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Vol. 77

Thursday,

No. 169

August 30, 2012

Part V

Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Part 3

Federal Reserve System
12 CFR Parts 208 and 225

Federal Deposit Insurance Corporation

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12 CFR Part 325
Risk-Based Capital Guidelines: Market Risk; Rule

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

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
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.
AGENCY:

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

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SUMMARY:

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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

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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 riskbased 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
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).

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implemented the MRA with an effective
date of January 1, 1997 (market risk
capital rule).5
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
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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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 riskbased capital requirement for modeled
correlation trading positions (2010
revisions).6
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
The 2009 revisions include changes to
the specific risk-weighting factors for
rated and unrated securitization
positions. For rated securitization
6 The June 2010 revisions can be found in their
entirety at http://bis.org/press/p100618/annex.pdf.
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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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 riskweighting 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 addon 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.
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.
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.

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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
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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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 VaRbased 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.
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
10 The consultative document is available at
http://www.bis.org/publ/bcbs219.htm.

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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 DoddFrank 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 oneyear 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

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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
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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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.
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

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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 shortterm 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

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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 noncovered 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.

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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

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

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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 VaRbased 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)

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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).
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 onbalance 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
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.

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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-todefault 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

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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 DoddFrank Act) to engage in proprietary
trading and have certain interests in, or
relationships with, a covered fund as
defined under section 619 of the DoddFrank 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.

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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 DoddFrank 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

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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 nontraded 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

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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 riskbased 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 riskweighted 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

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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-theart 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

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conservatively under realistic market
scenarios. The January 2011 proposal
also would require a bank to have a
rigorous process for re-estimating, reevaluating, 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

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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-ofday 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 outof-the-money products, jumps-todefault, 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

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Board with respect to the use of internal
and third-party models.14
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
14 See Supervisory Guidance on Model Risk
Management, issued by the OCC and Federal
Reserve (April 4, 2011).

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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
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 DoddFrank Act).15 Under the advanced
approaches rules, a bank is required to
calculate its risk-based capital
requirements under the general riskbased 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 riskbased 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 riskweighted 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 riskbased capital ratio calculation
requirements under the advanced
approaches rules.
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 addons, incremental risk capital
requirement, comprehensive risk capital
requirement, and capital requirement
for de minimis exposures, each
calculated according to defined
15 76

FR 37620 (June 28, 2011).
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.

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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 addon 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.

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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 VaRbased 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

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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

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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 VaRbased 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.
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
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.

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

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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 VaRbased 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
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
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.

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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 pvalue 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.

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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

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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 12month 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

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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

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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

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

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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 addon 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 addon 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

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53073

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

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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.

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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-asyou-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 addon. 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

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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 nonfinancial companies, and securitization
transactions. Each proposed standard
(including alternatives to the proposed
standards that the agencies requested

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

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TABLE 1—MAPPING OF CRC TO RISK
WEIGHTS UNDER THE BASEL ACCORD
CRC classification

Risk weight
(in percent)

0–1 ........................................
2 ............................................
3 ............................................
4 to 6 ....................................
7 ............................................
No classification assigned ....

0
20
50
100
150
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 riskweighting 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
0–1

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CRC of Sovereign .........................................................

2–3

Percent
0.0

Remaining contractual maturity of 6 months or less ....

0.25

Remaining contractual maturity of greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

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 riskweighting factor to sovereign debt

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.

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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

21 See

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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 riskweighting 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 riskweighting factors. The agencies
described potential difficulties in
implementing each of these marketbased 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

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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 marketbased 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 marketbased 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

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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 riskweighting 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 riskweighting 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 riskweighting 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 riskweighting factor to debt positions that

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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
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 riskweighting factor of 1.6 percent. GSE
equity exposures, including preferred
stock, were assigned a specific riskweighting 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

53077

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 riskweighting 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

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CRC of Sovereign .........................................................

0–2

Percent

Remaining contractual maturity of 6 months or less ....

0.25

Remaining contractual maturity of greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

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

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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 CRCbased methodologies allow for greater
differentiation of risk among exposures.
Also, market-based methodologies

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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.

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

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-weighting factor

CRC of Sovereign .........................................................

0–2

Percent

Remaining contractual maturity is 6 months or less .....

0.25

Remaining contractual maturity is greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

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-weighting factor

srobinson on DSK4SPTVN1PROD with RULES2

CRC of Sovereign .........................................................

0–1

Percent

Remaining contractual maturity is 6 months or less .....

0.25

Remaining contractual maturity is greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

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 riskweighting 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 riskweighting factor for such a position be
lower than the lowest specific riskweighting factor assigned to that PSE’s

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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

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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 riskweighting 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

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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
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 marketbased information and historical
accounting information (indicator-based
methodology) to assign specific riskweighting factors to corporate debt
positions that are exposures to publiclytraded 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 riskweighting 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

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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.
Several commenters expressed
concerns that the proposed indicatorbased 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
22 76

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53079

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 indicatorbased 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 marketbased 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 riskbased capital requirements. The
agencies have not identified a marketbased 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

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

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 riskweighting 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 riskweighting factor of 12.0 percent.

TABLE 6—SPECIFIC RISK-WEIGHTING FACTORS FOR CORPORATE DEBT POSITIONS UNDER THE INVESTMENT GRADE
METHODOLOGY
Remaining contractual maturity

Investment Grade ...................................................................

6 months or less .....................................................................

0.50

Greater than 6 and up to and including 24 months ...............

2.00

Greater than 24 months .........................................................

4.00

.................................................................................................

12.00

Not investment Grade ............................................................

srobinson on DSK4SPTVN1PROD with RULES2

Specific riskweighting factor
(in percent)

Category

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

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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

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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,

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

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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 riskweighting 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

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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 riskbased 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.

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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

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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

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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

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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
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).

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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 riskweighting 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.
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 nthto-default credit derivatives, as
computed therein. A bank would need
24 See

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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 riskweighting 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.

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Substituting this value into the
equation yields:

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

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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 (n1) 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 addon 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

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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 welldiversified portfolio of equity
instruments, the absolute value of the
current market value of each net long or
short position is multiplied by a riskweighting 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 futuresrelated 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

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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 ongoing basis, but no less frequently than
quarterly, the bank must also evaluate,
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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

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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

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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 oneyear 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

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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

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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.

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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
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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

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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

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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 creditrelated 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

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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

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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

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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

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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

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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
25 See

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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.
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
26 See

13 CFR 121.201.

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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

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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 riskbased 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
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
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.

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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.

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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-atRisk 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

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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 riskweighting 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 riskweighting 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.

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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 riskweighting 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 riskweighting 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

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1. Organizations Affected by the Final
Rule 29
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
29 Unless otherwise noted, the population of
banks used in this analysis consists of all FDICinsured national banks and uninsured national
bank and trust companies. Banking organizations
are aggregated to the top holding company level.
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

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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 riskweighted assets to determine a bank’s
risk-based capital ratio.

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
($ billions)

Measure
Total Assets ..........................
Trading Assets ......................
Trading Liabilities ..................
Consolidated Trading Activity: (Trading Assets +
Trading Liabilities) .............
Market Risk Equivalent Assets ....................................
Market Risk Measure ...........

7,697.3
651.3
282.7
934.0
197.9
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
Report data, no OCC-regulated thrift meets the
threshold for the Market Risk rule to apply.
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.

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53095

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
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 aftertax 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.
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
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.
33 See Merton H. Miller, (1995), ‘‘Do the M & M
propositions apply to banks?’’ Journal of Banking &
Finance, Vol. 19, pp. 483–489.
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.

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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 riskweighting 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 Cooperation 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 riskweighting 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.
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

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

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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

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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
hours per
institution

Trading position

Activity

Securitization ...................................................................

System development .............................................................................
Data acquisition .....................................................................................
Calculation, verification, and training .....................................................
System development .............................................................................
Data acquisition .....................................................................................
Calculation, verification, and training .....................................................
System development .............................................................................
Data acquisition .....................................................................................
Calculation, verification, and training .....................................................
System development .............................................................................
Data acquisition .....................................................................................
Calculation, verification, and training .....................................................

480
240
120
60
50
10
80
30
60
80
30
60

................................................................................................................

1,300

Corporate Debt ................................................................
Sovereign Debt ................................................................
Other Positions Combined ..............................................

Total Hours ...............................................................

TABLE 3—ESTIMATED COSTS OF CREDIT RATING ALTERNATIVES TO THE MARKET RISK RULE
Number of
institutions

Institution
National banking organizations .......................................

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

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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

38 Basel Committee on Banking Supervision,
‘‘Revisions to the Basel II market risk framework,’’
July 2009, available at www.bis.org.

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Estimated hours
per institution
14

Estimated cost
per institution

1,300

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

Estimated cost

$110,500

$1,547,000

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

UMRA requires a comparison
between the final rule and reasonable
alternatives when the impact
assessment exceeds the inflationadjusted 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

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.

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.

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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
TABLE 4—ALTERNATIVE A: IMPACT OF VARIATIONS IN TRADING BOOK SIZE THRESHOLD
[December 31, 2011 Call Reports]
Number of
institutions
affected

Size threshold

$5 billion ...........................................................................................
$4 billion ...........................................................................................
$3 billion ...........................................................................................
$2 billion ...........................................................................................
$1 billion ...........................................................................................
$500 million ......................................................................................
$250 million ......................................................................................

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

Increase in
market risk
measure
($billions)

Trading book
($billions)
7
7
7
9
14
18
21

$921.7
921.7
921.7
926.3
933.9
937.3
938.3

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
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

Estimated cost
of additional
capital
($millions)

$31.4
31.4
31.4
31.4
31.6
31.6
32.0

$177
177
177
177
178
178
180

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]
Number of
institutions
affected

Thresholds

$1 billion or 10 percent ....................................................................................
$2 billion and 10 percent .................................................................................
$1 billion and 10 percent .................................................................................
$500 million and 10 percent ............................................................................
$2 billion and 5 percent ...................................................................................
$1 billion and 5 percent ...................................................................................
$500 million and 5 percent ..............................................................................
$2 billion and 1 percent ...................................................................................
$1 billion and 1 percent ...................................................................................
$500 million and 1 percent ..............................................................................

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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
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.

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14
3
3
3
5
6
6
9
13
16

Trading book
($ billions)

$933.9
715.6
715.6
715.6
903.2
904.9
904.9
926.3
932.2
934.5

Increase in
market risk
measure
($ billions)
$31.6
21.8
21.8
21.8
30.6
30.8
30.8
31.4
31.6
31.6

Estimated
cost of
additional
capital
($ millions)
$178
123
123
123
173
174
174
177
178
178

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

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

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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.
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
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.

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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-LeachBliley 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.

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Text of the Common Rules (All
Agencies)
The text of the common rules appears
below:

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Appendix l to Part ll—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 riskbased 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 riskbased 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 riskbased capital requirement calculated under

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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 riskbased 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-ofsample 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 twoway 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

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(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:
(i) The position is a trading position or
hedges another covered position; 44 and
(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).
43 Securities subject to repurchase and lending
agreements are included as if they are still owned
by the lender.
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.

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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 § 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

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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:

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(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 wellfounded 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

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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 creditenhancing 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

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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
(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 shortterm 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-tomarket 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
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).

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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

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

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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),

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53103

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

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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 riskweighted 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 VaRbased 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.

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(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
factor

Number of exceptions
4 or fewer .........................
5 ........................................
6 ........................................
7 ........................................
8 ........................................
9 ........................................
10 or more ........................

3.00
3.40
3.50
3.65
3.75
3.85
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

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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 VaRbased 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-businessday movement in underlying risk factors,
such as rates, spreads, and prices. To
calculate VaR-based measures using a 10business-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 VaRbased measure must be relevant to the
[bank]’s actual exposures and of sufficient
quality to support the calculation of riskbased 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

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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
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 60day 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).

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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.

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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 addon 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

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53105

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 oneyear 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.

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(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

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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

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(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 riskweighting 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);

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(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

53107

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 addon.
(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 riskweighting 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 riskweighting 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
0–1

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CRC of Sovereign .........................................................

2–3

Percent
0.0

Remaining contractual maturity of 6 months or less ....

0.25

Remaining contractual maturity of greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

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 riskweighting 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

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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

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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 riskweighting 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.

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TABLE 3—SPECIFIC RISK-WEIGHTING FACTORS FOR DEPOSITORY INSTITUTION, FOREIGN BANK, AND CREDIT UNION DEBT
POSITIONS
Specific risk-weighting factor

CRC of Sovereign .........................................................

0–2

Percent

Remaining contractual maturity of 6 months or less ....

0.25

Remaining contractual maturity of greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

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 riskweighting 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 riskweighting factor to a debt position that is an
exposure to a PSE based on the specific riskweighting 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-weighting factor (in
percent)

CRC of Sovereign .........................................................

0–2

Percent

Remaining contractual maturity of 6 months or less ....

0.25

Remaining contractual maturity of greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

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

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Revenue obligation specific risk-weighting factor

CRC of Sovereign .........................................................

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0–1

Percent

Remaining contractual maturity of 6 months or less ....

0.25

Remaining contractual maturity of greater than 6 and
up to and including 24 months.

1.0

Remaining contractual maturity exceeds 24 months ....

1.6

2–3

8.0

4–7

12.0

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53109

TABLE 5—SPECIFIC RISK-WEIGHTING FACTORS FOR PSE REVENUE OBLIGATION DEBT POSITIONS—Continued
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

Category

Remaining contractual maturity

Investment Grade .........................................................

6 months or less .......................................................................................
Greater than 6 and up to and including 24 months .................................
Greater than 24 months ...........................................................................
...................................................................................................................

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Not-investment Grade ..................................................

(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

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(b)(2)(vii)(B) or the SSFA in section 11 of this
appendix.
(B) SFA. To calculate the specific risk addon 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 nthto-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 riskweighting 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

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Specific
riskweighting
factor
(in percent)
0.50
2.00
4.00
12.00

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-todefault 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 riskweighting 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

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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 riskweighting factor of 2.0 percent.46
(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 riskweighting 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 AllWorld 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.
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.

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(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, waterfallrelated 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

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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.

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30AUR2

(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

BILLING CODE 4810–33–C

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

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

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53111

revised to be set equal to KA. For the purpose
of this weighted-average calculation:
BILLING CODE 4810–33–P

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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:

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ER30AU12.005</GPH>

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(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 VaRbased measures over the reporting period and
the stressed VaR-based measure at periodend;
(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;

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

■

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

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

■

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

Board of Governors of the Federal
Reserve System
12 CFR Chapter II

Authority and Issuance
For the reasons set forth in the
common preamble, parts 208 and 225 of
chapter II of title 12 of the Code of
Federal Regulations are amended as
follows:
PART 208—MEMBERSHIP OF STATE
BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
(REGULATION H)
4. The authority citation for part 208
continues to read as follows:

■

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

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

■

Appendix E to Part 208—Capital
Adequacy Guidelines for State Member
Banks: Market Risk
6. Appendix E to part 208 is amended
by:
■ a. Removing ‘‘[the advanced capital
adequacy framework]’’ wherever it
■

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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
appears and adding in its place
‘‘Appendix F to this part’’;
■ b. Removing ‘‘[bank]’’ wherever it
appears and adding in its place ‘‘bank’’;
■ c. Removing ‘‘[banks]’’ wherever it
appears and adding in its place ‘‘banks’’;
■ d. Removing ‘‘[Call Report or FR Y–
9C]’’ wherever it appears and adding in
its place ‘‘Call Report’’;
■ e. Removing ‘‘[regulatory report]’’
wherever it appears and adding in its
place ‘‘Consolidated Reports of
Condition and Income (Call Report)’’;
■ f. Removing ‘‘[the general risk-based
capital rules]’’ wherever it appears and
adding in its place ‘‘Appendix A to this
part’’.
■ g. Removing ‘‘[Agency]’’ wherever it
appears in section 1 and adding in its
place ‘‘Board’’;
■ 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,’’;
■ i. Removing ‘‘[Agency]’’ in the
definitions of multilateral development
bank and securitization in section 2 and
adding in its place ‘‘Board’’;
■ 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,’’;
■ k. Revising section 3(c) to read as
follows:
Section 3. Requirements for
Application of the Market Risk Capital
Rule

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*

*

*

*

*

(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 riskweighted 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

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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.

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 60day lag:

*

■

*
*
*
*
■ l. Removing ‘‘[Agency]’’ in section
3(e)(4) and adding in its place ‘‘Board’’;
■ 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,’’;
■ n. Revising section (4)(b) to read as
follows:
Section 4. Adjustments to the RiskBased 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 VaRbased 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.

*

*
*
*
*
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,’’;
■ 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,’’;
■ 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,’’;
*
*
*
*
*
■ 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

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*

*
*
*
*
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:

*

*
*
*
*
t. Removing ‘‘[Agency]’’ in section
6(b)(4) and adding in its place ‘‘Board or
the appropriate Reserve Bank, with
concurrence of the Board,’’;
■ u. Removing ‘‘[Agency]’’ in section
8(a) and adding in its place ‘‘Board or
the appropriate Reserve Bank, with
concurrence of the Board,’’;
■ 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,’’;
■ 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’’;
■ 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)
7. The authority citation for part 225
continues to read as follows:

■

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

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

■

Appendix E to Part 225—Capital
Adequacy Guidelines for Bank Holding
Companies: Market Risk
9. Appendix E is amended by:
a. Removing ‘‘[the advanced capital
adequacy framework]’’ wherever it
appears and adding in its place
‘‘Appendix G to this part’’;

■
■

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53114

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

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

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

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*

*

*

*

*

(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 riskweighted 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

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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.

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:

*

*

*
*
*
*
l. Removing ‘‘[Agency]’’ in section
3(e)(4) and adding in its place ‘‘Board’’;
■ 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’’;
■ n. Revising section (4)(b) to read as
follows:
■

Section 4. Adjustments to the RiskBased 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.

*

*
*
*
*
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’’;
■ 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’’;
■ 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’’;
■ 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

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*
*
*
*
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:

*

*
*
*
*
t. Removing ‘‘[Agency]’’ in section
6(b)(4) and adding in its place ‘‘Board or
the appropriate Reserve Bank, with
concurrence of the Board’’;
■ u. Removing ‘‘[Agency]’’ in section
8(a) and adding in its place ‘‘Board or
the appropriate Reserve Bank, with
concurrence of the Board’’;
■ 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’’;
■ 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’’;
■ 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
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,

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Federal Register / Vol. 77, No. 169 / Thursday, August 30, 2012 / Rules and Regulations
4808; Pub. L. 102–233, 105 Stat. 1761, 1789,
1790 (12 U.S.C. 1831n note); Pub. L. 102–
242, 105 Stat. 2236, 2355, as amended by
Pub. L. 103–325, 108 Stat. 2160, 2233 (12
U.S.C. 1828 note); Pub. L. 102–242, 105 Stat.
2236, 2386, as amended by Pub. L. 102–550,
106 Stat. 3672, 4089 (12 U.S.C. 1828 note).

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

■

Appendix C to Part 325—Risk-Based
Capital for State Nonmember Banks:
Market Risk
12. Appendix C is further amended
by:
■ a. Removing ‘‘[Agency]’’ wherever it
appears and adding in its place ‘‘FDIC’’;
■ b. Removing ‘‘[Agency’s]’’ wherever it
appears and adding in its place
‘‘FDIC’s’’;

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■

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c. Removing ‘‘[bank]’’ wherever it
appears and adding in its place ‘‘bank’’;
■ d. Removing ‘‘[banks]’’ wherever it
appears and adding in its place ‘‘banks’’;
■ e. Removing [Call Report or FR Y–9C]
wherever it appears and adding in its
place ‘‘Call Report’’;
■ f. Removing ‘‘[the advanced capital
adequacy framework]’’ wherever it
appears and adding in its place
‘‘Appendix D to this part’’;
■ g. Removing ‘‘[regulatory report]’’
wherever it appears and adding in its
place ‘‘Consolidated Reports of
Condition and Income (Call Report)’’;
■ h. Removing ‘‘[the general risk-based
capital rules]’’ wherever it appears and
adding in its place ‘‘Appendix A to this
part’’.
■

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53115

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

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