date of the credit derivative hedge may not exceed the 
maturity date of the debt or securitization position by more than 90 
calendar days.
    Some commenters asked for clarification regarding whether the 20.0 
percent add-on treatment described above would apply to a credit 
derivative that fully hedges the credit risk of a debt or 
securitization position, provided there is an exact match as to the 
obligor or issuer but not necessarily an exact match as to the specific 
security or obligation. The agencies note that a credit derivative may 
allow delivery of more than one reference obligation in the event of 
default of an obligor. In that case, for purposes of determining the 
specific risk add-on, the criteria of an exact match in reference 
obligation is satisfied if the debt or securitization position is 
included among the deliverable obligations provided in the credit 
derivative documentation.
    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 a 
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 
higher specific risk add-on.
    With respect to calculating the specific risk add-on for 
securitization products under the standardized measurement method of 
section 10 of the January 2011 proposal, commenters indicated that a 
bank should be permitted to de-construct the components of tranched 
securitization

[[Page 53074]]

products in an index in order to give effect to the netting of long and 
short positions and hedges. Such an approach would mean, for example, 
that the exposure of various tranches that have some common issuers in 
otherwise different underlying portfolios would be calculated on an 
issuer basis and net exposure would be evaluated by aggregating across 
tranches at the issuer level. The agencies note that netting is allowed 
under the final rule, consistent with the proposal, for long and short 
securitization positions in identical issues or indices but not across 
positions in different issues or indices. Different tranches on the 
same underlying issue or index also do not qualify for netting. With 
regard to offsetting treatment, the agencies note that hedging offsets 
are available under certain conditions as discussed above. For 
instance, the hedge must have the identical underlying issue or index 
as the risk position and meet other criteria. A hedge with similar but 
different underlying issues or indices would not be a sufficient match 
for offsetting treatment. It is extremely unlikely that a hedge that is 
a different tranche from the securitization position would match 
changes in market value, fully hedge the credit risk, or even hedge 
substantially all the market risk of the securitization position. 
Therefore this matching of positions would not meet the definition of a 
hedge in the final rule, which requires a position or positions to 
offset all, or substantially all, of one or more material risk factors 
of another position.
    A commenter indicated that the agencies should permit banks to use 
a look-through approach for untranched indices that would allow netting 
at the individual issuer level of index positions against individual 
issuer credit derivative exposures. The agencies believe such treatment 
is appropriate in this case as netting of exposures between the 
individual issuer level and the index is possible, as changes in the 
market value of certain components of an index can be matched with 
individual issuer exposures. However, matching of positions at the 
individual issuer level with tranched index positions is difficult, as 
it is unlikely that changes in market value of the tranched index would 
reasonably match market value changes in tranched index positions. 
Therefore, the matching of such positions would also not meet the 
definition of a hedge under the final rule.
    Another commenter suggested specific treatments for various 
permutations of cash, synthetic, tranched, and untranched positions 
with different offsetting considerations. The agencies decided not to 
modify the final rule to accommodate these variations and believe the 
netting benefits and treatment of credit derivative hedges of debt and 
securitization positions as provided for in the final rule are 
consistent with the MRA.
    One commenter noted that a pay-as-you-go CDS should receive the 
same full hedge recognition as a total return swap for purposes of 
determining the specific risk add-on under the January 2011 proposal's 
standardized measurement method. While pay-as-you-go CDSs share several 
characteristics with total return swaps, the agencies do not believe 
the swap payments are sufficiently aligned with the changes in the 
market value of associated debt or securitization positions to warrant 
full offsetting treatment. If a credit derivative hedge does not have 
payments that match changes in the market value of the debt or 
securitization position, then it does not meet the criteria for no 
specific risk add-on. However, this hedge still may meet the criteria 
for a partial offset if it fully hedges the credit risk of the debt or 
securitization position.
    Another commenter suggested permitting banks to measure the 
specific risk of non-securitization positions that hedge securitization 
positions by using internal models rather than requiring use of the 
standardized measurement method for specific risk for these hedge 
positions. The commenter also requested that the agencies clarify 
whether securitization positions and their hedges or correlation 
trading positions and their hedges should be evaluated collectively or 
separately with regard to specific risk treatment under the January 
2011 proposal.
    In the case of a non-securitization position that hedges a 
securitization position that is not a correlation trading position, a 
bank is permitted to measure the specific risk of the hedge using 
either an approved internal model or the standardized measurement 
method. For the securitization position itself, a bank is required to 
use the standardized measurement method to calculate the specific risk 
add-on. Thus, in this case, the securitization position and its hedge 
are not necessarily treated collectively for purposes of measuring 
specific risk. In the case of a non-securitization position that hedges 
a correlation trading position, this same treatment applies to the 
extent the bank is not using a comprehensive risk model to measure the 
price risk of these positions. However, if a bank is using a 
comprehensive risk model for a portfolio of correlation trading 
positions, then the bank must use models to measure the specific risk 
of positions in that portfolio, inclusive of any hedges. That is, the 
portfolio is treated collectively when a bank is using a comprehensive 
risk model. The bank must also determine the total specific risk add-on 
for all positions in the portfolio using the standardized measurement 
method for purposes of determining the comprehensive risk measure. The 
final rule clarifies that a position that is a correlation trading 
position under paragraph (2) of that definition and that otherwise 
meets the definition of a debt position or an equity position shall be 
considered a debt position or an equity position, respectively, for 
purposes of section 10 of the final rule.
    Another commenter suggested permitting a bank the option of not 
using a derivative's delta to determine the effective notional amount 
of a derivative with a nonlinear payoff. The agencies expect an 
institution engaged in such derivatives activity to be able to 
calculate a delta and therefore have retained the delta calculation 
requirement in the final rule. The agencies believe this requirement 
provides the appropriate factor to convert the reference notional 
amount into an effective notional amount. While the final rule does not 
require supervisory approval to use the standardized measurement 
method, the model used to generate the delta value is subject to the 
model validation requirements under the final rule.
    Debt and Securitization Positions. In the December 2011 amendment, 
the agencies proposed alternative creditworthiness standards for 
certain positions, consistent with section 939A of the Dodd-Frank Act, 
as described above. In developing these alternative standards, the 
agencies strove to establish capital requirements comparable to those 
published in the 2005 and 2009 revisions to ensure international 
consistency and competitive equity. At the same time, the agencies 
sought to develop alternatives that incorporated relevant policy 
considerations, including risk sensitivity, transparency, consistency 
in application, and reduced opportunity for regulatory capital 
arbitrage.
    The proposed alternative standards would set specific risk-
weighting factors for various covered positions, including positions 
that are exposures to sovereign entities, depository institutions, 
public sector entities (PSEs), financial and non-financial companies, 
and securitization transactions. Each proposed standard (including 
alternatives to the proposed standards that the agencies requested

[[Page 53075]]

comment on in the December 2011 amendment) and the final rule 
provisions with respect to each standard, are discussed in detail in 
this section.
    Sovereign Debt Positions. Under the December 2011 amendment, a 
sovereign debt position was defined as a direct exposure to a sovereign 
entity. The proposal defined a sovereign entity as a central government 
or an agency, department, ministry, or central bank of a central 
government. A sovereign entity would not include commercial enterprises 
owned by the central government engaged in activities involving trade, 
commerce, or profit, which are generally conducted or performed in the 
private sector. The agencies have retained these definitions in the 
final rule.
    Under the December 2011 amendment, a bank would determine specific 
risk-weighting factors for sovereign debt positions based on the 
Organization for Economic Co-operation and Development (OECD) Country 
Risk Classifications (CRCs).\20\ The OECD's CRCs are used for 
transactions covered by the OECD arrangement on export credits in order 
to provide a basis under the arrangement for participating countries to 
calculate the premium interest rate to be charged to cover the risk of 
non-repayment of export credits.
---------------------------------------------------------------------------

    \20\ For more information on the OECD country risk 
classification methodology, see http://www.oecd.org/document/49/0,3343,en_2649_34169_1901105_1_1_1_1,00.html.
---------------------------------------------------------------------------

    The CRC methodology was established in 1999 and classifies 
countries into categories based on the application of two basic 
components (1) the country risk assessment model (CRAM), which is an 
econometric model that produces a quantitative assessment of country 
credit risk; and (2) the qualitative assessment of the CRAM results, 
which integrates political risk and other risk factors not fully 
captured by the CRAM. The two components of the CRC methodology are 
combined and result in countries being classified into one of eight 
risk categories (0-7), with countries assigned to the 0 category having 
the lowest possible risk assessment and countries assigned to the 7 
category having the highest. The OECD regularly updates CRCs for over 
150 countries. Also, CRCs are recognized by the BCBS as an alternative 
to credit ratings.\21\
---------------------------------------------------------------------------

    \21\ See ``Basel II,'' paragraph 55.
---------------------------------------------------------------------------

    In the December 2011 amendment, the agencies proposed to assign 
specific risk-weighting factors to CRCs in a manner consistent with the 
assignment of risk weights to CRCs under the Basel II standardized 
framework, as set forth in table 1.

     Table 1--Mapping of CRC to Risk Weights Under the Basel Accord
------------------------------------------------------------------------
                                                            Risk weight
                   CRC classification                      (in percent)
------------------------------------------------------------------------
0-1.....................................................               0
2.......................................................              20
3.......................................................              50
4 to 6..................................................             100
7.......................................................             150
No classification assigned..............................             100
------------------------------------------------------------------------

    Similar to the 2005 revisions, the proposed specific risk-weighting 
factors for sovereign debt positions would range from zero percent for 
those assigned a CRC of 0 or 1 to 12.0 percent for sovereign debt 
positions assigned a CRC of 7. Sovereign debt positions that are backed 
by the full faith and credit of the United States are to be treated as 
having a CRC of zero. Also similar to the 2005 revisions, the specific 
risk-weighting factor for certain sovereigns that are deemed to be of 
low credit risk based on their CRC would vary depending on the 
remaining contractual maturity of the position. The specific risk-
weighting factors for sovereign debt positions are shown in table 2.

                      Table 2--Specific Risk-Weighting Factors for Sovereign Debt Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                                 Specific risk-weighting factor       Percent
----------------------------------------------------------------------------------------------------------------
                                                         0-1                                                0.0
                                                ----------------------------------------------------------------
                                                               Remaining contractual maturity of            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          2-3   Remaining contractual maturity of            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                         4-6                                                8.0
                                                ----------------------------------------------------------------
                                                           7                                               12.0
----------------------------------------------------------------------------------------------------------------
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------

    Consistent with the general risk-based capital rules, in the 
December 2011 amendment the agencies proposed to permit banks to assign 
a sovereign debt position a specific risk-weighting factor that is 
lower than the applicable specific risk-weighting factor in table 2 if 
the position is denominated in the sovereign entity's currency, the 
bank has at least an equivalent amount of liabilities in that currency 
and the sovereign entity allows banks under its jurisdiction to assign 
the lower specific risk-weighting factor to the same exposure to the 
sovereign entity. The agencies have included these provisions in the 
final rule. As a supplement to the CRC methodology, to ensure that 
current sovereign defaults and sovereign defaults in the recent past 
are treated appropriately under the market risk capital rule, the 
agencies proposed applying a 12.0 percent specific risk-weighting 
factor to sovereign debt positions in the event the sovereign has 
defaulted during the previous five years, regardless of its CRC. The 
agencies proposed to define default by a sovereign entity as 
noncompliance with its external debt service obligations or its 
inability or unwillingness to service an existing obligation according 
to its terms, as evidenced by failure to make

[[Page 53076]]

full and timely payments of principal and interest, arrearages, or 
restructuring. In order to better capture restructuring of an 
obligation in the definition, the final rule defines default by a 
sovereign entity as noncompliance by the sovereign entity with its 
external debt service obligations or the inability or unwillingness of 
a sovereign entity to service an existing obligation according to its 
original contractual terms, as evidenced by failure to pay principal 
and interest timely and fully, arrearages, or restructuring. A default 
would include a voluntary or involuntary restructuring that results in 
a sovereign entity not servicing an existing obligation in accordance 
with the obligation's original terms. A bank must assign a specific 
risk-weighting factor of 8.0 percent to a sovereign debt position if 
the sovereign does not have a CRC assigned to it, unless the sovereign 
is in default.
    The December 2011 amendment also discussed the potential use of two 
market-based indicators, in particular CDS spreads or bond spreads, as 
alternatives or possible supplements to the proposed CRC methodology. 
The agencies indicated that CDS spreads for a given sovereign could be 
used to assign specific risk-weighting factors, with higher CDS spreads 
resulting in assignments of higher specific risk-weighting factors. 
Similarly, the agencies indicated that sovereign bond spreads could be 
used to assign specific risk-weighting factors, with higher bond credit 
spreads for a given sovereign resulting in higher specific risk-
weighting factors. The agencies described potential difficulties in 
implementing each of these market-based alternatives and solicited 
comment regarding potential solutions to these limitations.
    A number of commenters criticized the agencies' proposal to use 
CRCs for assigning specific risk-weighting factors, questioning the 
accuracy, reliability, and transparency of the CRC methodology. Two 
commenters raised policy concerns with respect to the purpose of 
section 939A around using measurements produced by the CRCs. One of 
these commenters expressed concern about the OECD having its own 
political and economic agenda. The other commenter noted that CRC 
ratings provide the most favorable rating to OECD members that are 
designated as high-income countries, without differentiating the 
varying risks among these countries.
    Commenters also suggested that the CRC methodology was not created 
by the OECD as sovereign risk classifications and should not be used 
for the purpose of measuring sovereign credit risk because they measure 
irrelevant factors such as transfer and convertibility risk. Others 
noted the technical challenges in using the CRC methodology as a result 
of its limited history that make correlation and probability of default 
difficult to calculate. Several commenters questioned the logic of 
replacing one third-party ratings system with another that has 
shortcomings, such as a lack of risk sensitivity. A few commenters also 
suggested that the increase in the specific risk-weighting factor due 
to default would not sufficiently address the lack of risk sensitivity 
of CRC ratings.
    Several commenters encouraged the agencies to further develop the 
market-based alternatives to the CRC methodology the agencies discussed 
in the proposal. One commenter indicated that either of the market-
based indicators would be superior to the CRC approach and should be 
developed further. Another commenter suggested an approach using CDS 
spreads in place of, or as a supplement to, the CRC methodology. One 
commenter indicated that sovereign bond spreads are not a reliable 
basis for the purpose of assigning specific risk-weighting factors 
because they can be affected by factors other than credit risk.
    While recognizing that CRCs have certain limitations, the agencies 
consider CRCs to be a reasonable alternative to credit ratings and to 
be a more granular measure of risk than the current treatment based on 
OECD membership. The proposed definition of default by a sovereign 
entity was in part meant to address concerns regarding a lack of 
differentiation among the OECD ``high-income'' countries. In addition, 
more than 10 years of historical data is available for CRCs, which the 
agencies believe is a sufficient basis to evaluate this information. 
While the two market-based indicators have some conceptual merit, as 
noted by certain commenters the application of either would require 
considerably more evaluation in order to mitigate potential CDS or bond 
spread volatility and other major operational difficulties. As the 
agencies believe practical application of these market-based indicators 
would require further study before they could be used in a prudential 
framework such as a final rule, the agencies are adopting the proposed 
CRC-based methodology in the final rule.
    In the final rule, the agencies made technical changes to section 
10(b)(2)(i) in order to improve clarity regarding when sovereign 
default will result in assignment of a 12.0 percent specific risk-
weighting factor. The language ``immediately upon determination that 
the sovereign entity has defaulted on any outstanding sovereign debt 
position'' has been replaced with ``immediately upon determination that 
a default has occurred.'' The language ``if the sovereign entity has 
defaulted on any sovereign debt position during the previous five 
years'' has been replaced with ``if a default has occurred within the 
previous five years.''
    Also, because the specific risk-weighting factors for debt 
positions that are exposures to a PSE, depository institution, foreign 
bank or credit union are tied to the CRC of the sovereign, the agencies 
have made clarifying and conforming changes to the specific risk-
weighting factor tables for these exposures. A bank must assign an 8.0 
percent specific risk-weighting factor to a sovereign debt position if 
the sovereign entity does not have a CRC assigned to it, unless the 
sovereign debt position must otherwise be assigned a higher specific 
risk-weighting factor. For each table, the agencies have added a 
``Default by the Sovereign Entity'' category with a corresponding 12.0 
percent specific risk-weighting factor.
Exposures to Certain Supranational Entities and Multilateral 
Development Banks
    The December 2011 amendment proposed assigning a specific risk-
weighting factor of zero to exposures to certain supranational entities 
and multilateral development banks. Consistent with the December 2011 
amendment, the final rule defines an MDB to include the International 
Bank for Reconstruction and Development, the Multilateral Investment 
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African 
Development Bank, the European Bank for Reconstruction and Development, 
the European Investment Bank, the European Investment Fund, the Nordic 
Investment Bank, the Caribbean Development Bank, the Islamic 
Development Bank, the Council of Europe Development Bank, and any other 
multilateral lending institution or regional development bank in which 
the U.S. government is a shareholder or contributing member or which 
the bank's primary federal supervisor determines poses comparable 
credit risk.
    Consistent with the treatment of exposures to certain supranational 
entities under Basel II, the final rule assigns a zero percent specific 
risk-weighting factor to debt positions that

[[Page 53077]]

are exposures to the Bank for International Settlements, the European 
Central Bank, the European Commission, and the International Monetary 
Fund.
    Also, generally consistent with the Basel framework, debt positions 
that are exposures to MDBs as defined in the final rule receive a zero 
percent specific risk-weighting factor under the final rule. This 
treatment is based on these MDBs' generally high-credit quality, strong 
shareholder support, and a shareholder structure comprised of a 
significant proportion of sovereign entities with strong 
creditworthiness.
    Debt positions that are exposures to other regional development 
banks and multilateral lending institutions that do not meet these 
requirements would generally be treated as corporate debt positions and 
would be subject to the methodology described below. The agencies 
received no comments on the proposed treatment of MDBs and are adopting 
the proposed treatment in the final rule.
    Exposures to Government-sponsored Entities. Under the December 2011 
amendment, a government-sponsored entity (GSE) was defined as an agency 
or corporation originally established or chartered by the U.S. 
government to serve public purposes specified by the U.S. Congress but 
whose obligations are not explicitly guaranteed by the full faith and 
credit of the U.S. government. Under the December 2011 amendment, debt 
positions that are exposures to GSEs would be assigned a specific risk-
weighting factor of 1.6 percent. GSE equity exposures, including 
preferred stock, were assigned a specific risk-weighting factor of 8.0 
percent.
    A few commenters suggested that the agencies treat debt positions 
that are exposures to GSEs as explicitly backed by the full faith and 
credit of the United States and assign them the same specific risk-
weighting factor as sovereign debt positions backed by the full faith 
and credit of the United States, which is zero. Although Fannie Mae and 
Freddie Mac are currently in government conservatorship and have 
certain capital support commitments from the U.S. Treasury, GSE 
obligations are not explicitly backed by the full faith and credit of 
the United States. Therefore, the agencies have adopted the proposed 
treatment of exposures to GSEs without change.
    Debt Positions that are Exposures to Depository Institutions, 
Foreign Banks, and Credit Unions. Under the December 2011 amendment, 
specific risk-weighting factors would be applied to debt positions that 
are exposures to depository institutions, foreign banks, or credit 
unions based on the applicable specific risk-weighting factor of the 
entity's sovereign of incorporation, as shown in table 3. The term 
``sovereign of incorporation'' refers to the country where an entity is 
incorporated, chartered, or similarly established. If a relevant 
entity's sovereign of incorporation is assigned to the 8.0 percent 
specific risk-weighting factor because of a lack of a CRC rating, then 
a debt position that is an exposure to that entity also would be 
assigned an 8.0 percent specific risk-weighting factor.

    Table 3--Specific Risk-Weighting Factors for Depository Institution, Foreign Bank, and Credit Union Debt
                                                    Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                                 Specific risk-weighting factor       Percent
----------------------------------------------------------------------------------------------------------------
                                                               Remaining contractual maturity of            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          0-2   Remaining contractual maturity of            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                           3                                                8.0
                                                ----------------------------------------------------------------
                                                         4-7                                               12.0
----------------------------------------------------------------------------------------------------------------
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------

    Consistent with the treatment under the general risk-based capital 
rules, debt positions that are exposures to a depository institution or 
foreign bank that are includable in the regulatory capital of that 
entity but that are not subject to deduction as a reciprocal holding 
would be assigned a specific risk-weighting factor of at least 8.0 
percent.
    A few commenters discussed the use of the CRC-based methodology to 
assign specific risk-weighting factors to positions that are exposures 
to depository institutions, foreign banks, and credit unions. Some of 
these commenters expressed concern that the CRC approach does not 
recognize differences in relative risk between individual entities 
under a given sovereign. One commenter suggested using a CDS spread 
methodology to increase risk sensitivity and decrease procyclicality, 
or where CDS spread data are unavailable, using asset swap or bond 
spreads as a proxy. Although there is a lack of risk differentiation 
among these entities in a given sovereign of incorporation, this 
approach allows for a consistent, standardized application of capital 
requirements to these positions and, like the Basel capital framework 
and the current market risk capital rule, links the ultimate credit 
risk associated with these entities to that of the sovereign entity. In 
contrast to the current treatment, however, the CRC-based methodologies 
allow for greater differentiation of risk among exposures. Also, 
market-based methodologies proposed for depository institutions would 
require further study to determine feasibility. Therefore, the agencies 
are adopting the CRC-based methodology as proposed.
    In addition, as discussed above, the agencies are clarifying in the 
final rule that a bank must assign a 12.0 percent specific risk-
weighting factor to a debt position that is an exposure to a foreign 
bank either upon determination that an event of sovereign default has 
occurred in the foreign bank's sovereign of incorporation, or if a 
sovereign default has occurred in the foreign bank's sovereign of 
incorporation within the previous five years.

[[Page 53078]]

    Exposures to Public Sector Entities. The December 2011 amendment 
would define a PSE as a state, local authority, or other governmental 
subdivision below the level of a sovereign entity. This definition does 
not include a commercial company owned by a government that engages in 
activities involving trade, commerce, or profit, which are generally 
conducted or performed in the private sector. In the December 2011 
amendment, the specific risk-weighting factor assigned to a debt 
position that is an exposure to a PSE would be based on the CRC 
assigned to the sovereign of incorporation of the PSE as well as 
whether the position is a general obligation or a revenue obligation of 
the PSE. This methodology is similar to the approach under the Basel II 
standardized approach for credit risk, which allows a bank to assign a 
risk weight to a PSE based on the credit rating of the PSE's sovereign 
of incorporation.
    Under the December 2011 amendment, a general obligation would be 
defined as a bond or similar obligation that is guaranteed by the full 
faith and credit of a state or other political subdivisions of a 
sovereign entity. A revenue obligation would be defined as a bond or 
similar obligation that is an obligation of a state or other political 
subdivision of a sovereign entity but which the government entity is 
committed to repay with revenues from a specific project or activity 
versus general tax funds.
    The proposed specific risk-weighting factors for debt positions 
that are exposures to general obligations and revenue obligations of 
PSEs, based on the PSE's sovereign of incorporation, are shown in 
tables 4 and 5, respectively.

               Table 4--Specific Risk-Weighting Factors for PSE General Obligation Debt Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                               General obligation specific risk-      Percent
                                                                        weighting factor
----------------------------------------------------------------------------------------------------------------
                                                               Remaining contractual maturity is            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          0-2   Remaining contractual maturity is            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                           3                                                8.0
                                                ----------------------------------------------------------------
                                                         4-7                                               12.0
----------------------------------------------------------------------------------------------------------------
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------


               Table 5--Specific Risk-Weighting Factors for PSE Revenue Obligation Debt Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                               General obligation specific risk-      Percent
                                                                        weighting factor
----------------------------------------------------------------------------------------------------------------
                                                               Remaining contractual maturity is            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          0-1   Remaining contractual maturity is            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                         2-3                                                8.0
                                                ----------------------------------------------------------------
                                                         4-7                                               12.0
----------------------------------------------------------------------------------------------------------------
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------

    In certain cases, the agencies have allowed a bank to use specific 
risk-weighting factors assigned by a foreign banking supervisor to debt 
positions that are exposures to PSEs in that supervisor's home country. 
Therefore, the agencies proposed to allow a bank to assign a specific 
risk-weighting factor to a debt position that is an exposure to a 
foreign PSE according to the specific risk-weighting factor that the 
foreign banking supervisor assigns. In no event, however, would the 
specific risk-weighting factor for such a position be lower than the 
lowest specific risk-weighting factor assigned to that PSE's sovereign 
of incorporation. The agencies have made a conforming change to the 
final rule, to more clearly indicate that the above treatment regarding 
exposures to PSEs in a supervisor's home country applies to both PSE 
general obligation and revenue obligation debt positions.
    Few commenters expressed views related to the treatment of 
positions that are exposures to PSEs. Several commenters expressed 
concern with the proposed approach noting that the methodology does not 
recognize differences in the relative risks of PSEs of the same 
sovereign. These commenters expressed support for the use of either CDS 
or bond spreads instead of the CRC-based approach. For the reasons 
discussed above with respect to the CRC methodology generally, the 
agencies have decided to finalize the proposed specific risk-weighting 
factors for PSEs. In addition, as for depository institutions, foreign 
banks and credit unions, the agencies are clarifying that a bank must 
assign a 12.0 percent specific risk-weighting factor to a debt position 
that is an exposure to a PSE either upon

[[Page 53079]]

determination that an event of sovereign default has occurred in the 
PSE's sovereign of incorporation, or if a sovereign default has 
occurred in the PSE's sovereign of incorporation within the previous 
five years.
    Corporate Debt Positions. The December 2011 amendment proposed to 
define a corporate debt position as a debt position that is an exposure 
to a company that is not a sovereign entity, the Bank for International 
Settlements, the European Central Bank, the European Commission, the 
International Monetary Fund, a multilateral development bank, a 
depository institution, a foreign bank, a credit union, a PSE, a GSE, 
or a securitization.
    In the December 2011 amendment, the agencies proposed to allow a 
bank to assign specific risk-weighting factors to corporate debt 
positions using a methodology that incorporates market-based 
information and historical accounting information (indicator-based 
methodology) to assign specific risk-weighting factors to corporate 
debt positions that are exposures to publicly-traded entities that are 
not financial institutions, and to assign a specific risk-weighting 
factor of 8.0 percent to all other corporate debt positions. Financial 
institutions were categorized separately from other entities because of 
the differences in their balance sheet structures. As an alternative to 
this methodology, the agencies proposed a simple methodology under 
which a bank would assign an 8.0 percent specific risk-weighting factor 
to all its corporate debt positions.
    In developing the December 2011 amendment, the agencies considered 
a number of alternatives to credit ratings for assigning specific risk-
weighting factors to debt positions that are exposures to financial 
institutions. However, each of these alternatives was viewed as either 
having significant drawbacks or as not being sufficiently developed to 
propose. Thus, the agencies proposed to assign a specific risk-
weighting factor of 8.0 percent to all corporate debt positions that 
are exposures to financial institutions.
    In the December 2011 amendment, the agencies requested comment on 
using bond spreads as an alternative approach to assign specific risk-
weighting factors to both financial and non-financial corporate debt 
positions. This type of approach would be forward-looking and may be 
useful for assigning specific risk-weighting factors to financial 
institutions.
    Another alternative that the agencies discussed in the December 
2011 amendment would permit banks to determine a specific risk-
weighting factor for a corporate debt position based on whether the 
position is ``investment grade,'' which would be defined in a manner 
generally consistent with the OCC's proposed revisions to its 
regulations at 12 CFR 1.2(d). The OCC proposed to revise its investment 
securities regulations to remove references to Nationally Recognized 
Statistical Rating Organization credit ratings, consistent with section 
939A of the Dodd-Frank Act.\22\ Under the OCC's proposed revisions, a 
security would be ``investment grade'' if the issuer of the security 
has an adequate capacity to meet financial commitments under the 
security for the projected life of the security. To meet this new 
standard, national banks would have to determine that the risk of 
default by the obligor is low and the full and timely repayment of 
principal and interest is expected. When determining whether a 
particular issuer has an adequate capacity to meet financial 
commitments under a security for the projected life of the security, 
the national banks would be required to consider a number of factors, 
which may include external credit ratings, internal risk ratings, 
default statistics, and other sources of information as appropriate for 
the particular security. While external credit ratings and assessments 
would remain a source of information and provide national banks with a 
standardized credit risk indicator, banks would be expected to 
supplement this information with due diligence processes and analyses 
appropriate for the bank's risk profile and for the size and complexity 
of the debt instrument. Under the OCC's approach, it would be possible 
for a security rated in the top four rating categories by a credit 
rating agency not to satisfy the proposed revised investment grade 
standard.
---------------------------------------------------------------------------

    \22\ 76 FR 73526 (Nov. 29, 2011).
---------------------------------------------------------------------------

    Several commenters expressed concerns that the proposed indicator-
based methodology for non-financial publicly traded company debt 
positions is over-simplified, not risk sensitive, and procyclical. 
These commenters indicated that the methodology does not distinguish 
risks across different industries nor does it reflect detailed debt 
characteristics that could affect creditworthiness, such as term 
structure. These commenters also stated that the methodology is 
excessively conservative and results in much higher capital 
requirements for corporate debt positions with minimal credit risk than 
required by the MRA. Several commenters also noted that the indicators 
tend to be backward-looking when capital requirements are intended to 
protect against the risk of possible future events.
    Some commenters supported the agencies' use of market data in 
assigning specific risk-weighting factors to corporate debt positions 
but also acknowledged that alternatives based on market data would 
require further study and refinement. These commenters suggested 
modifications to the proposed alternatives to be used to calculate 
specific risk capital requirements for corporate debt positions, such 
as recalibrating the indicator-based methodology, or using an approach 
based on relative CDS or bond spreads. Commenters acknowledged the 
agencies' concerns with using CDS or bond spreads and agreed that these 
approaches are imperfect but viewed these alternatives with refinement 
as potentially superior to the proposed indicator-based methodology.
    Specifically, several commenters suggested that a number of 
shortcomings of the proposed alternatives the agencies discussed in the 
December 2011 amendment could be addressed through technical 
modifications. These modifications include using rolling averages of 
CDS or bond spreads to reduce volatility, placing less reliance on 
inputs with illiquid underlying instruments, normalizing spreads 
against a more suitable benchmark, and possibly reducing the buckets to 
a binary ``low risk'' and ``high risk'' distinction to improve 
stability over time.
    With respect to assigning specific risk-weighting factors based on 
the OCC's investment grade approach, a few commenters expressed 
reservations about such an approach. While acknowledging that the 
approach would be simpler than the proposed indicator-based 
methodology, commenters noted that this approach would be subjective 
and could result in different banks arriving at different assessments 
of creditworthiness for similar exposures.
    The agencies continue to have significant reservations with the 
market-based alternatives, as bond markets may sometimes misprice risk 
and bond spreads may reflect factors other than credit risk. The 
agencies also are concerned that such an approach could introduce undue 
volatility into the risk-based capital requirements. The agencies have 
not identified a market-based alternative that they believe would 
provide sufficient risk sensitivity, transparency, and feasibility as a 
methodology for assigning specific risk-weighting factors to corporate 
debt positions. While certain suggested modifications of proposed 
alternatives

[[Page 53080]]

may provide some meaningful improvement, such modifications would 
require further study to determine appropriateness.
    The agencies have considered the commenters' concerns regarding the 
indicator-based methodology. The agencies have concluded that concerns 
about the feasibility and efficacy of the indicator-based methodology, 
as expressed by commenters, outweigh policy considerations for 
implementing it and have decided not to include the approach in the 
final rule. Instead, the agencies have adopted in the final rule an 
investment grade methodology for assigning specific risk-weighting 
factors to all corporate debt positions of entities that have issued 
and outstanding public debt instruments, revised to include a maturity 
factor consistent with the current rules. Adoption of the investment 
grade methodology is in response to the significant shortcomings of the 
indicator- and market-based methodologies noted by commenters, and the 
need for an alternative that is reasonably risk sensitive and simple to 
implement. Banks must apply the investment grade methodology to all 
applicable corporate debt positions as described below. Additionally, 
the agencies have not included the proposed ``simple methodology,'' 
which would assign a specific risk-weighting factor of 8.0 percent to 
all corporate debt positions, in the final rule. This alternative was 
introduced to allow banks an option that would mitigate calculation 
burden, but the agencies have determined that it is not necessary to 
include it in the final rule, as discussed below.
    The agencies acknowledge concerns regarding potential disparity 
between banks in their investment grade designation for similar 
corporate debt positions. However, the agencies believe that ongoing 
regulatory supervision of banks' credit risk assessment practices 
should address such disparities and that, on balance, the investment 
grade methodology would allow banks to calculate a more risk sensitive 
specific risk capital requirement for corporate debt positions, 
including those that are exposures to non-depository financial 
institutions. The agencies observe that this approach should be 
straightforward to implement because many banks would already be 
required to make similar investment grade determinations based on the 
OCC's revised investment permissibility standards. In addition, the 
agencies believe that concerns regarding potential disparate treatment 
would be addressed through ongoing supervision of bank's credit risk 
assessment practices.
    Under the final rule, except as provided below, for corporate debt 
positions of entities that have issued and outstanding publicly traded 
instruments, a bank will first need to determine whether or not a given 
corporate debt position meets the definition of investment grade. To be 
considered investment grade under the final rule, the entity to which 
the bank is exposed through a loan or security, or the reference entity 
(with respect to a credit derivative), must have adequate capacity to 
meet financial commitments for the projected life of the asset or 
exposure. An entity is considered to have adequate capacity to meet 
financial commitments if the risk of its default is low and the full 
and timely repayment of principal and interest is expected. 
Corporations with issued and outstanding public instruments generally 
have to meet significant public disclosure requirements which should 
facilitate a bank's ability to obtain information necessary to make an 
investment grade determination for such entities. In contrast, banks 
are less likely to have access to such information for an entity with 
no issued and outstanding public instruments. Therefore, banks will not 
be allowed to use the investment grade methodology for the positions of 
such ``private'' corporations, and positions that are exposures to such 
corporations will be assigned an 8.0 percent specific risk-weighting 
factor.
    Based on the bank's determination of whether a corporate debt 
position eligible for treatment under the investment grade methodology 
is investment grade, the bank must assign a specific risk-weighting 
factor based on the category and remaining contractual maturity of the 
position, in accordance with table 6 below. In general, there is a 
positive correlation between relative credit risk and the length of a 
corporate debt position's remaining contractual maturity. Therefore, 
corporate debt positions deemed investment grade with a shorter 
remaining contractual maturity are generally assigned a lower specific 
risk-weighting factor. Corporate debt positions not deemed investment 
grade must be assigned a specific risk-weighting factor of 12.0 
percent.

  Table 6--Specific Risk-Weighting Factors for Corporate Debt Positions
                 Under the Investment Grade Methodology
------------------------------------------------------------------------
                                                        Specific risk-
           Category            Remaining contractual   weighting factor
                                      maturity           (in percent)
------------------------------------------------------------------------
Investment Grade.............  6 months or less.....                0.50
                              ------------------------------------------
                               Greater than 6 and up                2.00
                                to and including 24
                                months.
                              ------------------------------------------
                               Greater than 24                      4.00
                                months.
------------------------------------------------------------------------
Not investment Grade.........  .....................               12.00
------------------------------------------------------------------------

    Consistent with the proposed rule, under the final rule, a bank 
must assign a specific risk-weighting factor of at least 8.0 percent to 
an interest-only mortgage-backed security that is not a securitization 
position. Also, because the ultimate economic condition of corporations 
is significantly dependent upon the economic conditions of their 
sovereign of incorporation, a bank shall not assign a corporate debt 
position a specific risk-weighting factor that is lower than the 
specific risk-weighting factor that corresponds to the CRC of the 
issuer's sovereign of incorporation.
    Securitization Positions. In the December 2011 amendment, the 
agencies proposed to allow banks to use a simplified version of the 
Basel II advanced approaches supervisory formula approach, referred to 
in the proposal as the SSFA, to assign specific risk-weighting factors 
to securitization and resecuritization positions. Additionally, the 
agencies proposed that a bank that either could not use the SSFA or 
chose not to use the SSFA must assign a specific risk-weighting factor 
of 100 percent to a securitization position,

[[Page 53081]]

(equivalent to a 1,250 percent risk weight).
    Similar to the SFA, the proposed SSFA is a formula that starts with 
a baseline capital requirement derived from the capital requirements 
that apply to all exposures underlying a securitization and then 
assigns specific risk-weighting factors based on the subordination 
level of a position. The proposed SSFA was designed to apply relatively 
higher capital requirements to the more risky junior tranches of a 
securitization that are the first to absorb losses, and relatively 
lower requirements to the most senior positions. As proposed in the 
December 2011 amendment, the SSFA makes use of a parameter 
``KG,'' which is the weighted-average risk weight of the 
underlying exposures calculated using the agencies' general risk-based 
capital rules. In addition, the proposed SSFA required as inputs the 
attachment and detachment points of a particular securitization 
position and the amount of cumulative losses experienced by the 
underlying exposures of the securitization.
    The SSFA as proposed would apply a 100 percent specific risk-
weighting factor (equivalent to a 1,250 percent risk weight) to 
securitization positions that absorb losses up to the amount of capital 
that would be required for the underlying exposures under the agencies' 
general risk-based capital rules had those exposures been held directly 
by a bank.
    In addition, the December 2011 amendment proposed a supervisory 
specific risk-weighting factor floor (flexible floor) that would have 
increased from 1.6 percent to as high as 100 percent when cumulative 
losses on the underlying assets of the securitization exceeded 150 
percent of KG. Thus, at the inception of a securitization, 
the SSFA as proposed would require more capital on a transaction-wide 
basis than would be required if the pool of assets had not been 
securitized. That is, if the bank held every tranche of a 
securitization, its overall capital charge would be greater than if the 
bank held the underlying assets in portfolio. The agencies believe this 
overall outcome is important in reducing the likelihood of regulatory 
capital arbitrage through securitizations.
    The agencies received significant comment on the proposed SSFA. 
Most commenters criticized the SSFA as proposed. Some commenters 
asserted that the application of the SSFA would result in prohibitively 
high capital requirements, which could lead to restricted credit access 
and place U.S. banks at a competitive disadvantage relative to non-U.S. 
banks. Commenters also stated that excessively high capital 
requirements for residential and commercial mortgage securitizations 
would stifle the growth of private residential mortgage-backed 
securitization and commercial real estate markets.
    Many commenters expressed concerns that the SSFA inputs lacked risk 
sensitivity. In particular, commenters stated that KG 
allowed for only two distinctions based on the type of underlying 
asset; residential mortgages and all other assets. Also, commenters 
asserted that the proposed SSFA would not consider structural features 
or enhancements (for example, trigger mechanisms and reserve accounts) 
that may mitigate the risk of a given securitization.
    In order to maintain uniform treatment between the final rule and 
the general risk-based capital rules, and minimize capital arbitrage, 
the agencies have maintained the definition of KG as the 
weighted-average total capital requirement of the underlying exposures 
calculated using the general risk-based capital rules. In terms of 
enhancements, the agencies note that the relative seniority of the 
position as well as all cash funded enhancements are recognized as part 
of the SSFA calculation.
    Commenters were concerned particularly with the flexible floor, 
which, as explained above, would increase the minimum specific risk-
weighting factor for a securitization position if losses on the 
underlying exposures reached certain levels. Several commenters noted 
that the proposed flexible floor would not take into consideration the 
lag between rapidly rising delinquencies and realized losses, which may 
lead to underestimation of market risk capital required to protect a 
bank against the actual risk of a position. In its place, commenters 
suggested using more forward-looking indicators, such as the level of 
delinquencies of a securitization's underlying exposures. Commenters 
also noted that in combination with a risk-insensitive KG, 
the flexible floor approach would lead to a situation in which 
relatively small losses may result in large increases in a senior 
tranche's capital requirements. Some commenters indicated that, in 
certain circumstances, the proposed approach could result in a high 
quality portfolio receiving a higher floor requirement than a lower 
quality portfolio with the same level of losses.
    Commenters also requested that the agencies clarify the definition 
of attachment point, because the proposed rule indicated that the 
attachment point may include a reserve account to the extent that cash 
is present in the account, but the preamble to the proposal indicated 
that credit enhancements, such as excess spread would not be 
recognized. In addition, commenters stated that the attachment point 
should recognize the carrying value of a securitization position if the 
position is held at a discount from par, because the cushion created by 
such a discount should be an important factor in determining the amount 
of risk-based capital a bank must hold against a securitization 
position. The agencies have considered whether discounts from par 
should be recognized as credit enhancement. The agencies are concerned 
about the uncertainty of valuing securitization positions and as a 
result have decided not to recognize discounts from par as credit 
enhancements for purposes of calculating specific risk add-ons for 
these positions.
    Commenters also stated that the proposed 20 percent absolute floor 
for specific risk-weighting factors assigned to securitization 
positions would be out of alignment with international standards and 
could place U.S. banks at a competitive disadvantage relative to non-
U.S. banks. The agencies believe that a 20 percent floor is reasonably 
prudent given recent performance of securitization structures during 
times of stress and have retained this floor in the final rule.
    Some commenters suggested that instead of applying the SSFA, the 
agencies should allow banks to ``look through'' senior-most 
securitization positions and use the risk weight applicable to the 
underlying assets of the securitization under the general risk-based 
capital rules. Given the considerable variability of tranche thickness 
for any given securitization, the agencies believe there is an 
opportunity for regulatory capital arbitrage with respect to the other 
approaches specified in the final rule. Therefore, the agencies have 
not included this alternative in the final rule.

[[Page 53082]]

[GRAPHIC] [TIFF OMITTED] TR30AU12.035

    As noted above, in the final rule, KG is the weighted-
average total capital requirement of the underlying exposures 
calculated using the general risk-based capital rules. The agencies 
believe it is important to calibrate specific risk-weighting factors 
for securitization exposures around the risk associated with the 
underlying assets of the securitization. This calibration also reduces 
the potential for arbitrage between the market risk and credit risk 
capital rules. The agencies therefore have maintained in the final rule 
the link between KG and the risk weights in the general 
risk-based capital rules and no additional distinctions based on the 
type of underlying assets has been added for determination of 
KG. The agencies believe that the SSFA as modified provides 
for more appropriate and risk-sensitive capital requirements for 
securitization positions.
BILLING CODE 4810-33-P

[[Page 53083]]

[GRAPHIC] [TIFF OMITTED] TR30AU12.000


[[Page 53084]]


[GRAPHIC] [TIFF OMITTED] TR30AU12.001


[[Page 53085]]


[GRAPHIC] [TIFF OMITTED] TR30AU12.002


[[Page 53086]]


[GRAPHIC] [TIFF OMITTED] TR30AU12.003

    Substituting this value into the equation yields:
    [GRAPHIC] [TIFF OMITTED] TR30AU12.004
    
    In the December 2011 amendment, the agencies described several 
possible alternative approaches to, or modifications of, the SSFA. 
These included alternative calibrations for the SSFA, a concentration 
ratio, a credit spread approach, a third-party vendor approach, and the 
use of the SFA for banks subject to the advanced approaches rules to 
calculate the specific risk-weighting factors for their securitization 
positions under the market risk capital rule. The agencies also 
requested comment on possible alterations to certain parameters in the 
SSFA, to better align specific risk-weighting factors produced by the 
SSFA with the specific risk-weighting factors that would otherwise be 
generated by the Basel Committee's market risk framework.
    Several commenters did not support adoption of the alternative 
market-based approaches or the vendor approach described in the 
December 2011 amendment, and stated that an analytical assessment of 
creditworthiness such as the SSFA would be preferable. In addition, 
several commenters strongly supported using the SFA as permitted under 
the advanced approaches rules, particularly for correlation trading 
positions.
    The agencies also have concerns about using a credit spread-based 
measure. These concerns relate particularly to the significant 
technical obstacles that would need to be overcome to make use of 
market based alternatives. The agencies therefore have decided to not 
include such measures as part of the final rule. Also, the agencies 
believe the vendor approach would require further study in order to 
implement it as part of a prudential framework.
    However, in response to favorable comments regarding inclusion of 
the SFA, the agencies are incorporating the SFA into the final 
rule.\23\ As discussed above, a bank that uses the advanced approaches 
rules and that qualifies for, and has a securitization position that 
qualifies for the SFA must use the SFA to calculate the specific risk 
add-on for the securitization position. The bank must calculate the 
specific risk add-on using the SFA as set forth in the advanced 
approaches rules and in accordance with section 10 of the final 
rule.\24\ As mentioned above, a bank may not use the SFA for the 
purpose of calculating its general risk-based capital ratio 
denominator. If the bank or the securitization position does not 
qualify for the SFA, the bank may assign a specific risk-weighting 
factor to the securitization position using the SSFA or assign a 100 
percent specific risk-weighting factor to the position. The agencies 
have established this hierarchy in order to provide flexibility to 
banks that have already implemented the SFA but also to avoid potential 
capital arbitrage by requiring uniform treatment of securitizations 
according to which approach is feasible for a bank, and not allowing 
selective use of the SFA or the SSFA for any given position.
---------------------------------------------------------------------------

    \23\ When using the SFA, a bank must meet minimum requirements 
under the Basel II internal ratings-based approach to estimate 
probability of default and loss given default for the underlying 
exposures. Under the U.S. risk-based capital rules, the SFA is 
available only to banks that have been approved to use the advanced 
approaches rules. See 12 CFR part 3, appendix C, section 45 (OCC); 
12 CFR part 208, appendix F, section 45, and 12 CFR part 225, 
appendix G, section 45 (Board); 12 CFR part 325, appendix D, section 
45 (FDIC).
    \24\ See id.
---------------------------------------------------------------------------

    Nth-to-default credit derivatives. Under the January 2011 proposal, 
the total specific risk add-on for a portfolio of nth-to-default credit 
derivatives would be calculated as the sum of the specific risk add-ons 
for individual nth-to-default credit derivatives, as computed therein. 
A bank would need

[[Page 53087]]

to 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 
would be the lesser of (1) the sum of the specific risk add-ons for the 
individual reference credit exposures in the group of reference 
exposures and (2) 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 the credit derivative hedges the bank's risk position, 
the bank would be 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 the 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 would be allowed only for the 
underlying exposure having the lowest specific risk add-on.
    For second-or-subsequent-to-default credit derivatives, the 
specific risk add-on would be 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. For second-or-subsequent-
to-default credit derivatives, no offset of the specific risk add-on 
with an underlying exposure would have been allowed under the proposed 
rule.
    Nth-to-default derivatives meet the definition of securitizations. 
To simplify the overall framework for securitizations while maintaining 
similar risk sensitivity and to provide for a more uniform capital 
treatment of all securitizations including nth-to-default derivatives 
the final rule requires that a bank determine a specific risk add-on 
using the SFA for, or assign a specific risk-weighting factor using the 
SSFA to an nth-to-default credit derivative. A bank that does not use 
the SFA or SSFA for its positions in an nth-to-default credit 
derivative must assign a specific risk-weighting factor of 100 percent 
to the position. A bank must either calculate a specific risk add-on or 
assign a specific risk-weighting factor to an nth-to-default 
derivative, irrespective of whether the bank is a net protection buyer 
or seller. A bank must determine its position in the nth-to-default 
credit derivative as the largest notional dollar amount of all the 
underlying exposure. This treatment should reduce the complexity of 
calculating specific risk capital requirements across a banking 
organization's securitization positions while aligning these 
requirements with the market risk of the positions in a consistent 
manner.
    When applying the SFA or the SSFA to nth-to-default derivatives, 
the attachment point (parameter A) is the ratio of the sum of the 
notional amounts of all underlying exposures that are subordinated to 
the bank's position to the total notional amount of all underlying 
exposures. For purposes of using the SFA to calculate the specific risk 
add-on for the bank's position in an nth-to-default derivative, 
parameter A must be set equal to the credit enhancement level (L) input 
to the SFA formula. In the case of a first-to-default credit 
derivative, there are no underlying exposures that are subordinated to 
the bank's position. In the case of a second-or-subsequent-to default 
credit derivative, the smallest (n-1) underlying exposure(s) are 
subordinated to the bank`s position.
    For the SFA and the SSFA, the detachment point (parameter D) is the 
sum of parameter A plus the ratio of the notional amount of the bank's 
position in the nth-to-default credit derivative to the total notional 
amount of the underlying exposures. For purposes of using the SFA to 
calculate the specific risk add-on for the bank's position in an nth-
to-default derivative, parameter D must be set to equal the L input 
plus the thickness of tranche (T) input to the SFA formula.
    Treatment under the Standardized Measurement Method for Specific 
Risk for Modeled Correlation Trading Positions and Non-modeled 
Securitization Positions. The December 2011 amendment specified the 
following treatment for the determination of the total specific risk 
add-on for a portfolio of modeled correlation trading positions and for 
non-modeled securitization positions. For purposes of a bank 
calculating its comprehensive risk measure with respect to either the 
surcharge or floor calculation for a portfolio of correlation trading 
positions modeled under section 9 of the rule, the total specific risk 
add-on would be the greater of: (1) The sum of the bank's specific risk 
add-ons for each net long correlation trading position calculated using 
the standardized measurement method, or (2) the sum of the bank's 
specific risk add-ons for each net short correlation trading position 
calculated using the standardized measurement method.
    For a bank's securitization positions that are not correlation 
trading positions and for securitization positions that are correlation 
trading positions not modeled under section 9 of the final rule, the 
total specific risk add-on would be the greater of: (1) The sum of the 
bank's specific risk add-ons for each net long securitization position 
calculated using the standardized measurement method, or (2) the sum of 
the bank's specific risk add-ons for each net short securitization 
position calculated using the standardized measurement method. This 
treatment would be consistent with the BCBS's revisions to the market 
risk framework and has been adopted in the final rule as proposed. With 
respect to securitization positions that are not correlation trading 
positions, the BCBS's June 2010 revisions provided a transitional 
period for this treatment. The agencies anticipate potential 
reconsideration of this provision at a future date.
    Equity Positions. Under the final rule and consistent with the 
January 2011 proposal, 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.
    Consistent with the 2009 revisions, the final rule requires a bank 
to 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 final rule, like the proposal 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 final 
rule also retains the current treatment for futures contracts on main 
indices that are

[[Page 53088]]

matched by offsetting positions in a basket of stocks comprising the 
index.
    Due Diligence Requirements for Securitization Positions. Like the 
proposed rule, the final rule requires banks to perform due diligence 
on all securitization positions. These due diligence requirements 
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 its performance by 
conducting and documenting the analysis described below of the risk 
characteristics of each 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 the bank's capital.
    The final rule requires a bank to conduct and document an analysis 
of the risk characteristics of each securitization position prior to 
acquiring the position, considering (1) Structural features of the 
securitization that would materially impact performance, 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; (2) 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 
loan-to-value ratio; and industry and geographic diversification data 
on the underlying exposure(s); (3) 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 (4) 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.
    The agencies sought comment on the challenges involved in meeting 
the proposed due diligence requirements and how the agencies might 
address these challenges while ensuring that a bank conducts an 
appropriate level of due diligence commensurate with the risks of its 
securitization positions. Several commenters agreed with the underlying 
purpose of the proposed due diligence requirements, which is to avoid 
undue reliance on credit ratings. However, they also stated that banks 
should still be allowed to consider credit ratings as a factor in the 
due diligence process. The agencies note that the rule does not 
preclude banks from considering the credit rating of a position as part 
of its due diligence. However, reliance on credit ratings alone is 
insufficient and not consistent with the expectations of the due 
diligence requirements.
    One commenter criticized the proposed requirements as excessive for 
``low risk'' securitizations, and others requested clarification as to 
whether the extent of due diligence would be determined by the relative 
risk of a position. Other commenters expressed concern that the 
proposed requirement to document the bank's analysis of the position 
would be very difficult to accomplish prior to acquisition of a 
position. As an alternative, some commenters suggested revising the 
documentation requirements to require completion by the end of the day, 
except for newly originated securities where banks should be allowed up 
to three days to satisfy the documentation requirement. Other 
commenters suggested a transition period for implementation of the 
proposed due diligence requirements, together with a provision that 
grandfathers positions acquired prior to the rule's effective date. The 
agencies appreciate these concerns and have revised the final rule to 
allow banks up to three business days after the acquisition of a 
securitization position to document its due diligence. Positions 
acquired before the final rule becomes effective will not be subject to 
this documentation requirement, but the agencies expect each bank to 
understand and actively manage the risks associated with all of its 
positions.
    Aside from changes noted above, the agencies have adopted in the 
final rule the due diligence requirements for securitizations as 
proposed.

11. Incremental Risk Capital Requirement

    Consistent with the proposed rule, under section 8 of the final 
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 (incremental risk 
model). Incremental risk consists of 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. 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. For purposes of the incremental risk capital 
requirement, default is deemed to occur with respect to an 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 final rule, a bank's incremental risk model 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, 
under the assumption of either a constant level of risk or 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 in a stressed market. The liquidity 
horizon for a position may not be less than the shorter 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 under the assumption of a 
constant level of risk because it puts into context a bank's overall 
risk exposure to an actively managed portfolio. 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

[[Page 53089]]

determine the rebalancing frequency in a manner consistent with the 
liquidity horizons of the positions in the portfolio. 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.
    Several commenters expressed concern that the proposed liquidity 
horizon of the shorter of three months or the contractual maturity of 
the position for the incremental risk measure would be excessively long 
for certain highly liquid exposures, including sovereign debt. A three-
month horizon is the minimum standard established by the BCBS for 
exposures with longer or no contractual maturities, and the agencies 
believe that it is important to establish a minimum liquidity horizon 
to address risks associated with stressed market conditions. Therefore, 
the agencies have not modified this requirement in the final rule.
    Under the January 2011 proposal, a bank could instead calculate the 
incremental risk measure under the assumption of constant positions. 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 would 
require a bank to promptly notify its primary federal supervisor if it 
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 final rule adopts these aspects of the proposal without 
change.
    Consistent with the proposal, the final rule requires a bank's 
incremental risk model to recognize the impact of correlations between 
default and credit migration events among obligors. In particular, the 
presumption of the existence of a macro-economically driven credit 
cycle implies some degree of correlation between 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 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.
    A 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).
    A bank's incremental risk model must also recognize the effect that 
liquidity horizons have on dynamic hedging strategies. In such cases, 
the bank must (1) Choose to model the rebalancing of the hedge 
consistently over the relevant set of trading positions; (2) 
demonstrate that inclusion of rebalancing results in more appropriate 
risk measurement; (3) demonstrate that the market for the hedge is 
sufficiently liquid to permit rebalancing during periods of stress; and 
(4) capture in the incremental risk model any residual risks arising 
from such hedging strategies.
    An 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 also must 
be consistent 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 rule must calculate its incremental risk capital requirement at 
least weekly. This capital requirement is the greater of (1) the 
average of the incremental risk measures over the previous 12 weeks and 
(2) the most recent incremental risk measure. The final rule adopts the 
proposed requirements for incremental risk without change.

12. Comprehensive Risk Capital Requirement

    Consistent with the January 2011 proposal, section 9 of the final 
rule permits a bank that has received prior approval from its primary 
federal supervisor, to measure all material price risks of one or more 
portfolios of correlation trading positions (comprehensive risk 
measure) using an internal 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 final 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 
as would be required under section 7(c) of the final rule, determined 
using the standardized measurement method for specific risk described 
in section 10 of the final rule.
    A bank's comprehensive risk model must meet several requirements. 
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 either of a constant level of 
risk or of constant positions. As noted above, 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.

[[Page 53090]]

    The final rule requires a bank's comprehensive risk model to 
capture all material price risk, including, but not limited to (1) 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); (2) credit spread risk, including 
nonlinear price risks; (3) volatility of implied correlations, 
including nonlinear price risks such as the cross-effect between 
spreads and correlations; (4) 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); (5) recovery rate volatility as it relates to the 
propensity for recovery rates to affect tranche prices; and (6) 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 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 final rule also requires a bank to 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. The final rule also 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.
    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. Under the January 2011 proposal, 
the comprehensive risk measure was equal to 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 proposed 
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 rule but have modified the surcharge in the final 
rule as described below.
    Under the final rule, a bank must initially 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 that certain conditions are met. These conditions are that the 
bank has met the comprehensive risk modeling requirements in the final 
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 bank's 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 does not sufficiently reflect 
the risks of the bank's modeled correlation trading positions.
    One commenter criticized the interim surcharge approach. The 
commenter stated that it is excessive, risk insensitive, and 
inconsistent with what the commenter viewed as a more customary 
practice of phasing in capital charges over time. The commenter, 
therefore, recommended that the agencies eliminate the surcharge 
provision and only adopt the floor approach discussed above. Several 
commenters also noted that the floor approach could eliminate a bank's 
incentive to hedge its risks, to the extent the floor is a binding 
constraint. Commenters suggested clarifications and modifications to 
the treatment of correlation trading positions, including applying a 
floor that is consistent with the MRA and recognizing hedges to avoid 
situations where unhedged positions are subjected to lower capital 
requirements than hedged positions.
    Notwithstanding these concerns, many banks have limited ability to 
perform robust validation of their comprehensive risk model using 
standard backtesting methods. Accordingly, the agencies believe it is 
appropriate to include a surcharge as an interim prudential measure 
until banks are better able to validate their comprehensive risk models 
and as an incentive for a bank to make ongoing model improvements. 
Accordingly, the agencies will maintain a surcharge in the rule but at 
a lower level of 8 percent. The agencies believe that a surcharge at 
this level helps balance the concerns raised by commenters regarding 
the proposed 15 percent surcharge and concerns about deficiencies in 
comprehensive risk models as mentioned above. Commenters also requested 
clarification as to whether multiple correlation trading portfolios can 
be treated on a combined basis for purposes of the comprehensive risk 
measure and floor calculations. The final rule clarifies that the floor 
applies to the aggregate comprehensive risk measure of all modeled 
portfolios.
    In addition to these requirements, the final rule, consistent with 
the proposal, requires a bank to 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 federal 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

[[Page 53091]]

indicate any material deficiencies in the comprehensive risk model.
    The agencies included various options for stress scenarios in the 
preamble to the proposed rule, including an approach that involved 
specifying stress scenarios based on credit spread shocks to certain 
correlation trading positions (for example, single-name CDSs, CDS 
indices, 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.
    The agencies sought comment on the benefits and drawbacks of the 
supervisory stress scenario requirements described above, and 
suggestions for possible specific stress scenario approaches for the 
correlation trading portfolio. One commenter suggested providing more 
specific requirements for the supervisory stress scenarios in the rule, 
particularly with regard to the time periods used to benchmark the 
shocks and candidate risk factors for banks to use in specifying the 
scenarios. This commenter believed that use of the same specifications 
across banks would improve supervisory benchmarking capabilities.
    Other commenters encouraged banks and supervisors to continue to 
work together to enhance stress test standards and approaches. These 
commenters also suggested that supervisors allow banks flexibility in 
stress testing their portfolios of correlation trading positions and 
recommended more benchmarking exercises through the use of so-called 
``test portfolio'' exercises.
    The agencies believe that benchmarking across banks is a worthwhile 
exercise, but wish to retain the proposed rule's level of specificity 
because appropriate factors, such as time periods and particular shock 
events, will likely vary over time and may be more appropriately 
specified through a different mechanism. The agencies appreciate the 
need to work with banks to improve stress testing, and expect to do so 
as part of the ongoing supervisory process. The agencies have evaluated 
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 have 
considered these comments and have retained the proposed stress testing 
requirements for the comprehensive risk measure in the final rule. 
Therefore, the final rule does not include supervisory stress 
scenarios.
    Several commenters expressed concern regarding how comprehensive 
risk models will be assessed by supervisors. One commenter expressed 
concern that it would be very difficult to benchmark against actual 
results of a comprehensive risk model, given that it is designed to 
capture ``deep tail loss'' over a relatively long time horizon. 
Instead, the commenter suggested comparing the distribution of shocks 
that produce the comprehensive risk measure to historical experiences 
or evaluating the pricing or market risk factor technique to determine 
if there is any reason to think that a deeper tail or longer horizon of 
the comprehensive risk measure is not supportable. The agencies believe 
that the techniques described by the commenter should be part of a 
robust benchmarking process. The agencies may use various methods 
including standard supervisory examinations, benchmarking exercises 
using test portfolios, and other relevant techniques to evaluate the 
models. The agencies recognize that backtesting models calibrated to 
long time horizons and higher percentiles is less informative than 
backtesting of standard VaR models. As a result, banks likely will need 
to use indirect model validation methods, such as stress tests, 
scenario analysis or other methods to assess their models.
    As under the proposal, under the final rule a bank that calculates 
a comprehensive risk measure under section 9 of the final rule is 
required to calculate its comprehensive risk capital requirement at 
least weekly. This 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.

13. Disclosure Requirements

    Like the January 2011 proposal, the final rule adopts 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 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.
    Consistent with the approach taken in the agencies' advanced 
approaches rules, the final rule requires a bank to comply with the 
disclosure requirements under section 12 of the 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 12 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 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 must attest that the 
disclosures meet the requirements, 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 12 of the final rule.
    The proposed rule would have required a bank, at least quarterly, 
to disclose publicly for each material portfolio of covered positions 
(1) The high, low, and mean VaR-based measures over the reporting 
period and the VaR-based measure at period-end; (2) the high, low, and 
mean stressed VaR-based measures over the reporting period and the 
stressed VaR-based measure at period-end; (3) the high, low, and mean 
incremental risk capital requirements over the reporting period and the 
incremental risk capital requirement at period-end; (4) the high, low, 
and mean comprehensive risk capital requirements over the reporting 
period and the comprehensive risk capital requirement at period-end; 
(5) 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 (6) a comparison of VaR-
based measures with actual results and an analysis of important 
outliers. In addition, a bank would have been required to publicly 
disclose the following information at least quarterly (1) the aggregate 
amount

[[Page 53092]]

of on-balance sheet and off-balance sheet securitization positions by 
exposure type and (2) the aggregate amount of correlation trading 
positions.
    The proposed rule also would have required a bank to make 
qualitative disclosures at least annually, or more frequently in the 
event of material changes, of the following information for each 
material portfolio of covered positions (1) The composition of material 
portfolios of covered positions; (2) 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; (3) 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; (4) a description of 
its approaches for validating the accuracy of its internal models and 
modeling processes; (5) a description of the stress tests applied to 
each market risk category; (6) the results of a comparison of the 
bank's internal estimates with actual outcomes during a sample period 
not used in model development; (7) 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; (8) 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 (9) a description of the bank's policy governing the use 
of credit risk mitigation to mitigate the risks of securitization and 
resecuritization positions.
    Several commenters expressed concerns that certain disclosure 
requirements, and in particular the requirement to disclose the median 
for various risk measures, exceeded those required under the 2009 
revisions. Upon consideration of such concerns, the agencies have 
removed this disclosure requirement from the final rule.
    Some commenters also asked for clarification as to whether banks 
have flexibility to determine or identify what constitutes a 
``portfolio'' and determine and disclose risk measures most meaningful 
for these portfolios. The final rule clarifies that the disclosure 
requirements apply to each material portfolio of covered positions. The 
market risk capital calculations should generally be the basis for 
disclosure content. A bank should provide further disclosure as needed 
for material portfolios or relevant risk measures.
    Some commenters also expressed concern that the proposed 
requirement to disclose information regarding stress test scenarios and 
their results could lead to the release of proprietary information. In 
response, the agencies note that the final rule, like the proposed 
rule, would allow a bank to withhold from disclosure any information 
that is proprietary or confidential if the bank believes that 
disclosure of specific commercial or financial information would 
prejudice seriously its position. Instead, the bank 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. In implementing this requirement, 
the agencies will work with banks on a case-by-case basis to address 
any questions about the types of more general information that would 
satisfy the final rule.
    Another commenter supported strengthening disclosure requirements 
regarding validation procedures and the stressed VaR-based measure, 
particularly correlation and valuation assumptions. The commenter 
believed such enhancements would provide the market more detailed 
information to assess a given bank's relative risk. The agencies 
recognize the importance of market discipline in encouraging sound risk 
management practices and fostering financial stability. However, 
requirements for greater information disclosure need to be balanced 
with the burden it places on banks providing the information. The 
agencies believe the rule's disclosure requirements (in alignment with 
the 2009 revisions) strike a reasonable balance in this respect.
    Some commenters expressed concern that certain disclosures would 
not improve transparency. Specifically, some commenters noted that the 
proposed requirement to report separate VaR-based measures for covered 
positions for market risk capital purposes and for public accounting 
standards is likely to cause market confusion. Another commenter 
believed that certain types of disclosures, particularly those relating 
to model outputs, will not necessarily lead to greater understanding of 
positions and risks, as they are either overly superficial or difficult 
to compare accurately between banks. Commenters also expressed concern 
that the timing of the proposal's required disclosures does not align 
with the timing of required disclosures under the advanced approaches 
rules and believed that the two disclosure regimes should become 
effective at the same time.
    The agencies believe that public disclosures allow the market to 
better understand the risks of a given bank and encourage banks to 
provide sufficient information to provide appropriate context to their 
public disclosures. In terms of the timing of market risk capital rule 
disclosures aligning with those required under the advanced approaches 
rules, the agencies note that certain banks subject to the market risk 
capital rule are not subject to the advanced approaches rules. Further, 
the implementation framework under the advanced approaches rules varies 
sufficiently from that of the market risk capital rule that required 
disclosures under the market risk capital rule could be unnecessarily 
delayed depending on a bank's implementation status under the advanced 
approaches rules. For these reasons, the agencies have not aligned the 
timing of the disclosure requirements across the rules.
    Except for the removal of the median measures in the quantitative 
disclosure requirements, described above, the final rule retains the 
proposed disclosure requirements. Many of the disclosure requirements 
reflect information already disclosed publicly by the banking industry. 
Banks are encouraged, but not required, to provide access to these 
disclosures in a central location on their Web sites.

IV. 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 a 
final regulatory flexibility analysis that describes the impact of a 
final rule on small entities.\25\ The regulatory flexibility analysis 
otherwise required under section 604 of the RFA is not required if an 
agency certifies that the rule will not have a significant economic 
impact on a substantial number of small entities and publishes its 
certification and a short, explanatory statement in the Federal 
Register along with its rule. Under regulations issued by the Small

[[Page 53093]]

Business Administration,\26\ a small entity includes a commercial bank 
or bank holding company with assets of $175 million or less (a small 
banking organization). As of December 31, 2011, there were 
approximately 2,385 small bank holding companies, 607 small national 
banks, 386 small state member banks, and 2,466 small state nonmember 
banks. No comments on the effect of small entities were received in 
response to the notice of proposed rulemaking.
---------------------------------------------------------------------------

    \25\ See 5 U.S.C. 603(a).
    \26\ See 13 CFR 121.201.
---------------------------------------------------------------------------

    As discussed above, the final rule applies only if a 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 bank holding companies or banks satisfy these 
criteria. Therefore, no small entities would be subject to this rule.

V. 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 
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 Regulatory Action

    Federal banking law directs federal banking agencies including the 
Office of the Comptroller of the Currency (OCC) to require banking 
organizations to hold adequate capital. The law authorizes federal 
banking agencies to set minimum capital levels to ensure that banking 
organizations maintain adequate capital. The law gives banking agencies 
broad discretion with respect to capital regulation by authorizing them 
to use other methods that they deem appropriate to ensure capital 
adequacy. As the primary supervisor of national banks and federally 
chartered savings associations, the OCC oversees the capital adequacy 
of national banks, federally chartered thrifts, and federal branches of 
foreign banking organizations (hereafter collectively referred to as 
``banks''). If banks under the OCC's supervision fail to maintain 
adequate capital, federal law authorizes the OCC to take enforcement 
action up to and including placing the bank in receivership, 
conservatorship, or requiring its sale, merger, or liquidation.
    In 1996, the Basel Committee on Banking Supervision amended its 
risk-based capital standards to include a requirement that banks 
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 OCC (along with the Federal Reserve 
Board and the FDIC) implemented this market risk amendment (MRA) 
effective January 1, 1997.\27\
---------------------------------------------------------------------------

    \27\ See Beverly J. Hirtle, ``What Market Risk Capital Reporting 
Tells Us about Bank Risk,'' Economic Policy Review, Federal Reserve 
Bank of New York, Sep. 2003, for a discussion of the role of market 
risk capital standards and an analysis of the information content of 
market risk capital levels. The author finds some evidence that 
market risk capital provides new information about an individual 
institution's risk exposure over time. In particular, a change in an 
institution's market risk capital is a strong predictor of change in 
future trading revenue volatility.
---------------------------------------------------------------------------

The Final Rule
    The final rule would modify the current market risk capital rule by 
adjusting the minimum risk-based capital calculation, introducing new 
measures of creditworthiness for purposes of determining appropriate 
risk weights, and adding public disclosure requirements. The final 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 
final 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 risk-based capital rules, a banking organization that 
is subject to the market risk capital guidelines must hold capital to 
support its exposure to general market risk arising from fluctuations 
in interest rates, equity prices, foreign exchange rates, and commodity 
prices, as well as its exposure to specific risk associated with 
certain debt and equity positions. Under current rules, covered 
positions include all positions in a bank's trading account

[[Page 53094]]

and all foreign exchange and commodity positions, whether or not in the 
trading account. The current rule covers assets held in the trading 
book, regardless of whether they are held with the intent to trade. The 
final rule would modify the definition of covered positions to include 
assets that are in the trading book and held with the intent to trade. 
The new covered positions would include trading assets and trading 
liabilities that are trading positions, i.e., held for the purpose of 
short-term resale, to lock in arbitrage profits, to benefit from actual 
or expected short-term price movements, or to hedge covered positions. 
In addition to commodities and foreign exchange positions, covered 
positions under the final rule would include certain debt positions, 
equity positions and securitization positions.
    The final rule also introduces new requirements for the 
identification of trading positions and the management of covered 
positions. The final rule would require banks to have clearly defined 
policies and procedures for actively managing all covered positions, 
for the prudent valuation and stress testing of covered positions and 
for specific internal model validation standards. Banks must also have 
clearly defined trading and hedging strategies. The final rule also 
requires banks to have a risk control unit that is independent of its 
trading units and that reports directly to senior management. Under the 
final rule, banks must also document all material aspects of its market 
risk modeling and management, and publicly disclose various measures of 
market risk for each material portfolio of covered positions.
    To be adequately capitalized, banks subject to the market risk 
capital guidelines must maintain an overall minimum 8.0 percent ratio 
of total qualifying capital (the sum of tier 1 capital and tier 2 
capital, net of all deductions) to the sum of risk-weighted assets and 
market risk equivalent assets. Market risk equivalent assets equal the 
bank's measure for market risk multiplied by 12.5.
    Under current rules, the measure for market risk is as follows:\28\
---------------------------------------------------------------------------

    \28\ 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 final rule, the new market risk measure would be as follows 
(new risk measure components are italicized):

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. The incremental risk 
requirement gathers in default risk and migration risk for 
unsecuritized items in the trading book. The comprehensive risk charge 
considers correlation trading activities and the stressed value-at-risk 
(VaR) component requires banks to include a VaR assessment that is 
calibrated to historical data from a 12-month period that reflects a 
period of significant financial stress.
Alternative Creditworthiness Standards
    In addition to introducing several new components into the formula 
for the market risk measure, the final rule will also introduce new 
creditworthiness standards to meet the requirements of Section 939A of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank). Section 939A requires federal agencies to remove references to 
credit ratings from regulations and replace credit ratings with 
appropriate alternatives. Institutions subject to the market risk rule 
will use the alternative measures of creditworthiness described below 
to determine appropriate risk-weighting factors within the specific 
risk component of the market risk measure.
Alternative Measure for Securitization Positions
    The alternative measure for securitization positions is a 
simplified version of the Basel II advanced approaches supervisory 
formula approach. The simplified supervisory formula approach (SSFA) 
applies a 100 percent risk-weighting factor to the junior-most portion 
of a securitization structure. This 100 percent factor applies to 
tranches that fall below the amount of capital that a bank would have 
to hold if it retained the entire pool on its balance sheet. For the 
remaining portions of the securitization pool, the SSFA uses an 
exponential decay function to assign a marginal capital charge per 
dollar of a tranche. Securitization positions for which a bank does not 
use the SSFA would be subject to a 100 percent risk-weighting factor. 
The final rule would also adjust the calibration of the SSFA based on 
the historical credit performance of the pool of securitized assets.
Alternative Measure for Corporate Debt Positions
    The alternative measure for corporate exposures will apply capital 
requirements to exposures to publicly traded corporate entities based 
on the remaining maturity of an exposure and whether the exposure is 
``investment grade,'' which is defined without reference to credit 
ratings, consistent with the OCC's definition of ``investment grade'' 
as that term has been defined for purposes of Part 1.
Alternative Measure for Exposures to Sovereign Entities
    The final rule would assign specific risk capital requirements to 
sovereign exposures based on OECD Country Risk Classifications (CRCs). 
The final rule would also apply a risk-weighting factor of 12 percent 
to sovereigns that have defaulted on any exposure during the previous 
five years. Default would include a restructure (whether voluntary or 
involuntary) that results in a sovereign entity not servicing an 
obligation according to its terms prior to the restructuring. Exposures 
to the United States government and its agencies would always carry a 
zero percent risk-weighting factor. Sovereign entities that have no CRC 
would carry an 8 percent risk-weighting factor. For sovereign exposures 
with a CRC rating of 2 or 3, the risk-weighting factor would also 
depend on the exposure's remaining maturity.
    The final rule would also apply risk-weighting factors of zero 
percent to exposures to supranational entities and multilateral 
development banks. International organizations that would receive a 
zero percent risk-weighting factor include the Bank for International 
Settlements, the European Central Bank, the European Commission, and 
the International Monetary Fund. The final rule would apply a zero 
percent risk-weighting factor to exposures to 13 named multilateral 
development banks and any multilateral lending institution or regional 
development bank in which the U.S. government is a shareholder or 
member, or if the bank's primary federal supervisor determines that the 
entity poses comparable credit risk.

[[Page 53095]]

Other Positions
    Government Sponsored Entities (GSEs): The proposal would apply a 
1.6 percent risk-weighting factor for GSE debt positions. GSE equity 
exposures would receive an 8 percent risk-weighting factor.
    Depository Institutions, Foreign Banks, and Credit Unions: 
Generally, the rule would apply a risk-weighting factor that is linked 
to the sovereign entity risk-weighting factor. Exposures to depository 
institutions with a sovereign CRC rating between zero and two would 
receive a risk-weighting factor between 0.25 percent and 1.6 percent 
depending on the remaining maturity. Depository institutions with no 
CRC sovereign rating or a sovereign CRC rating of 3 would receive an 
eight percent risk-weighting factor, and depository institutions where 
a sovereign default has occurred in the past five years or the 
sovereign CRC rating is between four and seven would receive a 12 
percent risk-weighting factor.
    Public Sector Entities (PSEs): A PSE is a state, local authority, 
or other governmental subdivision below the level of a sovereign 
entity. The final rule would assign a risk-weighting factor to a PSE 
based on the PSE's sovereign risk-weighting factor. One risk-weighting 
factor schedule would apply to general obligation claims and another 
schedule would apply to revenue obligations.

B. Cost-Benefit Analysis of the Final Rule

1. Organizations Affected by the Final Rule \29\
---------------------------------------------------------------------------

    \29\ 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 December 31, 2011 Call Report data, 208 FDIC-insured 
institutions had trading assets or trading liabilities. Of these 208 
institutions, 25 institutions had trading assets and liabilities that 
are at least 10 percent of total assets or at least $1 billion. 
Aggregated to the highest holding company there are 25 banking 
organizations, of which, 14 are national banking organizations. One 
federally chartered thrift holding company also meets the market risk 
threshold, but it is a subsidiary of one of the 14 national banking 
organizations.\30\ Table 1 shows the total assets, trading assets, 
trading liabilities, market risk equivalent assets, and the market risk 
measure for these 14 OCC-regulated institutions as of December 31, 
2011. The market risk measure is used to determine market risk 
equivalent assets, which are added to the denominator with adjusted 
risk-weighted assets to determine a bank's risk-based capital ratio.
---------------------------------------------------------------------------

    \30\ A national banking organization is any bank holding company 
with a subsidiary national bank. Federally chartered savings 
associations did not report comparable trading assets and trading 
liabilities data on the Thrift Financial Report, but began reporting 
this information with March 2012 Call Reports. According to March 
31, 2012 Call Report data, no OCC-regulated thrift meets the 
threshold for the Market Risk rule to apply.

 Table 1--Trading Book Measures of OCC-Regulated Organizations Affected
                         by the Market Risk Rule
          [Call Reports as of December 31, 2011, $ in billions]
------------------------------------------------------------------------
                                                             Amount ($
                         Measure                             billions)
------------------------------------------------------------------------
Total Assets............................................         7,697.3
Trading Assets..........................................           651.3
Trading Liabilities.....................................           282.7
Consolidated Trading Activity: (Trading Assets + Trading           934.0
 Liabilities)...........................................
Market Risk Equivalent Assets...........................           197.9
Market Risk Measure.....................................            15.8
------------------------------------------------------------------------

2. Impact of the Final Rule
    The key qualitative benefits of the final rule are the following:
     Makes required regulatory capital more sensitive 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 final 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 an analysis 
conducted by the Federal Reserve and the OCC.\31\ Based on these two 
assessments, we estimate that the market risk measure will increase 200 
percent on average. Because the market risk measure is equal to 8 
percent of market risk equivalent assets, the market risk measure 
itself provides one estimate of the amount of regulatory capital 
required for an adequately capitalized bank. Thus, tripling the market 
risk measure suggests that minimum required capital would be 
approximately $47.4 billion under the final rule, which would represent 
an increase of $31.6 billion.\32\
---------------------------------------------------------------------------

    \31\ The report, ``Analysis of the third trading book impact 
study'', is available at www.bis.org/publ/bcbs163.htm. The study 
gathered data from 43 banks in 10 countries, including six banks 
from the United States.
    \32\ An alternative estimate comparing adequate capital amounts 
under current and new market risk rules for each affected bank 
suggests that the capital increase would be approximately $31.7 
billion. Using capital levels reported in December 31, 2011 Call 
Reports, affected banks would remain adequately capitalized under 
either estimate.
---------------------------------------------------------------------------

    To estimate the cost to banks of this new capital requirement, we 
examine the effect of this requirement on capital structure and the 
overall cost of capital.\33\ The cost of financing a bank or any firm 
is the weighted average cost of its various financing sources, which 
amounts to a weighted average cost of the many different types of debt 
and equity financing. Because interest payments on debt are tax 
deductible, a more leveraged capital structure reduces corporate taxes, 
thereby lowering after-tax funding costs, and the weighted average cost 
of financing tends to decline as leverage marginally increases. Thus, 
an increase in required equity capital would force a bank to deleverage 
and--all else equal--would increase the cost of capital for that bank.
---------------------------------------------------------------------------

    \33\ See Merton H. Miller, (1995), ``Do the M & M propositions 
apply to banks?'' Journal of Banking & Finance, Vol. 19, pp. 483-
489.
---------------------------------------------------------------------------

    This increased cost would be tax benefits forgone: the capital 
requirement ($31.6 billion), multiplied by the interest rate on the 
debt displaced and by the effective marginal tax rate for the banks 
affected by the final rule. The effective marginal corporate tax rate 
is affected not only by the statutory federal and state rates, but also 
by the probability of positive earnings (since there is no tax benefit 
when earnings are negative), and for the offsetting effects of personal 
taxes on required bond yields. Graham (2000) considers these factors 
and estimates a median marginal tax benefit of $9.40 per $100 of 
interest. So, using an estimated interest rate on debt of 6 percent, we 
estimate that the annual tax benefits foregone on $31.6 billion of 
capital switching from debt to equity is approximately $31.6 billion * 
0.06 (interest rate) * 0.094 (median marginal tax savings) = $178 
million.\34\
---------------------------------------------------------------------------

    \34\ See John R. Graham, (2000), How Big Are the Tax Benefits of 
Debt?, Journal of Finance, Vol. 55, No. 5, pp. 1901-1941. Graham 
points out that ignoring the offsetting effects of personal taxes 
would increase the median marginal tax rate to $31.5 per $100 of 
interest.

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

[[Page 53096]]

    In addition to the revised market risk measure, the final rule 
includes new disclosure requirements. We estimate that the new 
disclosure requirements and implementation of calculations for the new 
market risk measures may involve some additional system costs. Because 
the proposed market risk rule only applies to 14 national bank holding 
companies and will only affect institutions already subject to the 
current market risk rule, we expect these additional system costs to be 
de minimis.\35\ We do not anticipate that the final rule will create 
significant additional administrative costs for the OCC.\36\
---------------------------------------------------------------------------

    \35\ We estimate that these additional costs will be close to 
zero because institutions that are subject to the current market 
risk rule have the systems in place to calculate the current market 
risk measure. These existing systems should be able to accommodate 
the new components of the revised market risk measure. Also, items 
affected by the new disclosure requirements are primarily byproducts 
of the management of market risk and the calculation of the market 
risk measure.
    \36\ Discussion with the Director of the Market Risk Analysis 
Division indicated that the division would be able to accommodate 
the proposed revisions to the market risk rule with current staffing 
levels.
---------------------------------------------------------------------------

Estimated Costs of Credit Rating Alternatives
    The final rule will also require institutions to (1) establish 
systems to determine risk-weighting factors using the alternative 
measures of creditworthiness described in the proposal, and (2) apply 
these alternative measures to the bank's trading portfolio. We believe 
that the principal costs of this component of the rule will involve the 
costs of gathering and updating the information necessary to calculate 
the relevant risk-weighting factors, and establishing procedures and 
maintaining the programs that perform the calculations.
    In particular, the final rule would require each affected 
institution to:
    1. Establish and maintain a system to implement the simplified 
supervisory formula approach (SSFA) for securitization positions.
    2. Establish and maintain a system to determine risk-weighting 
factors for corporate debt positions.
    3. Establish and maintain a system to assign risk-weighting factors 
to sovereign exposures.
    4. Establish and maintain systems to assign risk-weighting factors 
to public sector entities, depository institutions, and other 
positions.
    Listed below are the variables banks will need to gather to 
calculate the risk-weighting factors under the final rule:
    Securitization Positions:
1. Weighted average risk-weighting factor of assets in the securitized 
pool as determined under generally applicable risk-based capital rules
2. The attachment point of the relevant tranche
3. The detachment point of the relevant tranche
4. Cumulative losses
    Corporate Debt Positions:
1. Investment grade determination
2. Remaining contractual maturity
    Sovereign Entity Debt Positions:
1. Organization for Economic Co-operation and Development Country Risk 
Classifications (CRC) Score
2. Remaining contractual maturity
    Table 2 shows our estimate of the number of hours required to 
perform the various activities necessary to meet the requirements of 
the final rule. We base these estimates on the scope of work required 
by the final rule and the extent to which these requirements extend 
current business practices. Although the total cost of gathering the 
new variables will depend on the size of the institution's consolidated 
trading activity, we believe that the costs of establishing systems to 
match variables with exposures and calculate the appropriate risk-
weighting factor will account for most of the expenses associated with 
the credit rating alternatives. Once a bank establishes a system, we 
expect the marginal cost of calculating the risk-weighting factor for 
each additional asset in a particular category, e.g., securitizations 
and corporate exposures, to be relatively small.
    We estimate that financial institutions covered by the final rule 
will spend approximately 1,300 hours during the first year the rule is 
in effect. In subsequent years, we estimate that financial institutions 
will spend approximately 180 hours per year on activities related to 
determining risk-weighting factors using the alternative measures of 
creditworthiness in the final rule.
    Table 3 shows our overall cost estimate tied to developing 
alternative measures of creditworthiness under the market risk rule. 
Our estimate of the compliance cost of the final rule is the product of 
our estimate of the hours required per institution, our estimate of the 
number of institutions affected by the rule, and an estimate of hourly 
wages. To estimate hours necessary per activity, we estimate the number 
of employees each activity is likely to need and the number of days 
necessary to assess, implement, and perfect the required activity. To 
estimate hourly wages, we reviewed data from May 2010 for wages (by 
industry and occupation) from the U.S. Bureau of Labor Statistics (BLS) 
for depository credit intermediation (NAICS 522100). To estimate 
compensation costs associated with the final rule, we use $85 per hour, 
which is based on the average of the 90th percentile for seven 
occupations (i.e., accountants and auditors, compliance officers, 
financial analysts, lawyers, management occupations, software 
developers, and statisticians) plus an additional 33 percent to cover 
inflation and private sector benefits.\37\ As shown in table 3, we 
estimate that the cost of the alternative measures of creditworthiness 
in the first year of implementation will be approximately $1.5 million.
---------------------------------------------------------------------------

    \37\ According to the BLS' employer costs of employee benefits 
data, thirty percent represents the average private sector costs of 
employee benefits.
---------------------------------------------------------------------------

    We also recognize that risk-weighting factors, and hence, market 
risk capital requirements may change as a result of these new measures 
of creditworthiness. We expect that the largest capital impact of the 
new risk-weighting factors will occur with securitizations, corporate 
debt positions, and exposures to sovereigns. The increased sensitivity 
to risk of the alternative measures of creditworthiness implies that 
specific risk capital requirements may go down for some trading assets 
and up for others. For those assets with a higher specific risk capital 
charge under the final rule, however, that increase may be large, in 
some instances requiring a dollar-for-dollar capital charge.
    At this time we are not able to estimate the capital impact of the 
alternative measures of creditworthiness with any degree of precision. 
While we know that the impact on U.S. Treasury Securities will be zero, 
the impact on the other asset categories is less clear. For instance, 
while anecdotal evidence suggests that roughly half of ``other debt 
securities'' is corporate debt and half is non-U.S. government 
securities, the actual capital impact will depend on the quality of 
these assets as determined by the measures of creditworthiness. While 
we anticipate that this impact could be large, we lack information on 
the composition and quality of the trading portfolio that would allow 
us to accurately estimate a likely capital charge. The actual impact on 
market risk capital requirements will also depend on the extent to 
which institutions model specific risk.
    Combining capital costs ($178 million) with the costs of applying 
the alternative measures of creditworthiness ($1.5 million), we 
estimate that the total

[[Page 53097]]

cost of the final rule will be $179.5 million per year in 2012 dollars.

    Table 2--Estimated Annual Hours for Creditworthiness Measurement
       Activities for Institutions Subject to the Market Risk Rule
------------------------------------------------------------------------
                                                             Estimated
        Trading position                 Activity            hours per
                                                            institution
------------------------------------------------------------------------
Securitization.................  System development.....             480
                                 Data acquisition.......             240
                                 Calculation,                        120
                                  verification, and
                                  training.
Corporate Debt.................  System development.....              60
                                 Data acquisition.......              50
                                 Calculation,                         10
                                  verification, and
                                  training.
Sovereign Debt.................  System development.....              80
                                 Data acquisition.......              30
                                 Calculation,                         60
                                  verification, and
                                  training.
Other Positions Combined.......  System development.....              80
                                 Data acquisition.......              30
                                 Calculation,                         60
                                  verification, and
                                  training.
                                                         ---------------
    Total Hours................  .......................           1,300
------------------------------------------------------------------------


                 Table 3--Estimated Costs of Credit Rating Alternatives to the Market Risk Rule
----------------------------------------------------------------------------------------------------------------
                                       Number of        Estimated hours     Estimated cost
           Institution               institutions       per institution     per institution     Estimated cost
----------------------------------------------------------------------------------------------------------------
National banking organizations..                  14               1,300            $110,500          $1,547,000
----------------------------------------------------------------------------------------------------------------

3. Additional Costs and Benefits of the Final Rule
    As the Basel Committee on Banking Supervision points out in the 
July 2009 paper that recommends revisions to the market risk framework, 
the trading book proved to be an important source of losses during the 
financial crisis that began in mid-2007 and an important source of the 
buildup of leverage that preceded the crisis.\38\ These concerns find 
some echo in empirical evidence. Stiroh (2004) studies the potential 
diversification benefits from various types of noninterest income and 
finds that trading activities are associated with lower risk-adjusted 
returns and higher risk.\39\
---------------------------------------------------------------------------

    \38\ Basel Committee on Banking Supervision, ``Revisions to the 
Basel II market risk framework,'' July 2009, available at 
www.bis.org.
    \39\ See Kevin J. Stiroh, ``Diversification in Banking: Is 
Noninterest Income the Answer?'' Journal of Money, Credit, and 
Banking, Vol. 36, No. 5, October 2004.
---------------------------------------------------------------------------

C. Comparison Between Final Rule and Baseline

    Under the baseline scenario, the current market risk rule would 
continue to apply. Because the final rule affects the same institutions 
as the current rule, table 1 reflects the current baseline. Thus, under 
the baseline, required market risk capital would remain at current 
levels and there would be no additional cost associated with adding 
capital. However, the final rule's qualitative benefits of making 
required regulatory capital more sensitive to market risk, increased 
transparency, and the improved targeting of trading positions would be 
lost under the baseline scenario.

D. Comparison Between Final Rule and Alternatives

    UMRA requires a comparison between the final rule and reasonable 
alternatives when the impact assessment exceeds the inflation-adjusted 
expenditure threshold. In this regulatory impact analysis, we compare 
the final rule with two alternatives that modify the size thresholds 
for the rule. The baseline provides a comparison between the rule and 
the economic environment with no modifications to the current market 
risk measure. For Alternative A, we assess the impact of a rule with 
various size thresholds. For Alternative B, we assess the impact of a 
rule that changes the conditional statement of the rule's thresholds 
from ``or'' to ``and''. Thus, alternative B assesses the impact of a 
market risk rule that applies to banks with trading assets and 
liabilities greater than $1 billion and a trading book to assets ratio 
of at least 10 percent.
Assessment of Alternative A
    Under Alternative A, we consider a rule that has the same 
provisions as the final rule, but we alter the rule's trading book size 
threshold. In our analysis of alternative A, we do not alter the 10 
percent threshold for the trading book to asset ratio. Rather, we only 
vary the $1 billion trading book threshold. Table 4 shows how changing 
the dollar threshold changes the number of institutions affected by the 
rule and the estimated cost of the rule, continuing to assume that 
market risk capital will increase by 200 percent. The results for the 
final rule are shown in bold.

[[Page 53098]]



                   Table 4--Alternative A: Impact of Variations in Trading Book Size Threshold
                                        [December 31, 2011 Call Reports]
----------------------------------------------------------------------------------------------------------------
                                                                                 Increase in     Estimated cost
                                              Number of       Trading book       market risk      of additional
             Size threshold                 institutions       ($billions)         measure           capital
                                              affected                           ($billions)       ($millions)
----------------------------------------------------------------------------------------------------------------
$5 billion..............................                 7            $921.7             $31.4              $177
$4 billion..............................                 7             921.7              31.4               177
$3 billion..............................                 7             921.7              31.4               177
$2 billion..............................                 9             926.3              31.4               177
$1 billion..............................                14             933.9              31.6               178
$500 million............................                18             937.3              31.6               178
$250 million............................                21             938.3              32.0               180
----------------------------------------------------------------------------------------------------------------

    Because trading assets and liabilities are concentrated in 
relatively few 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. Table 4 suggests that the banking 
agencies' systemic concerns could play a role in determining the 
appropriate size threshold for applicability of the market risk rule. 
The banking agencies may select a size threshold that ensures that the 
market risk rule applies to appropriate institutions as this choice has 
little impact on aggregate costs. The banking agencies' decision to use 
the same threshold as applies under current rules makes sense as 
implementation costs could be significant for individual institutions 
not already subject to the market risk rule.\40\
---------------------------------------------------------------------------

    \40\ We estimate that these start-up costs could range between 
$0.5 million and $2 million depending on the size and complexity of 
the trading book. These start-up costs include new system costs, 
acquisition of expertise, training and compliance costs.
---------------------------------------------------------------------------

Assessment of Alternative B
    Under Alternative B, we consider a rule that has the same 
provisions as the final rule, but we change the condition of the size 
thresholds from ``or'' to ``and''. With this change, the final 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. Table 5 shows the effect of changing the rule so that an 
institution must meet both thresholds for the market risk rule to 
apply. Again, we assume that the provisions of the final rule lead to a 
200 percent increase in the market risk measure.
    As Table 5 shows, 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 three using the current thresholds of $1 
billion and 10 percent. Not surprisingly, as this alternative affects 
some institutions with larger trading books, the estimated cost of the 
rule does decrease with the number of institutions affected by the 
rule.

                    Table 5--Alternative B: Impact of Variations in Size Threshold Conditions
                                        [December 31, 2011 Call Reports]
----------------------------------------------------------------------------------------------------------------
                                                                                                     Estimated
                                                     Number of                      Increase in       cost of
                   Thresholds                      institutions    Trading book     market risk     additional
                                                     affected      ($ billions)     measure ($      capital  ($
                                                                                     billions)       millions)
----------------------------------------------------------------------------------------------------------------
$1 billion or 10 percent........................              14          $933.9           $31.6            $178
$2 billion and 10 percent.......................               3           715.6            21.8             123
$1 billion and 10 percent.......................               3           715.6            21.8             123
$500 million and 10 percent.....................               3           715.6            21.8             123
$2 billion and 5 percent........................               5           903.2            30.6             173
$1 billion and 5 percent........................               6           904.9            30.8             174
$500 million and 5 percent......................               6           904.9            30.8             174
$2 billion and 1 percent........................               9           926.3            31.4             177
$1 billion and 1 percent........................              13           932.2            31.6             178
$500 million and 1 percent......................              16           934.5            31.6             178
----------------------------------------------------------------------------------------------------------------

E. Overall Impact of Final 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 
$15.8 billion applies to 14 national banks. Under the final rule, this 
capital charge would continue to apply to the same 14 banks but the 
capital charge would likely triple. We estimate that the cost of the 
additional capital would be approximately $178 million per year. Our 
overall estimate of the cost of the final market risk rule is $179.5 
million, which reflects capital costs and compliance costs associated 
with implementing the alternative measures of creditworthiness.\41\
---------------------------------------------------------------------------

    \41\ Our capital estimate reflects the amount of capital banks 
would need to accumulate to meet the eight percent minimum capital 
requirement after implementation of the final market risk rule 
relative to the eight percent minimum capital requirement under the 
current rule. Because the banks affected by the rule are currently 
well capitalized, our estimates suggest that they could remain 
adequately capitalized under the final rule even if they keep 
capital at current levels. The availability of this reservoir of 
capital offsets the need for banks to incur the cost of accumulating 
further capital to meet the requirements of the final market risk 
rule. The extent to which they use current capital to offset the new 
market risk capital requirement is up to the banks. Should they 
elect to acquire the full $31.6 billion in minimum capital required 
by the final rule, we estimate that cost at $178 million.

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

[[Page 53099]]

    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 
final rule. Although varying the size threshold changed the number of 
institutions affected by the rule, the overall capital cost of the rule 
did not change significantly. This reflects the high concentration of 
trading assets and liabilities in a relatively small number of banks. 
As long as the final rule applies to these 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 final rule and the cost of the final 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 asset ratio of at least 10 
percent. Only three national banks currently meet both of these 
criteria, and applying the final rule to these institutions would 
require an additional $21.8 billion in market risk capital at a cost of 
approximately $123 million per year. Clearly, the estimated cost of the 
final 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 final rule, capture those 
institutions that the regulatory agencies believe should be subject to 
market risk capital rules.
    The final rule changes covered positions, disclosure requirements, 
and methods relating to calculating the market risk measure. These 
changes achieve the important objectives of making required regulatory 
capital more sensitive 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 final 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 $31.6 billion under the final 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,\42\ in the OCC's opinion, the final rule 
offers a better balance between costs and benefits than either the 
baseline or the alternatives.
---------------------------------------------------------------------------

    \42\ When financial institutions are strong and financial 
markets are robust, raising new capital or adjusting capital funding 
sources poses little difficulty for the financial institution. As 
financial markets weaken, factors affecting a bank's financing may 
have spillover effects that may affect bank operational decisions 
such as lending.
---------------------------------------------------------------------------

    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.

VI. Paperwork Reduction Act

    In accordance with the requirements of the Paperwork Reduction Act 
(PRA) 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 OMB control number for 
the OCC and the FDIC will be assigned and the OMB control number for 
the Board will be 7100-0314. In conjunction with the January 2011 
notice of proposed rulemaking, the OCC and the FDIC submitted the 
information collection requirements contained therein to OMB for 
review. In response, OMB filed comments with the OCC and FDIC in 
accordance with 5 CFR 1320.11(c) withholding PRA approval. The agencies 
subsequently determined that there were no additional information 
collection requirements in the December 2011 Amendment and, therefore, 
the agencies made no PRA filing in conjunction with it. In addition, 
this final rule contains no additional information collection 
requirements. The OCC and the FDIC have submitted the information 
collection requirements in the final rule to OMB for review and 
approval under 44 U.S.C. 3506 and 5 CFR part 1320. The Board reviewed 
the final rule under the authority delegated to the Board by OMB. The 
final rule contains requirements subject to the PRA. The information 
collection requirements are found in sections 3, 4, 5, 6, 7, 8, 9, 10, 
and 13 of the final rule.
    No comments concerning PRA were received in response to the notice 
of proposed rulemaking. Therefore, the hourly burden estimates for 
respondents noted in the proposed rule have not changed. The burden in 
the proposed rule for section 10(d), which requires documentation 
quarterly for analysis of risk characteristics of each securitization 
position it holds, has been renumbered to 10(f). The burden in the 
proposed rule for section 11, which 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, has been 
renumbered to 13. The agencies have an ongoing interest in your 
comments.
    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.

VII. Plain Language

    Section 722 of the Gramm-Leach-Bliley Act requires the Federal 
banking agencies to use plain language in all proposed and final rules 
published after January 1, 2000. The agencies invited comment on 
whether the proposed rule was written plainly and clearly or whether 
there were ways the agencies could make the rule easier to understand. 
The agencies received no comments on these matters and believe that the 
final rule is written plainly and clearly in conjunction with the 
agencies' risk-based capital rules.

[[Page 53100]]

Text of the Common Rules (All Agencies)

    The text of the common rules appears below:

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

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 Simplified Supervisory Formula Approach
Section 12 Market Risk Disclosures

Section 1. Purpose, Applicability, and Reservation of Authority

    (a) Purpose. This appendix establishes risk-based capital 
requirements for [banks] with significant exposure to market risk 
and provides methods for these [banks] 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 [bank] with 
aggregate trading assets and trading liabilities (as reported in the 
[bank]'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 [bank] if the 
[Agency] deems it necessary or appropriate because of the level of 
market risk of the [bank] or to ensure safe and sound banking 
practices.
    (3) The [Agency] may exclude a [bank] that meets the criteria of 
paragraph (b)(1) of this section from application of this appendix 
if the [Agency] 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.
    (c) Reservation of authority. (1) The [Agency] may require a 
[bank] to hold an amount of capital greater than otherwise required 
under this appendix if the [Agency] determines that the [bank]'s 
capital requirement for market risk as calculated under this 
appendix is not commensurate with the market risk of the [bank]'s 
covered positions. In making determinations under paragraphs (c)(1) 
through (c)(3) of this section, the [Agency] will apply notice and 
response procedures generally in the same manner as the notice and 
response procedures set forth 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 [bank] 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 [bank] 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 [bank] 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:
    Affiliate with respect to a company means any company that 
controls, is controlled by, or is under common control with, the 
company.
    Backtesting means the comparison of a [bank]'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.
    Control A person or company controls a company if it:
    (1) Owns, controls, or holds with power to vote 25 percent or 
more of a class of voting securities of the company; or
    (2) Consolidates the company for financial reporting purposes.
    Corporate debt position means a debt position that is an 
exposure to a company that is not a sovereign entity, the Bank for 
International Settlements, the European Central Bank, the European 
Commission, the International Monetary Fund, a multilateral 
development bank, a depository institution, a foreign bank, a credit 
union, a public sector entity, a government-sponsored entity, or a 
securitization.
    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.
    Country risk classification (CRC) for a sovereign entity means 
the consensus CRC published from time to time by the Organization 
for Economic Cooperation and Development that provides a view of the 
likelihood that the sovereign entity will service its external debt.
    Covered position means the following positions:
    (1) A trading asset or trading liability (whether on- or off-
balance sheet),\43\ as reported on Schedule RC-D of the Call Report 
or Schedule HC-D of the FR Y-9C, that meets the following 
conditions:
---------------------------------------------------------------------------

    \43\ 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; \44\ and
---------------------------------------------------------------------------

    \44\ 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 [bank] 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 [bank] 
chooses to exclude with prior supervisory approval); and
    (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 [bank]'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 [bank] recognizes as a guarantee 
for risk-weighted asset amount calculation purposes under [the 
advanced capital adequacy framework] or [the general risk-based 
capital rules];
    (v) Any equity position that is not publicly traded, other than 
a derivative that references a publicly traded equity;
    (vi) Any position a [bank] 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).

[[Page 53101]]

    Credit union means an insured credit union as defined under the 
Federal Credit Union Act (12 U.S.C. 1752).
    Default by a sovereign entity means noncompliance by the 
sovereign entity with its external debt service obligations or the 
inability or unwillingness of a sovereign entity to service an 
existing obligation according to its original contractual terms, as 
evidenced by failure to pay principal and interest timely and fully, 
arrearages, or restructuring.
    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 equity or hybrid equity 
positions as a result of a financial event, such as the announcement 
or occurrence of a company merger, acquisition, spin-off, or 
dissolution.
    Foreign bank means a foreign bank as defined in Sec.  211.2 of 
the Federal Reserve Board's Regulation K (12 CFR 211.2), other than 
a depository institution.
    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.
    General obligation means a bond or similar obligation that is 
guaranteed by the full faith and credit of states or other political 
subdivisions of a sovereign entity.
    Government-sponsored entity (GSE) means an entity established or 
chartered by the U.S. government to serve public purposes specified 
by the U.S. Congress but whose debt obligations are not explicitly 
guaranteed by the full faith and credit of the U.S. government.
    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.
    Investment grade means that the entity to which the [bank] is 
exposed through a loan or security, or the reference entity with 
respect to a credit derivative, has adequate capacity to meet 
financial commitments for the projected life of the asset or 
exposure. Such an entity or reference entity has adequate capacity 
to meet financial commitments if the risk of its default is low and 
the full and timely repayment of principal and interest is expected.
    Market risk means the risk of loss on a position that could 
result from movements in market prices.
    Multilateral development bank means the International Bank for 
Reconstruction and Development, the Multilateral Investment 
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African 
Development Bank, the European Bank for Reconstruction and 
Development, the European Investment Bank, the European Investment 
Fund, the Nordic Investment Bank, the Caribbean Development Bank, 
the Islamic Development Bank, the Council of Europe Development 
Bank, and any other multilateral lending institution or regional 
development bank in which the U.S. government is a shareholder or 
contributing member or which the [Agency] determines poses 
comparable credit risk.
    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.
    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.
    Public sector entity (PSE) means a state, local authority, or 
other governmental subdivision below the sovereign entity level.
    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 [bank] 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 [bank] 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 [bank], and the [bank] 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 [bank] 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 a covered position that is:
    (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.
    Revenue obligation means a bond or similar obligation, including 
loans and leases, that is an obligation of a state or other 
political subdivision of a sovereign entity, but for which the 
government entity is committed to repay with revenues from the 
specific project financed rather than with general tax funds.
    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

[[Page 53102]]

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
    (2) An exposure that directly or indirectly references a 
securitization exposure described in paragraph (1) of this 
definition.
    Sovereign debt position means a direct exposure to a sovereign 
entity.
    Sovereign entity means a central government (including the U.S. 
government) or an agency, department, ministry, or central bank of a 
central government.
    Sovereign of incorporation means the country where an entity is 
incorporated, chartered, or similarly established.
    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 [bank]'s tier 1 and tier 2 capital; or
    (4) A position designed to hedge a [bank]'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 [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:
    (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 [bank] 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; \45\ and
---------------------------------------------------------------------------

    \45\ 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 [bank] 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 [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.
    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 a relatively short time frame conforming to trade 
custom.
    Underlying exposure means one or more exposures that have been 
securitized in a securitization transaction.
    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 [bank] 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 [bank] must have clearly 
defined trading and hedging strategies for its trading positions 
that are approved by senior management of the [bank].
    (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 [bank] is willing to 
accept and must detail the instruments, techniques, and strategies 
the [bank] will use to hedge the risk of the portfolio.
    (b) Management of covered positions. (1) Active management. A 
[bank] 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 [bank]'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 [bank] 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, liquidity, and 
model risk.
    (c) Requirements for internal models. (1) A [bank] 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 [bank] must meet all of the requirements of this section 
on an ongoing basis. The [bank] must promptly notify the [Agency] 
when:
    (i) The [bank] 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 [bank] makes any change to an internal model approved 
by the [Agency] under this appendix that would result in a material 
change in the [bank]'s risk-weighted asset amount for a portfolio of 
covered positions; or
    (iii) The [bank] makes any material change to its modeling 
assumptions.
    (3) The [Agency] may rescind its approval of the use of any 
internal model (in whole

[[Page 53103]]

or in part) or of the determination of the approach under section 
9(a)(2)(ii) of this appendix for a [bank]'s modeled correlation 
trading positions 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 [bank]'s 
covered positions.
    (4) The [bank] 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 [bank]'s covered 
positions.
    (5) The [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.
    (6) The level of sophistication of a [bank]'s internal models 
must be commensurate with the complexity and amount of its covered 
positions. A [bank]'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 [bank]'s internal models must properly measure all the 
material risks in the covered positions to which they are applied.
    (8) The [bank]'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 [bank] must have a rigorous and well-defined process for 
re-estimating, re-evaluating, and updating its internal models to 
ensure continued applicability and relevance.
    (10) If a [bank] 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 
[bank] must have a risk control unit that reports directly to senior 
management and is independent from the business trading units.
    (2) The [bank] must validate its internal models initially and 
on an ongoing basis. The [bank]'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 [bank]'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 [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.
    (3) The [bank] 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 [bank]'s trading activities that may not be adequately captured 
in its internal models.
    (4) The [bank] must 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 calculation of the [bank]'s measures 
for market risk under this appendix. At least annually, the internal 
audit function must report its findings to the [bank]'s board of 
directors (or a committee thereof).
    (e) Internal assessment of capital adequacy. The [bank] 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 [bank] 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 denominators. A [bank] must 
calculate its general risk-based capital ratio denominator by 
following the steps described in paragraphs (a)(1) through (a)(4) of 
this section. A [bank] subject to [the advanced capital adequacy 
framework] must use its general risk-based capital ratio denominator 
for purposes of determining its total risk-based capital ratio and 
its tier 1 risk-based capital ratio under section 3(a)(2)(ii) and 
section 3(a)(3)(ii), respectively, of [the advanced capital adequacy 
framework], provided that the [bank] may not use the supervisory 
formula approach (SFA) in section 10(b)(2)(vii)(B) of this appendix 
for purposes of this calculation. A [bank] subject to [the advanced 
capital adequacy framework] also must calculate an advanced risk-
based capital ratio denominator by following the steps in paragraphs 
(a)(1) through (a)(4) of this section for purposes of determining 
its total risk-based capital ratio and its tier 1 risk-based capital 
ratio under sections 3(a)(2)(i) and section 3(a)(3)(i), 
respectively, of [the advanced capital adequacy framework].
    (1) Adjusted risk-weighted assets. (i) The [bank] must 
calculate:
    (A) General adjusted risk-weighted assets, which equals risk-
weighted assets as determined in accordance with [the general risk-
based capital rules] with the adjustments in paragraphs (a)(1)(ii) 
and, if applicable, (a)(1)(iii) of this section; and
    (B) For a [bank] subject to [the advanced capital adequacy 
framework], advanced adjusted risk-weighted assets, which equal 
risk-weighted assets as determined in accordance with [the advanced 
capital adequacy framework] with the adjustments in paragraph 
(a)(1)(ii) of this section.
    (ii) For purposes of calculating its general and advanced 
adjusted risk-weighted assets under paragraphs (a)(1)(i)(A) and 
(a)(1)(i)(B) of this section, respectively, the [bank] 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).
    (iii) For purposes of calculating its general adjusted risk-
weighted assets under paragraph (a)(1)(i)(A) of this section, a 
[bank] 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 [bank] must calculate the 
general measure for market risk (except, as provided in paragraph 
(a) of this section, that the [bank] may not use the SFA in section 
10(b)(2)(vii)(B) of this appendix for purposes of this calculation), 
which equals the sum of the VaR-based capital requirement, stressed 
VaR-based capital requirement, specific risk add-ons, incremental 
risk capital requirement, comprehensive risk capital requirement, 
and capital requirement for de minimis exposures all as defined 
under this paragraph (a)(2). A [bank] subject to [the advanced 
capital adequacy framework] also must calculate the advanced measure 
for market risk, which equals the sum of the VaR-based capital 
requirement, stressed VaR-based capital requirement, specific risk 
add-ons, incremental risk capital requirement, comprehensive risk 
capital requirement, and capital requirement for de minimis 
exposures as defined under this paragraph (a)(2).
    (i) VaR-based capital requirement. A [bank]'s 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. A [bank]'s 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

[[Page 53104]]

this appendix for each of the preceding 12 weeks multiplied by 
three, except as provided in paragraph (b) of this section.
    (iii) Specific risk add-ons. A [bank]'s specific risk add-ons 
equal any specific risk add-ons that are required under section 7 of 
this appendix and are calculated in accordance with section 10 of 
this appendix.
    (iv) Incremental risk capital requirement. A [bank]'s 
incremental risk capital requirement equals any incremental risk 
capital requirement as calculated under section 8 of this appendix.
    (v) Comprehensive risk capital requirement. A [bank]'s 
comprehensive risk capital requirement equals any comprehensive risk 
capital requirement as calculated under section 9 of this appendix.
    (vi) Capital requirement for de minimis exposures. A [bank]'s 
capital requirement for de minimis exposures equals:
    (A) The absolute value of the market value of those de minimis 
exposures that are not captured in the [bank]'s VaR-based measure or 
under paragraph (a)(2)(vi)(B) of this section; and
    (B) With the prior written approval of the [Agency], the capital 
requirement for any de minimis exposures using alternative 
techniques that appropriately measure the market risk associated 
with those exposures.
    (3) Market risk equivalent assets. The [bank] must calculate 
general market risk equivalent assets as the general measure for 
market risk (as calculated in paragraph (a)(2) of this section) 
multiplied by 12.5. A [bank] subject to [the advanced capital 
adequacy framework] also must calculate advanced market risk 
equivalent assets as the advanced measure for market risk (as 
calculated in paragraph (a)(2) of this section) multiplied by 12.5.
    (4) Denominator calculation. (i) The [bank] must add general 
market risk equivalent assets (as calculated in paragraph (a)(3) of 
this section) to general adjusted risk-weighted assets (as 
calculated in paragraph (a)(1)(i) of this section). The resulting 
sum is the [bank]'s general risk-based capital ratio denominator.
    (ii) A [bank] subject to [the advanced capital adequacy 
framework] must add advanced market risk equivalent assets (as 
calculated in paragraph (a)(3) of this section) to advanced adjusted 
risk-weighted assets (as calculated in paragraph (a)(1)(i) of this 
section). The resulting sum is the [bank]'s advanced risk-based 
capital ratio denominator.
    (b) Backtesting. A [bank] must compare each of its most recent 
250 business days' trading losses (excluding fees, commissions, 
reserves, net interest income, and intraday trading) with the 
corresponding daily VaR-based measures calibrated to a one-day 
holding period and at a one-tail, 99.0 percent confidence level. A 
[bank] must begin backtesting as required by this paragraph no later 
than one year after the later of January 1, 2013, and the date on 
which the [bank] becomes subject to this appendix. In the interim, 
consistent with safety and soundness principles, a [bank] subject to 
this appendix as of its effective date should continue to follow 
backtesting procedures in accordance with the [Agency]'s supervisory 
expectations.
    (1) Once each quarter, the [bank] 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 [bank] 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 (a)(2)(ii) of this 
section until it obtains the next quarter's backtesting results, 
unless the [Agency] notifies the [bank] 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 [bank] 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 [bank]'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 of this appendix. The 
daily VaR-based measure must also reflect the [bank]'s specific risk 
for any portfolio of correlation trading positions that is modeled 
under section 9 of this appendix. A [bank] may elect to include term 
repo-style transactions in its VaR-based measure, provided that the 
[bank] includes all such term repo-style transactions consistently 
over time.
    (1) The [bank]'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 [bank] 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 [bank] 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 [bank] 
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 [bank] 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 [bank] uses in its pricing models.
    (5) The [bank] must demonstrate to the satisfaction of the 
[Agency] the appropriateness of any proxies used to capture the 
risks of the [bank]'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 [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 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 [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 a [bank] that uses a weighting 
scheme or other method for 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 the [Agency] that its weighting scheme is 
more effective than a weighting scheme with an average time lag of 
at least six months representing the volatility of the [bank]'s 
trading portfolio over a full business cycle. A [bank] using this 
option must update its data more frequently than monthly and in a 
manner appropriate for the type of weighting scheme.
    (c) A [bank] must divide its portfolio into a number of 
significant subportfolios approved by the [Agency] for subportfolio 
backtesting purposes. These subportfolios

[[Page 53105]]

must be sufficient to allow the [bank] 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 [bank]'s covered positions. The 
[bank] 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 [bank] 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 [bank] 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 of this 
appendix, 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 [bank]'s current portfolio.
    (2) The stressed VaR-based measure must be calculated at least 
weekly and be no less than the [bank]'s VaR-based measure.
    (3) A [bank] must 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 under this section 
and must be able to provide empirical support for the period used. 
The [bank] must obtain the prior approval of the [Agency] for, and 
notify the [Agency] if the [bank] makes any material changes to, 
these policies and procedures. The 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 its 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 period to the [bank]'s current portfolio.
    (4) Nothing in this section prevents the [Agency] from requiring 
a [bank] to use a different period of significant financial stress 
in the calculation of the stressed VaR-based measure.

Section 7. Specific Risk

    (a) General requirement. A [bank] 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 [bank] may use models to measure 
the specific risk of covered positions as provided in paragraph (a) 
of section 5 of this appendix (therefore, excluding securitization 
positions that are not modeled under section 9 of this appendix). A 
[bank] 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 [bank] 
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 to changes 
in portfolio composition and concentrations.
    (ii) If a [bank] calculates an incremental risk measure for a 
portfolio of debt or equity positions under section 8 of this 
appendix, 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.
    (2) Specific risk fully modeled for one or more portfolios. If 
the [bank]'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 [bank] 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 [bank]'s VaR-based measure does not capture all 
material aspects of specific risk for a portfolio of debt, equity, 
or correlation trading positions, the [bank] 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 [bank] must calculate a specific risk add-on under the 
standardized measurement method as described in section 10 of this 
appendix for all of its securitization positions that are not 
modeled under section 9 of this appendix.

Section 8. Incremental Risk

    (a) General requirement. A [bank] that measures the specific 
risk of a portfolio of debt positions under section 7(b) of this 
appendix 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 
[bank]'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 [bank] 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 [bank] 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 [bank] 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 [bank] 
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 [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. The liquidity 
horizon of a position or set of positions is the time required for a 
[bank] 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 shorter of 
three months or the contractual maturity of the position.
    (ii) A constant position assumption means that the [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.
    (iii) A [bank]'s selection of a constant position or a constant 
risk assumption must be consistent between the [bank]'s incremental 
risk model and its comprehensive risk model described in section 9 
of this appendix, if applicable.
    (iv) A [bank]'s treatment of liquidity horizons must be 
consistent between the [bank]'s incremental risk model and its 
comprehensive risk model described in section 9 of this appendix, 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.

[[Page 53106]]

    (6) Recognize the effect that liquidity horizons have on dynamic 
hedging strategies. In such cases, a [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.
    (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 [bank]'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 [bank] 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 [bank] 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 [bank]'s modeled measure of all price risk determined 
according to the requirements in paragraph (b) of this section; and
    (B) A surcharge for the [bank]'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 8.0 
percent; or
    (ii) With approval of the [Agency] and provided the [bank] 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 [bank]'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.
    (b) Requirements for modeling all price risk. If a [bank] 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 [bank] 
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 [bank] must use market data that are relevant in 
representing the risk profile of the [bank]'s correlation trading 
positions in order to ensure that the [bank] fully captures the 
material risks of the correlation trading positions in its 
comprehensive risk measure in accordance with this section; and
    (4) 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.
    (c) Requirements for stress testing.
    (1) A [bank] 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 [bank] must retain and make 
available to the [Agency] the results of the supervisory stress 
testing, including comparisons with the capital requirements 
generated by the [bank]'s comprehensive risk model.
    (ii) A [bank] 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 [bank] must 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 all securitization 
positions that are not modeled under section 9 of this appendix. A 
[bank] must calculate each specific risk add-on in accordance with 
the requirements of this section. Notwithstanding any other 
definition or requirement in this appendix, a position that would 
have qualified as a debt position or an equity position but for the 
fact that it qualifies as a correlation trading position under 
paragraph (2) of the definition of correlation trading position, 
shall be considered a debt position or an equity position, 
respectively, for purposes of this section 10.
    (1) The specific risk add-on for an individual debt or 
securitization position that represents sold credit protection is 
capped at the notional amount of the credit derivative contract. The 
specific risk add-on for an individual debt or securitization 
position that represents purchased credit protection is capped at 
the current market value of the transaction plus the absolute value 
of the present value of all remaining payments to the protection 
seller under the transaction. This sum is equal to the value of the 
protection leg of the transaction.
    (2) For debt, equity, or securitization positions that are 
derivatives with linear payoffs, a [bank] must assign a specific 
risk-weighting factor to the market value of the effective notional 
amount of the underlying instrument or index portfolio, except for a 
securitization position for which the [bank] directly calculates a 
specific risk add-on using the SFA in paragraph (b)(2)(vii)(B) of 
this section. 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 [bank] 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 [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.
    (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:
    (i) The debt or securitization position is fully hedged by a 
total return swap (or similar instrument where there is a matching 
of swap payments and changes in market value of the debt or 
securitization position);

[[Page 53107]]

    (ii) There is an exact match between the reference obligation of 
the swap and the debt or securitization position;
    (iii) There is an exact match between the currency of the swap 
and the debt or securitization position; and
    (iv) There is either an exact match between the maturity date of 
the swap and the maturity date of the debt or securitization 
position; or, in cases where a total return swap references a 
portfolio of positions with different maturity dates, the total 
return swap maturity date must match the maturity date of the 
underlying asset in that portfolio that has the latest maturity 
date.
    (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 specific risk add-on when:
    (i) The credit risk of the position is fully hedged by a credit 
default swap or similar instrument;
    (ii) There is an exact match between the reference obligation of 
the credit derivative hedge and the debt or securitization position;
    (iii) There is an exact match between the currency of the credit 
derivative hedge and the debt or securitization position; and
    (iv) There is either an exact match between the maturity date of 
the credit derivative hedge and the maturity date of the debt or 
securitization position; or, in the case where the credit derivative 
hedge has a standard maturity date:
    (A) The maturity date of the credit derivative hedge is within 
30 business days of the maturity date of the debt or securitization 
position; or
    (B) For purchased credit protection, the maturity date of the 
credit derivative hedge is later than the maturity date of the debt 
or securitization position, but is no later than the standard 
maturity date for that instrument that immediately follows the 
maturity date of the debt or securitization position. The maturity 
date of the credit derivative hedge may not exceed the maturity date 
of the debt or securitization position by more than 90 calendar 
days.
    (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) 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 [bank] 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 specific 
risk-weighting factor as set forth in paragraphs (b)(2)(i) through 
(b)(2)(vii) of this section.
    (2) For the purpose of this section, the appropriate specific 
risk-weighting factors include:
    (i) Sovereign debt positions. (A) In general. A [bank] must 
assign a specific risk-weighting factor to a sovereign debt position 
based on the CRC applicable to the sovereign entity and, as 
applicable, the remaining contractual maturity of the position, in 
accordance with table 2. Sovereign debt positions that are backed by 
the full faith and credit of the United States are treated as having 
a CRC of 0.

                      Table 2--Specific Risk-Weighting Factors for Sovereign Debt Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                                 Specific risk-weighting factor       Percent
----------------------------------------------------------------------------------------------------------------
                                                         0-1                                                0.0
                                                ----------------------------------------------------------------
                                                               Remaining contractual maturity of            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          2-3   Remaining contractual maturity of            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                         4-6                                                8.0
                                                ----------------------------------------------------------------
                                                           7                                               12.0
----------------------------------------------------------------------------------------------------------------
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------

     (B) Notwithstanding paragraph (b)(2)(i)(A) of this section, a 
[bank] may assign to a sovereign debt position a specific risk-
weighting factor that is lower than the applicable specific risk-
weighting factor in table 2 if:
    (1) The position is denominated in the sovereign entity's 
currency;
    (2) The [bank] has at least an equivalent amount of liabilities 
in that currency; and
    (3) The sovereign entity allows banks under its jurisdiction to 
assign the lower specific risk-weighting factor to the same 
exposures to the sovereign entity.
    (C) A [bank] must assign a 12.0 percent specific risk-weighting 
factor to a sovereign debt position immediately upon determination 
that a default has occurred; or if a default has occurred within the 
previous five years.
    (D) A [bank] must assign an 8.0 percent specific risk-weighting 
factor to a sovereign debt position if the sovereign entity does not 
have a CRC assigned to it, unless the sovereign debt position must 
be assigned a higher specific risk-weighting factor under paragraph 
(b)(2)(i)(C) of this section.
    (ii) Certain supranational entity and multilateral development 
bank debt positions. A [bank] may assign a 0.0 percent specific 
risk-weighting factor to a debt position that is an exposure to the 
Bank for International Settlements, the European Central Bank, the 
European Commission, the International Monetary Fund, or an MDB.
    (iii) GSE debt positions. A [bank] must assign a 1.6 percent 
specific risk-weighting factor to a debt position that is an 
exposure to a GSE. Notwithstanding the foregoing, a [bank] must 
assign an 8.0 percent specific risk-weighting factor to preferred 
stock issued by a GSE.
    (iv) Depository institution, foreign bank, and credit union debt 
positions. (A) Except as provided in paragraph (b)(2)(iv)(B) of this 
section, a [bank] must assign a specific risk-weighting factor to a 
debt position that is an exposure to a depository institution, a 
foreign bank, or a credit union using the specific risk-weighting 
factor that corresponds to that entity's sovereign of incorporation 
and, as applicable, the remaining contractual maturity of the 
position, in accordance with table 3.

[[Page 53108]]



    Table 3--Specific Risk-Weighting Factors for Depository Institution, Foreign Bank, and Credit Union Debt
                                                    Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                                 Specific risk-weighting factor       Percent
----------------------------------------------------------------------------------------------------------------
                                                               Remaining contractual maturity of            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          0-2   Remaining contractual maturity of            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                           3                                                8.0
                                                ----------------------------------------------------------------
                                                         4-7                                               12.0
----------------------------------------------------------------------------------------------------------------
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------

     (B) A [bank] must assign a specific risk-weighting factor of 
8.0 percent to a debt position that is an exposure to a depository 
institution or a foreign bank that is includable in the depository 
institution's or foreign bank's regulatory capital and that is not 
subject to deduction as a reciprocal holding under the [general 
risk-based capital rules].
    (C) A [bank] must assign a 12.0 percent specific risk-weighting 
factor to a debt position that is an exposure to a foreign bank 
immediately upon determination that a default by the foreign bank's 
sovereign of incorporation has occurred or if a default by the 
foreign bank's sovereign of incorporation has occurred within the 
previous five years.
    (v) PSE debt positions. (A) Except as provided in paragraph 
(b)(2)(v)(B) of this section, a [bank] must assign a specific risk-
weighting factor to a debt position that is an exposure to a PSE 
based on the specific risk-weighting factor that corresponds to the 
PSE's sovereign of incorporation and to the position's 
categorization as a general obligation or revenue obligation and, as 
applicable, the remaining contractual maturity of the position, as 
set forth in tables 4 and 5.
    (B) A [bank] may assign a lower specific risk-weighting factor 
than would otherwise apply under tables 4 and 5 to a debt position 
that is an exposure to a foreign PSE if:
    (1) The PSE's sovereign of incorporation allows banks under its 
jurisdiction to assign a lower specific risk-weighting factor to 
such position; and
    (2) The specific risk-weighting factor is not lower than the 
risk weight that corresponds to the PSE's sovereign of incorporation 
in accordance with tables 4 and 5.
    (C) A [bank] must assign a 12.0 percent specific risk-weighting 
factor to a PSE debt position immediately upon determination that a 
default by the PSE's sovereign of incorporation has occurred or if a 
default by the PSE's sovereign of incorporation has occurred within 
the previous five years.

               Table 4--Specific Risk-Weighting Factors for PSE General Obligation Debt Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                               General obligation specific risk-      Percent
                                                                  weighting factor (in percent)
----------------------------------------------------------------------------------------------------------------
                                                               Remaining contractual maturity of            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          0-2   Remaining contractual maturity of            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                           3                                                8.0
                                                ----------------------------------------------------------------
                                                         4-7                                               12.0
----------------------------------------------------------------------------------------------------------------
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------


               Table 5--Specific Risk-Weighting Factors for PSE Revenue Obligation Debt Positions
----------------------------------------------------------------------------------------------------------------
 
----------------------------------------------------------------------------------------------------------------
                                                               Revenue obligation specific risk-      Percent
                                                                        weighting factor
----------------------------------------------------------------------------------------------------------------
                                                               Remaining contractual maturity of            0.25
                                                                6 months or less.
                                                              --------------------------------------------------
CRC of Sovereign...............................          0-1   Remaining contractual maturity of            1.0
                                                                greater than 6 and up to and
                                                                including 24 months.
                                                              --------------------------------------------------
                                                               Remaining contractual maturity               1.6
                                                                exceeds 24 months.
                                                ----------------------------------------------------------------
                                                         2-3                                                8.0
                                                ----------------------------------------------------------------
                                                         4-7                                               12.0
----------------------------------------------------------------------------------------------------------------

[[Page 53109]]

 
No CRC.......................................................                                               8.0
----------------------------------------------------------------------------------------------------------------
Default by the Sovereign Entity..............................                                              12.0
----------------------------------------------------------------------------------------------------------------

     (vi) Corporate debt positions. Except as otherwise provided in 
paragraph (b)(2)(vi)(B), a [bank] must assign a specific risk-
weighting factor to a corporate debt position in accordance with the 
investment grade methodology in paragraph (b)(2)(vi)(A) of this 
section.
    (A) Investment grade methodology. (1) For corporate debt 
positions that are exposures to entities that have issued and 
outstanding publicly traded instruments, a [bank] must assign a 
specific risk-weighting factor based on the category and remaining 
contractual maturity of the position, in accordance with table 6. 
For purposes of this paragraph (A), the [bank] must determine 
whether the position is in the investment grade or not investment 
grade category.

  Table 6--Specific Risk-Weighting Factors for Corporate Debt Positions
                 Under the Investment Grade Methodology
------------------------------------------------------------------------
                                                          Specific  risk-
                                  Remaining contractual      weighting
            Category                     maturity           factor (in
                                                             percent)
------------------------------------------------------------------------
Investment Grade...............  6 months or less.......            0.50
                                 Greater than 6 and up              2.00
                                  to and including 24
                                  months.
                                 Greater than 24 months.            4.00
Not-investment Grade...........  .......................           12.00
------------------------------------------------------------------------

    (2) A [bank] must assign an 8.0 percent specific risk-weighting 
factor for corporate debt positions that are exposures to entities 
that do not have publicly traded instruments outstanding.
    (B) Limitations. (1) A [bank] must assign a specific risk-
weighting factor of at least 8.0 percent to an interest-only 
mortgage-backed security that is not a securitization position.
    (2) A [bank] shall not assign a corporate debt position a 
specific risk-weighting factor that is lower than the specific risk-
weighting factor that corresponds to the CRC of the issuer's 
sovereign of incorporation in table 1.
    (vii) Securitization positions. (A) General requirements. (1) A 
[bank] that does not use the [advanced capital adequacy framework] 
must assign a specific risk-weighting factor to a securitization 
position using either the simplified supervisory formula approach 
(SSFA) in accordance with section 11 of this appendix or assign a 
specific risk-weighting factor of 100 percent to the position.
    (2) A [bank] that uses the [advanced capital adequacy framework] 
must calculate a specific risk add-on for a securitization position 
using the SFA in section 45 of [the advanced capital adequacy 
framework] and in accordance with paragraph (b)(2)(vii)(B) of this 
section if the [bank] and the securitization position each qualifies 
to use the SFA under the [advanced capital adequacy framework]. A 
[bank] that uses the [advanced capital adequacy framework] and that 
has a securitization position that does not qualify for the SFA may 
assign a specific risk-weighting factor to the securitization 
position using the SSFA in accordance with section 11 of this 
appendix or assign a specific risk-weighting factor of 100 percent 
to the position.
    (3) A [bank] must treat a short securitization position as if it 
is a long securitization position solely for calculation purposes 
when using the SFA in paragraph (b)(2)(vii)(B) or the SSFA in 
section 11 of this appendix.
    (B) SFA. To calculate the specific risk add-on for a 
securitization position using the SFA, a [bank] that is subject to 
[the advanced capital adequacy framework] must set the specific risk 
add-on for the position equal to the risk-based capital requirement, 
calculated under section 45 of [the advanced capital adequacy 
framework].
    (C) SSFA. To use the SSFA to determine the specific risk-
weighting factor for a securitization position, a [bank] must 
calculate the specific risk-weighting factor in accordance with 
section 11 of this appendix.
    (D) Nth-to-default credit derivatives. A [bank] must determine a 
specific risk add-on using the SFA in paragraph (b)(2)(vii)(B), or 
assign a specific risk-weighting factor using the SSFA in section 11 
of this appendix to an nth-to-default credit derivative in 
accordance with this paragraph (D), irrespective of whether the 
[bank] is a net protection buyer or net protection seller. A [bank] 
must determine its position in the nth-to-default credit derivative 
as the largest notional dollar amount of all the underlying 
exposures.
    (1) For purposes of determining the specific risk add-on using 
the SFA in paragraph (b)(2)(vii)(B) or the specific risk-weighting 
factor for an nth-to-default credit derivative using the SSFA in 
section 11 of this appendix, the [bank] must calculate the 
attachment point and detachment point of its position as follows:
    (i) The attachment point (parameter A) is the ratio of the sum 
of the notional amounts of all underlying exposures that are 
subordinated to the [bank]'s position to the total notional amount 
of all underlying exposures. For purposes of using the SFA to 
calculate the specific add-on for its position in an nth-to-default 
credit derivative, parameter A must be set equal to the credit 
enhancement level (L) input to the SFA formula. In the case of a 
first-to-default credit derivative, there are no underlying 
exposures that are subordinated to the [bank]'s position. In the 
case of a second-or-subsequent-to-default credit derivative, the 
smallest (n-1) notional amounts of the underlying exposure(s) are 
subordinated to the [bank]'s position.
    (ii) The detachment point (parameter D) equals the sum of 
parameter A plus the ratio of the notional amount of the [bank]'s 
position in the nth-to-default credit derivative to the total 
notional amount of all underlying exposures. For purposes of using 
the SFA to calculate the specific risk add-on for its position in an 
nth-to-default credit derivative, parameter D must be set to equal L 
plus the thickness of tranche (T) input to the SFA formula.
    (2) A [bank] that does not use the SFA to determine a specific 
risk-add on, or the SSFA to determine a specific risk-weighting 
factor for its position in an nth-to-default credit derivative must 
assign a specific risk-weighting factor of 100 percent to the 
position.
    (c) Modeled correlation trading positions. For purposes of 
calculating the comprehensive risk measure for modeled correlation 
trading positions under either paragraph (a)(2)(i) or (a)(2)(ii) of 
section 9 of this appendix, the total specific risk add-on is the 
greater of:
    (1) The sum of the [bank]'s specific risk add-ons for each net 
long correlation trading position calculated under this section; or
    (2) The sum of the [bank]'s specific risk add-ons for each net 
short correlation trading position calculated under this section.
    (d) Non-modeled securitization positions. For securitization 
positions that are not correlation trading positions and for 
securitizations that are correlation trading positions not modeled 
under section 9 of this

[[Page 53110]]

appendix, the total specific risk add-on is the greater of:
    (1) The sum of the [bank]'s specific risk add-ons for each net 
long securitization position calculated under this section; or
    (2) The sum of the [bank]'s specific risk add-ons for each net 
short securitization position calculated under this section.
    (e) 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 [bank] must multiply the absolute value of the current 
market value of each net long or net short equity position by the 
appropriate specific risk-weighting factor as determined under this 
paragraph:
    (1) The [bank] must multiply the absolute value of the current 
market value of each net long or net short equity position by a 
specific 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 specific 
risk-weighting factor of 2.0 percent.\46\
---------------------------------------------------------------------------

    \46\ 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 [bank] may apply a 2.0 percent 
specific 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 
[bank] may apply a 2.0 percent specific 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 [bank] 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.
    (f) Due diligence requirements. (1) A [bank] must 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 by conducting and documenting 
the analysis set forth in paragraph (f)(2) of this section. The 
[bank]'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 [bank] must:
    (i) Conduct an analysis of the risk characteristics of a 
securitization position prior to acquiring the position and document 
such analysis within three business days after 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 loan-to-value 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 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 (f)(1) of this section for each securitization 
position.

Section 11. Simplified Supervisory Formula Approach

    (a) General requirements. To use the SSFA to determine the 
specific risk-weighting factor for a securitization position, a 
[bank] must have data that enables it to assign accurately the 
parameters described in paragraph (b) of this section. Data used to 
assign the parameters described in paragraph (b) of this section 
must be the most currently available data and no more than 91 
calendar days old. A [bank] that does not have the appropriate data 
to assign the parameters described and defined, for purposes of this 
section, in paragraph (b) of this section must assign a specific 
risk-weighting factor of 100 percent to the position.
    (b) SSFA parameters. To calculate the specific risk-weighting 
factor for a securitization position using the SSFA, a [bank] must 
have accurate information on the five inputs to the SSFA calculation 
described in paragraphs (b)(1) through (b)(5) of this section:
    (1) KG is the weighted-average (with unpaid principal 
used as the weight for each exposure) total capital requirement of 
the underlying exposures calculated using the [general risk-based 
capital rules]. KG is expressed as a decimal value 
between zero and 1 (that is, an average risk weight of 100 percent 
represents a value of KG equal to .08).
    (2) Parameter W is expressed as a decimal value between zero and 
one. Parameter W is the ratio of the sum of the dollar amounts of 
any underlying exposures within the securitized pool that meet any 
of the criteria as set forth in paragraphs (i) through (vi) of this 
paragraph (b)(2) to the ending balance, measured in dollars, of 
underlying exposures:
    (i) Ninety days or more past due;
    (ii) Subject to a bankruptcy or insolvency proceeding;
    (iii) In the process of foreclosure;
    (iv) Held as real estate owned;
    (v) Has contractually deferred interest payments for 90 days or 
more; or
    (vi) Is in default.
    (3) Parameter A is the attachment point for the position, which 
represents the threshold at which credit losses will first be 
allocated to the position. Parameter A equals the ratio of the 
current dollar amount of underlying exposures that are subordinated 
to the position of the [bank] to the current dollar amount of 
underlying exposures. Any reserve account funded by the accumulated 
cash flows from the underlying exposures that is subordinated to the 
position that contains the [bank]'s securitization exposure may be 
included in the calculation of parameter A to the extent that cash 
is present in the account. Parameter A is expressed as a decimal 
value between zero and one.
    (4) Parameter D is the detachment point for the position, which 
represents the threshold at which credit losses of principal 
allocated to the position would result in a total loss of principal. 
Parameter D equals parameter A plus the ratio of the current dollar 
amount of the securitization positions that are pari passu with the 
position (that is, have equal seniority with respect to credit risk) 
to the current dollar amount of the underlying exposures. Parameter 
D is expressed as a decimal value between zero and one.
    (5) A supervisory calibration parameter, p, is equal to 0.5 for 
securitization positions that are not resecuritization positions and 
equal to 1.5 for resecuritization positions.
    (c) Mechanics of the SSFA. KG and W are used to 
calculate KA, the augmented value of KG, which 
reflects the observed credit quality of the underlying pool of 
exposures. KA is defined in paragraph (d) of this 
section. The values of parameters A and D, relative to KA 
determine the specific risk-weighting factor assigned to a position 
as described in this paragraph and paragraph (d) of this section. 
The specific risk-weighting factor assigned to a securitization 
position, or portion of a position, as appropriate, is the larger of 
the specific risk-weighting factor determined in accordance with 
this paragraph and paragraph (d) of this section and a specific 
risk-weighting factor of 1.6 percent.
    (1) When the detachment point, parameter D, for a securitization 
position is less than or equal to KA, the position must 
be assigned a specific risk-weighting factor of 100 percent.
    (2) When the attachment point, parameter A, for a securitization 
position is greater than or equal to KA, the [bank] must 
calculate the specific risk-weighting factor in accordance with 
paragraph (d) of this section.

[[Page 53111]]

    (3) When A is less than KA and D is greater than 
KA, the specific risk-weighting factor is a weighted-
average of 1.00 and KSSFA calculated in accordance with 
paragraph (d) of this section, but with the parameter A revised to 
be set equal to KA. For the purpose of this weighted-
average calculation:
BILLING CODE 4810-33-P
[GRAPHIC] [TIFF OMITTED] TR30AU12.005

BILLING CODE 4810-33-C

Section 12. Market Risk Disclosures

    (a) Scope. A [bank] 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. A [bank] must make 
quantitative disclosures publicly each calendar quarter. If a 
significant change occurs, such that the most recent reporting 
amounts are no longer reflective of the [bank]'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 [bank] 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 [bank] is not 
required to 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 [bank] must have a formal disclosure 
policy approved by the board of directors that addresses the 
[bank]'s approach for determining its market risk disclosures. 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 [bank] 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 material portfolio of covered positions, the [bank] 
must disclose publicly the following information at least quarterly:

[[Page 53112]]

    (i) The high, low, and mean VaR-based measures over the 
reporting period and the VaR-based measure at period-end;
    (ii) The high, low, and mean stressed VaR-based measures over 
the reporting period and the stressed VaR-based measure at period-
end;
    (iii) The high, low, and mean incremental risk capital 
requirements over the reporting period and the incremental risk 
capital requirement at period-end;
    (iv) The high, low, 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 [bank], with an analysis of important 
outliers.
    (2) In addition, the [bank] must disclose publicly 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. For each material portfolio of 
covered positions, the [bank] must disclose publicly the following 
information at least annually, or more frequently in the event of 
material changes for each portfolio:
    (1) The composition of material portfolios of covered positions;
    (2) 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;
    (3) 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:
    (i) The approach used by the [bank] to determine liquidity 
horizons;
    (ii) The methodologies used to achieve a capital assessment that 
is consistent with the required soundness standard; and
    (iii) The specific approaches used in the validation of these 
models;
    (4) A description of the approaches used for validating and 
evaluating the accuracy of internal models and modeling processes 
for purposes of this appendix;
    (5) 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;
    (6) The results of the comparison of the [bank]'s internal 
estimates for purposes of this appendix with actual outcomes during 
a sample period not used in model development;
    (7) The soundness standard on which the [bank]'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;
    (8) 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
    (8) A description of the [bank]'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 Common Rule

    The adoption of the final 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 are amended as 
follows:

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

0
1. The authority citation for part 3 continues to read as follows:

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

0
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

0
3. Appendix B to part 3 is further amended by:
0
a. Removing ``[the advanced capital adequacy framework]'' wherever it 
appears and adding in its place ``Appendix C to this part'';
0
b. Removing ``[Agency]'' wherever it appears and adding in its place 
``OCC'';
0
c. Removing ``[Agency's]'' wherever it appears and adding in its place 
``OCC's'';
0
d. Removing ``[bank]'' wherever it appears and adding in its place 
``bank'';
0
e. Removing ``[banks]'' wherever it appears and adding in its place 
``banks'';
0
f. Removing ``[Call Report or FR Y-9C]'' wherever it appears and adding 
in its place ``Call Report'';
0
g. Removing ``[regulatory report]'' wherever it appears and adding in 
its place ``Consolidated Reports of Condition and Income (Call 
Report)'';
0
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 
amended as follows:

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

0
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.

0
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

0
6. Appendix E to part 208 is amended by:
0
a. Removing ``[the advanced capital adequacy framework]'' wherever it

[[Page 53113]]

appears and adding in its place ``Appendix F to this part'';
0
b. Removing ``[bank]'' wherever it appears and adding in its place 
``bank'';
0
c. Removing ``[banks]'' wherever it appears and adding in its place 
``banks'';
0
d. Removing ``[Call Report or FR Y-9C]'' wherever it appears and adding 
in its place ``Call Report'';
0
e. Removing ``[regulatory report]'' wherever it appears and adding in 
its place ``Consolidated Reports of Condition and Income (Call 
Report)'';
0
f. Removing ``[the general risk-based capital rules]'' wherever it 
appears and adding in its place ``Appendix A to this part''.
0
g. Removing ``[Agency]'' wherever it appears in section 1 and adding in 
its place ``Board'';
0
h. Removing ``[Agency]'' in the definition of covered position in 
section 2 and adding in its place ``Board or the appropriate Reserve 
Bank, with concurrence of the Board,'';
0
i. Removing ``[Agency]'' in the definitions of multilateral development 
bank and securitization in section 2 and adding in its place ``Board'';
0
j. Removing ``[Agency]'' in the definition of covered position in 
section 2 and adding in its place ``Board or the appropriate Reserve 
Bank, with concurrence of the Board,'';
0
k. Revising section 3(c) to read as follows:

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

* * * * *
    (c) Requirements for internal models. (1) A bank must obtain the 
prior written approval of the Board or the appropriate Reserve Bank, 
with concurrence of the Board, before using any internal model to 
calculate its risk-based capital requirement under this appendix.
    (2) A bank must meet all of the requirements of this section on 
an ongoing basis. The bank must promptly notify the Board and the 
appropriate Reserve Bank when:
    (i) The bank plans to extend the use of a model that the Board 
or the appropriate Reserve Bank, with concurrence of the Board, has 
approved under this appendix to an additional business line or 
product type;
    (ii) The bank makes any change to an internal model approved by 
the Board or the appropriate Reserve Bank, with concurrence of the 
Board, under this appendix that would result in a material change in 
the bank's risk-weighted asset amount for a portfolio of covered 
positions; or
    (iii) The bank makes any material change to its modeling 
assumptions.
    (3) The Board or the appropriate Reserve Bank, with concurrence 
of the Board, may rescind its approval of the use of any internal 
model (in whole or in part) or of the determination of the approach 
under section 9(a)(2)(ii) of this appendix for a bank's modeled 
correlation trading positions and determine an appropriate capital 
requirement for the covered positions to which the model would 
apply, if the Board or the appropriate Reserve Bank, with 
concurrence of the Board, determines that the model no longer 
complies with this appendix or fails to reflect accurately the risks 
of the bank's covered positions.
* * * * *

0
l. Removing ``[Agency]'' in section 3(e)(4) and adding in its place 
``Board'';
0
m. Removing ``[Agency]'' in the section 4(a)(2)(vi)(B) and adding in 
its place ``Board or the appropriate Reserve Bank, with concurrence of 
the Board,'';
0
n. Revising section (4)(b) to read as follows:

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

* * * * *
    (b) Backtesting. A bank must compare each of its most recent 250 
business days' trading losses (excluding fees, commissions, 
reserves, net interest income, and intraday trading) with the 
corresponding daily VaR-based measures calibrated to a one-day 
holding period and at a one-tail, 99.0 percent confidence level. A 
bank must begin backtesting as required by this paragraph no later 
than one year after the later of January 1, 2013 and the date on 
which the bank becomes subject to this appendix. In the interim, 
consistent with safety and soundness principles, a bank subject to 
this appendix as of its effective date should continue to follow 
backtesting procedures in accordance with the supervisory 
expectations of the Board or the appropriate Reserve Bank.
* * * * *
0
o. Removing ``[Agency]'' in section 4(b)(2) and adding in its place 
``Board or the appropriate Reserve Bank, with the concurrence of the 
Board,'';
0
p. Removing ``[Agency]'' in sections 5(a)(4) and 5(a)(5) and adding in 
its place ``Board or the appropriate Reserve Bank, with concurrence of 
the Board,'';
0
q. Removing ``[Agency]'' in sections 5(b)(1) and 5(b)(2)(ii) and adding 
in its place ``Board or the appropriate Reserve Bank, with concurrence 
of the Board,'';
* * * * *
0
r. Revising section 5(c) to read as follows:

Section 5. VaR-Based Measure

* * * * *
    (c) A bank must divide its portfolio into a number of 
significant subportfolios approved by the Board or the appropriate 
Reserve Bank, with concurrence of the Board, for subportfolio 
backtesting purposes. These subportfolios must be sufficient to 
allow the bank and the Board or the appropriate Reserve Bank, with 
concurrence of the Board, to assess the adequacy of the VaR model at 
the risk factor level; the Board or the appropriate Reserve Bank, 
with concurrence of the Board, will evaluate the appropriateness of 
these subportfolios relative to the value and composition of the 
bank's covered positions. The bank must retain and make available to 
the Board and the appropriate Reserve Bank 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:
* * * * *
0
s. Revising section 6(b)(3) to read as follows:
* * * * *
    (3) A bank must 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 under this section 
and must be able to provide empirical support for the period used. 
The bank must obtain the prior approval of the Board or the 
appropriate Reserve Bank, with concurrence of the Board, for, and 
notify the Board and the appropriate Reserve Bank if the bank makes 
any material changes to, these policies and procedures. The policies 
and procedures must address:
* * * * *

0
t. Removing ``[Agency]'' in section 6(b)(4) and adding in its place 
``Board or the appropriate Reserve Bank, with concurrence of the 
Board,'';
0
u. Removing ``[Agency]'' in section 8(a) and adding in its place 
``Board or the appropriate Reserve Bank, with concurrence of the 
Board,'';
0
v. Removing ``[Agency]'' in sections 9(a)(1) and 9(a)(2)(ii) and adding 
in its place ``Board or the appropriate Reserve Bank, with concurrence 
of the Board,'';
0
w. Removing ``[Agency]'' in sections 9(c)(2)(i) and (ii) wherever it 
appears and adding in its place ``Board and the appropriate Reserve 
Bank'';
0
x. Removing ``[Agency]'' in sections 10(e) and (f) and adding in its 
place ``Board or the appropriate Reserve Bank, with concurrence of the 
Board,'';

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

0
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.


0
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

0
9. Appendix E is amended by:
0
a. Removing ``[the advanced capital adequacy framework]'' wherever it 
appears and adding in its place ``Appendix G to this part'';

[[Page 53114]]

0
b. Removing ``[bank]'' wherever it appears and adding in its place 
``bank holding company'';
0
c. Removing ``[banks]'' wherever it appears and adding in its place 
``bank holding companies'';
0
d. Removing ``[Call Report or FR Y-9C]'' wherever it appears and adding 
in its place ``FR Y-9C'';
0
e. Removing ``[regulatory report]'' wherever it appears and adding in 
its place ``Consolidated Financial Statements for Bank Holding 
Companies (FR Y-9C)''; and
0
f. Removing ``[the general risk-based capital rules]'' wherever it 
appears and adding in its place ``Appendix A to this part''.
0
g. Removing ``[Agency]'' wherever it appears in section 1 and adding in 
its place ``Board'';
0
h. Removing ``[Agency]'' in the definition of covered position in 
section 2 and adding in its place ``Board or the appropriate Reserve 
Bank, with concurrence of the Board'';
0
i. Removing ``[Agency]'' in the definitions of multilateral development 
bank and securitization in section 2 and adding in its place ``Board'';
0
j. Removing ``[Agency]'' in the definition of covered position in 
section 2 and adding in its place ``Board or the appropriate Reserve 
Bank, with concurrence of the Board'';
0
k. Revising section 3(c) to read as follows:

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

* * * * *
    (c) Requirements for internal models. (1) A bank holding company 
must obtain the prior written approval of the Board or the 
appropriate Reserve Bank, with concurrence of the Board, before 
using any internal model to calculate its risk-based capital 
requirement under this appendix.
    (2) A bank holding company must meet all of the requirements of 
this section on an ongoing basis. The bank holding company must 
promptly notify the Board and the appropriate Reserve Bank when:
    (i) The bank holding company plans to extend the use of a model 
that the Board or the appropriate Reserve Bank, with concurrence of 
the Board has approved under this appendix to an additional business 
line or product type;
    (ii) The bank holding company makes any change to an internal 
model approved by the Board or the appropriate Reserve Bank, with 
concurrence of the Board, under this appendix that would result in a 
material change in the bank holding company's risk-weighted asset 
amount for a portfolio of covered positions; or
    (iii) The bank holding company makes any material change to its 
modeling assumptions.
    (3) The Board or the appropriate Reserve Bank, with concurrence 
of the Board, may rescind its approval of the use of any internal 
model (in whole or in part) or of the determination of the approach 
under section 9(a)(2)(ii) of this appendix for a bank holding 
company's modeled correlation trading positions and determine an 
appropriate capital requirement for the covered positions to which 
the model would apply, if the Board or the appropriate Reserve Bank, 
with concurrence of the Board, determines that the model no longer 
complies with this appendix or fails to reflect accurately the risks 
of the bank holding company's covered positions.
* * * * *
0
l. Removing ``[Agency]'' in section 3(e)(4) and adding in its place 
``Board'';
0
m. Removing ``[Agency]'' in the section 4(a)(2)(vi)(B) and adding in 
its place ``Board or the appropriate Reserve Bank, with concurrence of 
the Board'';
0
n. Revising section (4)(b) to read as follows:

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

* * * * *
    (b) Backtesting. A bank holding company must compare each of its 
most recent 250 business days' trading losses (excluding fees, 
commissions, reserves, net interest income, and intraday trading) 
with the corresponding daily VaR-based measures calibrated to a one-
day holding period and at a one-tail, 99.0 percent confidence level. 
A bank holding company must begin backtesting as required by this 
paragraph no later than one year after the later of January 1, 2013 
and the date on which the bank holding company becomes subject to 
this appendix. In the interim, consistent with safety and soundness 
principles, a bank holding company subject to this appendix as of 
its effective date should continue to follow backtesting procedures 
in accordance with the supervisory expectations of the Board or the 
appropriate Reserve Bank.
* * * * *
0
o. Removing ``[Agency]'' in section 4(b)(2) and adding in its place 
``Board or the appropriate Reserve Bank, with the concurrence of the 
Board'';
0
p. Removing ``[Agency]'' in sections 5(a)(4) and 5(a)(5) and adding in 
its place ``Board or the appropriate Reserve Bank, with concurrence of 
the Board'';
0
q. Removing ``[Agency]'' in sections 5(b)(1) and 5(b)(2)(ii) and adding 
in its place ``Board or the appropriate Reserve Bank, with concurrence 
of the Board'';
0
r. Revising section 5(c) to read as follows:

Section 5. VaR-based Measure

* * * * *
    (c) A bank holding company must divide its portfolio into a 
number of significant subportfolios approved by the Board or the 
appropriate Reserve Bank, with concurrence of the Board, for 
subportfolio backtesting purposes. These subportfolios must be 
sufficient to allow the bank holding company and the Board or the 
appropriate Reserve Bank, with concurrence of the Board, to assess 
the adequacy of the VaR model at the risk factor level; the Board or 
the appropriate Reserve Bank, with concurrence of the Board, will 
evaluate the appropriateness of these subportfolios relative to the 
value and composition of the bank holding company's covered 
positions. The bank holding company must retain and make available 
to the Board and the appropriate Reserve Bank 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:
* * * * *
0
s. Revising section 6(b)(3) to read as follows:
* * * * *
    (3) A bank holding company must have policies and procedures 
that describe how it determines the period of significant financial 
stress used to calculate the bank holding company's stressed VaR-
based measure under this section and must be able to provide 
empirical support for the period used. The bank holding company must 
obtain the prior approval of the Board or the appropriate Reserve 
Bank, with concurrence of the Board, for, and notify the Board and 
the appropriate Reserve Bank if the bank holding company makes any 
material changes to, these policies and procedures. The policies and 
procedures must address:
* * * * *
0
t. Removing ``[Agency]'' in section 6(b)(4) and adding in its place 
``Board or the appropriate Reserve Bank, with concurrence of the 
Board'';
0
u. Removing ``[Agency]'' in section 8(a) and adding in its place 
``Board or the appropriate Reserve Bank, with concurrence of the 
Board'';
0
v. Removing ``[Agency]'' in sections 9(a)(1) and 9(a)(2)(ii) and adding 
in its place ``Board or the appropriate Reserve Bank, with concurrence 
of the Board'';
0
w. Removing ``[Agency]'' in sections 9(c)(2)(i) and (ii) wherever it 
appears and adding in its place ``Board and the appropriate Reserve 
Bank'';
0
x. Removing ``[Agency]'' in sections 10(e) and (f) and adding in its 
place ``Board or the appropriate Reserve Bank, with concurrence of the 
Board,'';

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 amended 
as follows:

PART 325--CAPITAL MAINTENANCE

0
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,

[[Page 53115]]

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).


0
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

0
12. Appendix C is further amended by:
0
a. Removing ``[Agency]'' wherever it appears and adding in its place 
``FDIC'';
0
b. Removing ``[Agency's]'' wherever it appears and adding in its place 
``FDIC's'';
0
c. Removing ``[bank]'' wherever it appears and adding in its place 
``bank'';
0
d. Removing ``[banks]'' wherever it appears and adding in its place 
``banks'';
0
e. Removing [Call Report or FR Y-9C] wherever it appears and adding in 
its place ``Call Report'';
0
f. Removing ``[the advanced capital adequacy framework]'' wherever it 
appears and adding in its place ``Appendix D to this part'';
0
g. Removing ``[regulatory report]'' wherever it appears and adding in 
its place ``Consolidated Reports of Condition and Income (Call 
Report)'';
0
h. Removing ``[the general risk-based capital rules]'' wherever it 
appears and adding in its place ``Appendix A to this part''.

    Dated: June 11, 2012.
Thomas J. Curry,
Comptroller of the Currency.


    By order of the Board of Governors of the Federal Reserve 
System, July 3, 2012.
Jennifer J. Johnson,
Secretary of the Board.


    Dated at Washington, DC, this 12th day of June, 2012.

    By order of the Board of Directors.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2012-16759 Filed 8-10-12; 8:45 am]
BILLING CODE 4810-33-P; 6714-10-P