Federal Register Vol. 81, No.114,

In proposed rule document FR 2016-12547 appearing on page 36704, in the issue of Tuesday, June 7, 2016, (81 FR 36704), the following corrections should be made:

On page 36704, in the second column, the next to the last paragraph in the ADDRESSES section is corrected to the following:

1. Richland, WA: HAMMER Federal Training Facility, State Department Room, 2890 Horn Rapids Road, Richland, WA 99354;

On page 36704, in the third column, the first paragraph in the ADDRESSES section is corrected to the following:

3. Las Vegas, NV: North Las Vegas Facility, 2621 Losee Road, Building C1, Auditorium, North Las Vegas, NV 89030-4129.

I. Introduction

Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) directs the Board of Governors of the Federal Reserve System (Board) to establish enhanced prudential standards for nonbank financial companies that the Financial Stability Oversight Council (Council) has determined should be supervised by the Board and bank holding companies with total consolidated assets equal to or greater than $50 billion in order to prevent or mitigate risks to U.S. financial stability that could arise from the material financial distress or failure, or ongoing activities, of these companies.1 The enhanced prudential standards must include risk-based capital requirements and leverage limits, liquidity requirements, certain risk-management requirements, resolution-planning requirements, single-counterparty credit limits, and stress-test requirements. Section 165 also permits the Board to establish additional enhanced prudential standards, including a contingent capital requirement, an enhanced public disclosure requirement, a short-term debt limit, and any other prudential standards that the Board determines are appropriate.

In prescribing enhanced prudential standards, section 165(a)(2) of the Dodd-Frank Act permits the Board to tailor the enhanced prudential standards among companies on an individual basis, taking into consideration their “capital structure, riskiness, complexity, financial activities (including the financial activities of their subsidiaries), size, and any other risk-related factors that the Board . . . deems appropriate.” 2 In addition, under section 165(b)(3) of the Dodd-Frank Act, the Board is required to take into account differences among bank holding companies covered by section 165 of the Dodd-Frank Act and nonbank financial companies supervised by the Board, based on statutory considerations.3

The factors the Board must consider include: (1) The factors described in sections 113(a) and (b) of the Dodd-Frank Act (12 U.S.C. 5313(a) and (b)); (2) whether the companies own an insured depository institution; (3) nonfinancial activities and affiliations of the companies; and (4) any other risk-related factors that the Board determines appropriate.4 The Board must, as appropriate, adapt the required standards in light of any predominant line of business of nonbank financial companies, including activities for which particular standards may not be appropriate.5 Section 165(b)(3) of the Dodd-Frank Act also requires the Board, to the extent possible, to ensure that small changes in the factors listed in sections 113(a) and 113(b) of the Dodd-Frank Act would not result in sharp, discontinuous changes in the enhanced prudential standards established by the Board under section 165(b)(1) of the Dodd-Frank Act.6 The statute also directs the Board to take into account any recommendations made by the Council pursuant to its authority under section 115 of the Dodd-Frank Act.7

For bank holding companies with total consolidated assets equal to or greater than $50 billion and certain foreign banking organizations, the Board has issued an integrated set of enhanced prudential standards through a series of rulemakings, including the Board's capital plan rule,8 stress-testing rules,9 resolution plan rule,10 and the Board's enhanced prudential standards rule under Regulation YY.11 As part of the integrated enhanced prudential standards applicable to the largest, most complex bank holding companies, the Board also adopted enhanced liquidity requirements through the liquidity coverage ratio rule and adopted enhanced leverage capital requirements through a supplementary leverage ratio. Further, the Board issued risk-based capital charges and an enhanced supplementary leverage ratio for the most systemic bank holding companies.12 In addition, through a final order the Board established enhanced prudential standards for General Electric Capital Corporation, a nonbank financial company designated by the Council for supervision by the Board.13 In the preamble accompanying the final enhanced prudential standards regulation for bank holding companies, the Board stated its intent to assess thoroughly the business model, capital structure, and risk profile of each company in considering the application of enhanced prudential standards to nonbank financial companies designated by the Council, consistent with the Dodd-Frank Act.14

The Board invites public comment on the application of corporate governance and risk-management and liquidity risk-management standards to certain insurance-focused nonbank financial companies that the Council determined should be subject to Board supervision.15 Specifically, the enhanced prudential standards would apply to any nonbank financial company that meets two requirements: (1) The Council has determined pursuant to section 113 of the Dodd-Frank Act that the company should be supervised by the Board and subjected to enhanced prudential standards, and (2) the company has 40 percent or more of its total consolidated assets related to insurance activities as of the end of either of the two most recently completed fiscal years (systemically important insurance companies) or otherwise has been made subject to these requirements by the Board. As of the date of publication of this document in the Federal Register, American International Group, Inc. (AIG), and Prudential Financial, Inc. (Prudential), would be required to comply with the proposed enhanced prudential standards, if adopted as proposed.16

The corporate governance and risk-management standard would build on the core provisions of the Board's SR letter 12-17, Consolidated Supervision Framework for Large Financial Institutions.17 The proposed liquidity risk-management requirements would help mitigate liquidity risks at systemically important insurance companies. The proposal would tailor these standards to account for the differences in business models, capital structure, risk profiles, existing supervisory framework, and systemic footprints between bank holding companies and systemically important insurance companies.

The Board believes that it is appropriate to seek public comment on the application of the proposed standards in order to provide transparency regarding the regulation and supervision of systemically important insurance companies. The public comment process will provide systemically important insurance companies supervised by the Board and interested members of the public with the opportunity to comment and will help guide the Board in future application of enhanced prudential standards to other nonbank financial companies.

Question 1: The Board invites comment on all aspects of the proposed rule, including in particular the aspects noted in more detailed questions at the end of each section.

Question 2: The Board invites comment on the 40 percent threshold contained in the proposed definition of systemically important insurance company. Would an alternative measure be more appropriate? Why or why not?

During the preceding decades and the recent financial crisis in particular, a number of insurers that experienced material financial distress had significant deficiencies in key areas of corporate governance and risk management.18 Effective enterprise-wide risk management by large, interconnected financial companies promotes financial stability by reducing the likelihood of a large, interconnected financial company's material distress or failure. An enterprise-wide approach to risk management would allow systemically important insurance companies to appropriately identify, measure, monitor, and control risk throughout their entire organizations, including risks that may arise from intragroup transactions, unregulated entities, or centralized material operations that would not be subject to review at the legal entity level.

Accordingly, the Board is proposing to apply to systemically important insurance companies an enhanced corporate governance and risk-management standard that would build on the core provisions of SR 12-17, the Board's consolidated supervision framework for large financial institutions.19 These standards would be applied, however, in a manner that is tailored to account for the business model, capital structure, risk profile, and activities of financial firms that are largely engaged in insurance (rather than banking) activities. Specifically, the proposal creates responsibilities for a systemically important insurance company's risk committee, chief risk officer, and chief actuary.

Consistent with section 165(h)(1) of the Dodd-Frank Act, the proposed rule would require a systemically important insurance company to maintain a risk committee that approves and periodically reviews the risk-management policies of the company's global operations and oversees the operation of the company's global risk-management framework.20 A large, interconnected financial institution's risk committee, acting in its oversight role, should fully understand the institution's corporate governance and risk-management framework and have a general understanding of its risk-management practices.

The proposal would also require that the risk committee oversee the systemically important insurance company's enterprise-wide risk-management framework, and that this framework be commensurate with the systemically important insurance company's structure, risk profile, complexity, activities, and size. An enterprise-wide risk-management framework facilitates management of and creates accountability for risks that reside in different geographic areas and lines of business. The risk-management framework would be required to include policies and procedures for establishing risk-management governance and procedures and risk-control infrastructure for the company's global operations. To implement and monitor compliance with these policies and procedures, the proposal would require the company to have processes and systems that (1) have mechanisms to identify and report risks and risk-management deficiencies, including emerging risks, and ensure effective and timely implementation of actions to address such risks and deficiencies; (2) establish managerial and employee responsibility for risk management; (3) ensure the independence of the risk-management function; and (4) integrate risk-management and associated controls with management goals and its compensation structure for its global operations.

A systemically important insurance company's risk-management framework would be strengthened by having an appropriate level of stature within its overall corporate governance framework. Accordingly, the proposal would provide that a systemically important insurance company's risk committee be an independent committee of the company's board of directors and have, as its sole and exclusive function, responsibility for the risk-management policies of the company's global operations and oversight of the operation of the company's global risk-management framework. The risk committee would be required to report directly to the systemically important insurance company's board of directors and would receive and review regular reports on not less than a quarterly basis from the company's chief risk officer. In addition, the risk committee would be required to meet at least quarterly, fully document and maintain records of its proceedings, and have a formal, written charter that is approved by the systemically important insurance company's board of directors.

Consistent with section 165(h)(3)(C) of the Dodd-Frank Act, the proposal would require that the risk committee include at least one member with experience in identifying, assessing, and managing risk exposures of large, complex financial firms.21 For this purpose, a financial firm would include an insurance company, a securities broker-dealer, or a bank. The individual's experience in risk management would be expected to be commensurate with the company's structure, risk profile, complexity, activities, and size, and the company would be expected to demonstrate that the individual's experience is relevant to the particular risks facing the company. While the proposal would require that only one member of the risk committee have experience in identifying, assessing, and managing risk exposures of large, complex firms, all risk committee members should have a general understanding of risk-management principles and practices relevant to the company.

Consistent with section 165(h)(3)(B) of the Dodd-Frank Act, the proposed rule also would include certain requirements to ensure that the chair of the risk committee has sufficient independence from the systemically important insurance company.22 The proposal would require that the chair of the risk committee (1) not be an officer or employee of the company nor have been one during the previous three years; (2) not be a member of the immediate family of a person who is, or has been within the last three years, an executive officer of the company; 23 and (3) meet the requirements for an independent director under Item 407 of the Securities and Exchange Commission's (SEC) Regulation S-K, or must qualify as an independent director under the listing standards of a national securities exchange, as demonstrated to the satisfaction of the Board, if the company does not have an outstanding class of securities traded on a national securities exchange.

The Board views the active involvement of independent directors as vital to robust oversight of risk management and encourages companies generally to include additional independent directors as members of their risk committees. However, the Board notes that not all members of the risk committee would be required to be independent, and involvement of directors affiliated with the company on the risk committee could complement the involvement of independent directors.

Question 3: Are there additional qualifications and experience that the Board should require of a member or members of the risk committee of a systemically important insurance company?

Question 4: The Board invites comment on whether the structure of the risk committee and the duties proposed to be assigned to the risk committee are appropriate.

Most large, interconnected financial institutions, including large insurance companies, designate a chief risk officer to facilitate an enterprise-wide approach to the identification and management of all risks within an organization, regardless of where they are originated or housed. The chief risk officer supplements the work of legal entity, risk level (e.g., credit or operational risk), and line of business risk-management activities by identifying, measuring, and monitoring risks that may exist intentionally or unintentionally. The proposed rule would require each systemically important insurance company to have a chief risk officer and describes the minimum responsibilities of the chief risk officer. Under the proposal, the chief risk officer's function would extend to all risks facing the systemically important insurance company, including risks from non-insurance activities and insurance activities, such as risks arising out of unanticipated increases in reserves.

The proposal provides that the chief risk officer would be responsible for overseeing (1) the establishment of risk limits on an enterprise-wide basis and monitoring compliance with such limits; (2) the implementation of and ongoing compliance with the policies and procedures establishing risk-management governance and the development and implementation of the processes and systems related to the global risk-management framework; and (3) management of risks and risk controls within the parameters of the company's risk control framework, and monitoring and testing of such risk controls. The chief risk officer also would be responsible for reporting risk-management deficiencies and emerging risks to the risk committee.

The proposal would require the chief risk officer to have experience in identifying, assessing, and managing risk exposures of large, complex financial firms. The minimum qualifications for a chief risk officer would be similar to the risk-management experience requirement that at least one member of the company's risk committee must meet. The proposal was designed with the expectation that a systemically important insurance company would be able to demonstrate that its chief risk officer's experience is relevant to the particular risks facing the company and is commensurate with the company's structure, risk profile, complexity, activities, and size.

The proposed standard would also require systemically important insurance companies to have a chief actuary to ensure an enterprise-wide view of reserve adequacy across legal entities, lines of business, and geographic boundaries. Inadequate reserving is a common cause of insurer insolvencies.24 Insurance companies have complex balance sheets that depend heavily on estimates concerning the amount and timing of payments. Actuaries at insurance companies serve a critical role by developing these estimates and providing other technical insights on risk and financial performance. The estimates and the related processes, methodologies, and documentation can vary across jurisdictions and lines of businesses. The systemically important insurance companies have numerous insurance company subsidiaries and lines of businesses with their own actuarial functions. The organization may not have, however, an actuarial role or roles with the appropriate amount of stature and independence from the lines of business and legal entities.

The chief actuary would be responsible for advising the chief executive officer and other members of senior management and the board's audit committee on the level of reserves. Under the proposed rule, the chief actuary would also have oversight responsibilities over (1) implementation of measures that assess the sufficiency of reserves; (2) review of the appropriateness of actuarial models, data, and assumptions used in reserving; and (3) implementation of and compliance with appropriate policies and procedures relating to actuarial work in reserving. The chief actuary would be required to ensure that the company's actuarial units perform in accordance with an articulated set of standards that govern process, methodologies, data, and documentation; comply with applicable jurisdictional regulations; and adhere to the relevant codes of actuarial conduct and practice standards. The proposed rule would permit the chief actuary to have additional responsibilities, including overseeing ratemaking for insurance products.

If a systemically important insurance company has significant amounts of life insurance and property and casualty insurance business, the proposal would allow systemically important insurance companies to have co-chief actuaries—one responsible for the company's life business and one responsible for the company's property and casualty business. Within the United States, the two different businesses have historically had separate professional organizations and correspondingly different professional examination requirements to obtain actuarial credentials. The actuarial techniques used in these two businesses starkly differ. While a single position with an enterprise-wide view of reserve adequacy is desirable, the Board recognizes that the need for chief actuaries to have the expertise necessary to carry out their duties. Thus, the proposed rule would permit, but not require, a systemically important insurance company to appoint a chief actuary with enterprise-wide responsibility for the life insurance activities and a separate chief actuary with enterprise-wide responsibility for the property and casualty insurance activities.

Under the proposed rule, the chief actuary would be expected to have experience that is relevant to the functions performed and commensurate with the company's structure, risk profile, complexity, activities, and size. This background should allow the chief actuary to discuss reserve adequacy with executive management and to communicate on actual practices and techniques with the underwriting, claims, legal, treasury, and other departments.

Under the proposed rule, the chief risk officer and chief actuary would be required to maintain a level of independence. In addition to other lines of reporting, the chief risk officer and chief actuary would be required to report directly to their board's risk committee and audit committee, respectively. Requiring the chief risk officer and chief actuary to report directly to board committees provides stature and independence from the lines of businesses and legal entities, which facilitates unbiased insurance risk assessment and estimation of insurance reserves. Furthermore, the proposal would not allow the chief risk officer and chief actuary roles to be performed by the same person because the positions serve distinct and separate independent oversight functions within the company. This separation would allow the risk group to review and challenge the actuarial assumptions used to prepare financial statements and provide an extra line of defense against improper reserving.

In addition, the proposal would require a systemically important insurance company to ensure that the compensation and other incentives provided to the chief risk officer and chief actuary are consistent with their functions of providing objective assessments of a company's risks and actuarial estimates. This requirement would supplement existing Board guidance on incentive compensation, which provides, among other things, that compensation for employees in risk-management and control functions should avoid conflicts of interest and that incentive compensation received by these employees should not be based substantially on the financial performance of the business units that they review.25 In addition, the proposed requirement would allow systemically important insurance companies wide discretion to adopt compensation structures for chief risk officers and chief actuaries, whether through a compensation committee or otherwise, as long as the structure of their compensation allows them to objectively assess risk and does not create improper incentives to take inappropriate risks.

Question 5: Are the responsibilities and requirements for the chief risk officer and the chief actuary of a systemically important insurance company appropriate? What additional responsibilities and requirements should the Board consider imposing?

Question 6: Should the Board require a single, enterprise-wide chief actuary instead of allowing the position to be split between life and property and casualty operations? Why or why not?

The activities and liabilities of systemically important insurance companies generate liquidity risk. The financial crisis that began in 2007 demonstrated that liquidity can evaporate quickly and cause severe stress in the financial markets. In some cases, financial companies had difficulty in meeting their obligations as they became due because sources of funding became severely restricted. The financial crisis and past insurance failures also demonstrate that even solvent insurers may experience material financial distress, including failure, if they do not manage their liquidity in a prudent manner.26 Although many of a systemically important insurance company's liabilities are long-term or contingent upon the occurrence of a future event, such as the death of the insured or destruction of insured property, certain insurance contracts are subject to surrender or withdrawal with little or no penalty and on short notice and may create significant unanticipated demands for liquidity. Additionally, some activities and liabilities such as securities lending, issuance of some forms of funding agreements, collateral calls on derivatives used for hedging, and other sources can create liquidity needs during stress. For systemically important insurance companies, the negative effects of their material financial distress from a liquidity shortage could be transmitted to the broader economy through the sale of financial assets in a manner that could disrupt the functioning of key markets or cause significant losses or funding problems at other firms with similar holdings.

The proposal would require that a systemically important insurance company implement a number of provisions to manage its liquidity risk. For purposes of the proposed rule, liquidity is defined as a systemically important insurance company's capacity to meet efficiently its expected and unexpected cash flows and collateral needs at a reasonable cost without adversely affecting the daily operations or the financial condition of the systemically important insurance company. Under the proposed rule, liquidity risk means the risk that a systemically important insurance company's financial condition or safety and soundness will be adversely affected by its actual or perceived inability to meet its cash and collateral obligations.

The proposed rule would require a systemically important insurance company to meet key internal control requirements with respect to liquidity risk management, to generate comprehensive cash-flow projections, to establish and monitor its liquidity risk tolerance, and to maintain a contingency funding plan to manage liquidity stress events when normal sources of funding may not be available. The proposed rule also would introduce liquidity stress-testing requirements for a systemically important insurance company and would require the company to maintain liquid assets sufficient to meet net cash outflows for 90 days over the range of liquidity stress scenarios used in the internal stress testing.

To reduce the risk of failure triggered by a liquidity event, the proposed rule would require a systemically important insurance company's board of directors, risk committee, and senior management to fulfill key corporate governance and internal control functions with respect to liquidity risk management. The proposed rule would also require a systemically important insurance company to institute an independent review function to provide an objective assessment of the company's liquidity risk-management framework.

The proposed rule would require a systemically important insurance company's board of directors to approve at least annually the company's liquidity risk tolerance. This liquidity risk tolerance should set forth the acceptable level of liquidity risk that a systemically important insurance company may assume in connection with its operating strategies and should take into account the company's capital structure, risk profile, complexity, activities, and size. Typically, more liquid, shorter-duration assets provide lower expected returns than similar assets with longer durations. Risk tolerances should be articulated in a way that all levels of management can clearly understand and apply these tolerances to all aspects of liquidity risk management throughout the organization. In addition, the proposal would require the board of directors to (1) review liquidity risk practices and performance at least semi-annually to determine whether the systemically important insurance company is operating in accordance with its established liquidity risk tolerance, and (2) approve and periodically review the liquidity risk-management strategies, policies, and procedures established by senior management.

The proposal would also require the risk committee or a designated subcommittee of the risk committee to review and approve the systemically important insurance company's contingency funding plan at least annually and whenever the company materially revises the plan. As discussed below, the contingency funding plan is the systemically important insurance company's compilation of policies, procedures, and action plans for managing liquidity stress events. In fulfilling this proposed requirement, the risk committee or designated subcommittee would report the results of its review to a systemically important insurance company's board of directors.

To ensure that a systemically important insurance company properly implements its liquidity risk-management framework within the tolerances established by the company's board of directors, the Board is proposing to require senior management of a systemically important insurance company to be responsible for several key liquidity risk-management functions.

First, the proposed rule would require senior management to establish and implement strategies, policies, and procedures designed to manage effectively the systemically important insurance company's liquidity risk. In addition, the proposal would require that senior management oversee the development and implementation of liquidity risk measurement and reporting systems and determine at least quarterly whether the systemically important insurance company is operating in accordance with such policies and procedures and is in compliance with the liquidity risk-management, stress-testing, and buffer requirements.

Second, the proposal would require senior management to report at least quarterly to the board of directors or the risk committee on the systemically important insurance company's liquidity risk profile and liquidity risk tolerance. More frequent reporting would be warranted if material changes in the company's liquidity profile or market conditions occur.

Third, before a systemically important insurance company offers a new product or initiates a new activity that could potentially have a significant effect on the systemically important insurance company's liquidity risk profile, senior management would be required to evaluate the liquidity costs, benefits, and risks of the product or activity and approve it. As part of the evaluation, senior management would be required to determine whether the liquidity risk associated with the new product or activity (under both current and stressed conditions) is within the company's established liquidity risk tolerance. In addition, senior management would be required to review at least annually significant business activities and products to determine whether any of these activities or products creates or has created any unanticipated liquidity risk and whether the liquidity risk of each activity or product is within the company's established liquidity risk tolerance. An example of a significant business activity might include a company's securities lending operations or a particular line of business such as the issuance of funding agreements. This review should be done on a granular enough basis to allow for consideration of material differences in liquidity risk that might occur across jurisdictions or product features, such as a market value adjustment feature in an insurance contract.27

Fourth, senior management would be required to review the cash-flow projections (as described below) at least quarterly to ensure that the liquidity risk of the systemically important insurance company is within the established liquidity risk tolerance.

Fifth, senior management would be required to establish liquidity risk limits and review the company's compliance with those limits at least quarterly. As described in § 252.164(g) of the proposed rule, systemically important insurance companies would be required to establish limits on (1) concentrations in sources of funding by instrument type, single counterparty, counterparty type, secured and unsecured funding, and as applicable, other forms of liquidity risk; (2) potential sources of liquidity risk arising from insurance liabilities; (3) the amount of non-insurance liabilities that mature within various time horizons; and (4) off-balance sheet exposures and other exposures that could create funding needs during liquidity stress events. In addition, the proposal would require the size of each limit to be consistent with the company's established liquidity risk tolerance and reflect the company's capital structure, risk profile, complexity, activities, and size.

Sixth, senior management would be required to (1) approve the liquidity stress testing practices, methodologies, and assumptions as set out in § 252.165(a) of the proposed rule at least quarterly and whenever the systemically important insurance company materially revises such practices, methodologies, or assumptions; (2) review at least quarterly both the liquidity stress-testing results produced under § 252.165(a) of the proposed rule and the liquidity buffer provided in § 252.165(b) of the proposed rule; and (3) review periodically the independent review of the liquidity stress tests under § 252.165(d) of the proposed rule.

The proposal would allow a systemically important insurance company to assign these senior management responsibilities to its chief risk officer, who would be considered a member of the senior management of the systemically important insurance company.

Question 7: The Board invites comment on whether there are additional liquidity risk-management responsibilities that the rule should require of senior management.

An independent review function is a critical element of a financial institution's liquidity risk-management program because it can identify weaknesses in liquidity risk management that would be overlooked by the management functions that execute funding. Accordingly, the Board is proposing to require a systemically important insurance company to maintain an independent review function that meets frequently (but no less than annually) to review and evaluate the adequacy and effectiveness of the company's liquidity risk-management processes, including its liquidity stress-test processes and assumptions. Under the proposal, this review function would be required to be independent of management functions that execute funding (e.g., the treasury function), but it would not be required to be independent of the liquidity risk-management function. In addition, the proposal would require the independent review function to assess whether the company's liquidity risk-management framework complies with applicable laws, regulations, supervisory guidance, and sound business practices, and report for corrective action any material liquidity risk-management issues to the board of directors or the risk committee.

An appropriate internal review conducted by the independent review function under the proposed rule should address all relevant elements of the liquidity risk-management framework, including adherence to the established policies and procedures and the adequacy of liquidity risk identification, measurement, and reporting processes. Personnel conducting these reviews should seek to understand, test, and evaluate the liquidity risk-management processes, document their review, and recommend solutions for any identified weaknesses.

Comprehensive projections of cash flows from a firm's various operations are a critical tool to help the institution manage its liquidity risk. The proposal would require that the company produce comprehensive enterprise-wide cash-flow projections that project cash flows arising from assets, liabilities, and off-balance sheet exposures over short and long-term time horizons, including time horizons longer than one year. Longer time horizons are particularly important for insurance companies, which generally have liabilities that extend far into the future. In addition, tracking cash-flow mismatches can help a systemically important insurance company identify potential liquidity issues and facilitate asset liability management, particularly as it relates to reinvestment risk from interest rate changes. The proposal would require that the systemically important insurance company update short-term cash-flow projections daily and update longer-term cash-flow projections at least monthly. These updates would not always require revisiting actuarial estimates; however, the updates would need to roll the cash flows forward and revise assumptions as needed based on new data and changing market conditions.

To ensure that the cash flow projections would sufficiently analyze liquidity risk exposure to contingent events, the proposed rule would require that a systemically important insurance company establish a methodology for making projections that include all material liquidity exposures and sources, including cash flows arising from (1) anticipated claim and annuity payments; (2) policyholder options including surrenders, withdrawals, and policy loans; (3) collateral requirements on derivatives and other obligations; (4) intercompany transactions; (5) premiums on new and renewal business; (6) expenses; (7) maturities and renewals of funding instruments, including through the operation of any provisions that could accelerate the maturity; and (8) investment income and proceeds from assets sales. The proposal would require that the methodology (1) include reasonable assumptions regarding the future behavior of assets, liabilities, and off-balance sheet exposures, (2) identify and quantify discrete and cumulative cash flow mismatches over various time periods, and (3) include sufficient detail to reflect the capital structure, risk profile, complexity, currency exposure, activities, and size of the systemically important insurance company, and any applicable legal and regulatory requirements. The proposal provides that analyses may be categorized by business line, currency, or legal entity.

Given the critical importance that the methodology and underlying assumptions play in liquidity risk management, a systemically important insurance company would be required to adequately document its methodology and assumptions used in making its cash flow projections.

Question 8: The Board invites comment on whether the above requirements are appropriate for managing cash flows at systemically important insurance companies. Should any aspects of this cash-flow projection requirement be modified to better address the risk of systemically important insurance companies?

Question 9: Should the Board consider a different level of frequency for requiring systemically important insurance companies to update their cash flow projections? If so, what frequency would be appropriate and why?

Under the proposed rule, a systemically important insurance company would be required to establish and maintain a contingency funding plan for responding to a liquidity crisis, identify alternate liquidity sources that the company can access during liquidity stress events, and describe steps that should be taken to ensure that the company's sources of liquidity are sufficient to fund its normal operating requirements under stress events. These provisions require the firm to develop and put in place plans designed to ensure that the firm will have adequate sources of liquidity to meet its obligations during the normal course of business. The proposal does not itself set a minimum liquidity requirement that would apply to all firms.

The proposal would require the contingency funding plan to include a quantitative assessment, an event management process, and monitoring requirements. The proposal would also require the plan to be commensurate with a systemically important insurance company's capital structure, risk profile, complexity, activities, size, and established liquidity risk tolerance.

Under the proposed rule, a systemically important insurance company would perform a quantitative assessment to identify liquidity stress events that could have a significant effect on the company's liquidity, assess the level and nature of such effect, and assess available funding sources during identified liquidity events. Such an assessment should delineate the various levels of stress severity that could occur during a stress event and identify the various stages for each type of event, spanning from the event's inception until its resolution. The types of events would include temporary, intermediate, and long-term disruptions. Under the proposal, possible stress events may include deterioration in asset quality, a spike in interest rates, an insurance catastrophe such as a pandemic that results in a large number of claims, an equity market decline, multiple ratings downgrades, a widening of credit default swap spreads, operating losses, negative press coverage, or other events that call into question a systemically important insurance company's liquidity. The stress events should be forecast in a comprehensive way across legal entities to identify gaps on an enterprise-wide basis. In addition, the proposal would require a systemically important insurance company to incorporate information generated by liquidity stress testing.

The proposed rule would provide that a systemically important insurance company include in its contingency funding plan procedures for monitoring emerging liquidity stress events and identifying early warning indicators that are tailored to the company's capital structure, risk profile, complexity, activities, and size. Early warning indicators should include negative publicity concerning an asset class owned by the company, potential deterioration of the company's financial condition, a rating downgrade, and/or a widening of the company's debt or credit default swap spreads. In addition, a systemically important insurance company's contingency funding plan would be required to at least incorporate collateral and legal entity liquidity risk monitoring.

As part of the quantitative assessment, a systemically important insurance company would be required to include in its contingency funding plan both an assessment of available funding sources and needs and an identification of alternative funding sources that may be used during the identified liquidity stress events. To determine available and alternative funding sources, a systemically important insurance company would be expected under the proposal to analyze the potential erosion of available funding at various stages and severity levels of each stress event and identify potential cash flow mismatches that may occur. This analysis would include all material on- and off-balance sheet cash flows and their related effects, and would be based on a realistic assessment of both the behavior of policyholders and other counterparties and of a systemically important insurance company's cash inflows, outflows, and funds that would be available (after considering restrictions on the transferability of funds within the group) at different time intervals during the identified liquidity stress event. In addition, a systemically important insurance company should work proactively to have in place any administrative procedures and agreements necessary to access any alternative funding source.

The proposed rule would also require a systemically important insurance company's contingency funding plan to identify the circumstances in which the company would implement an action plan to respond to liquidity shortfalls for identified liquidity stress events. The action plan would clearly describe the strategies that a systemically important insurance company would use during such an event, including (1) the methods that the company would use to access alternative funding sources, (2) the identification of a management team to execute the action plan, (3) the process, responsibilities, and triggers for invoking the contingency funding plan, and (4) the decision-making process during the identified liquidity stress events and the process for executing the action plan's contingency measures. In addition, the proposal sets out reporting and communication requirements to facilitate a systemically important insurance company's implementation of its action plan during an identified liquidity stress event.

The proposal would require that a systemically important insurance company periodically test (1) the components of its contingency funding plan to assess its reliability during liquidity stress events, (2) the operational elements of the contingency funding plan, and (3) the methods the company would use to access alternative funding sources to determine whether those sources would be available when needed. The tests required by the proposal would focus on the operational aspects of the contingency funding plan. This can often be done via “table-top” or “war-room” type exercises. In some cases, the testing would also require actual liquidation of assets in the buffer periodically as part of the exercise. This can be critical in demonstrating treasury control over the assets and an ability to convert the assets into cash. With proper planning, this can be done in a way that does not send a distress signal to the marketplace.

Market circumstances and the composition of a systemically important insurance company's business and product mix change over time. These types of changes could affect the effectiveness of a systemically important insurance company's contingency funding plan. To ensure that the contingency funding plan remains useful and instructive, the proposal would require a systemically important insurance company to update its contingency funding plan at least annually, and more frequently when changes to market and idiosyncratic conditions warrant.

Question 10: The Board invites comment on whether the above requirements for a contingency funding plan are appropriate for systemically important insurance companies. What alternative approaches to the contingency funding requirements outlined above should the Board consider?

Question 11: Should the proposed rule allow systemically important insurance companies to plan for any delay or stay of payments to policyholders or other counterparties within their contingency funding plans? Why or why not?

Question 12: What specific information should a systemically important insurance company be required to include in its action plan to describe the strategies that the company would use to respond to liquidity shortfalls for identified liquidity stress events?

The proposal would require a systemically important insurance company to establish and maintain procedures for monitoring collateral, legal entity, and intraday liquidity risk. Robust monitoring of collateral availability, legal entity level liquidity, and intraday liquidity risk triggers contribute to effective and appropriate management of potential or evolving liquidity stress events.

Under the proposal, the systemically important insurance company would be required to establish and maintain procedures to monitor assets that have been, or are available to be, pledged as collateral in connection with transactions to which it or its affiliates are counterparties. The policies and procedures would include the frequency in which a systemically important insurance company calculates its collateral positions, requirements for a company to monitor the levels of unencumbered assets (as discussed in section III.F.2, below) available to be pledged and shifts in a company's funding patterns, and requirements for a company to track operational and timing requirements associated with accessing collateral at its physical location.

A systemically important insurance company would also be required under the proposal to establish and maintain policies and procedures for monitoring and controlling liquidity risk exposures and funding needs within and across significant legal entities, currencies, and business lines, taking into account legal and regulatory restrictions on the transfer of liquidity among legal entities.

The proposal would require a systemically important insurance company to maintain policies and procedures for monitoring the intraday liquidity risk exposure of the company, as applicable to its business, including obligations that must be settled at a specific time within the day or where intraday events could affect a systemically important insurance company's liquidity positions in a material and adverse manner. For instance, the company should have procedures in place to monitor the risk that an intraday movement in equity prices or the price of hedge instruments could materially affect the company's liquidity position. If applicable, these procedures would be required to address, among other things, how the systemically important insurance company will prioritize payments and derivative transactions to settle critical obligations and effectively hedge its risks.

Question 13: The Board invites comments on whether there are specific activities that, if carried out by a systemically important insurance company, should result in a requirement that the company engage in intraday liquidity monitoring?

To reduce the risk of a systemically important insurance company's failure due to adverse liquidity conditions, the proposal would require a systemically important insurance company to conduct rigorous and regular stress testing and scenario analysis that incorporate comprehensive information about its funding position under both normal circumstances, when regular sources of liquidity are readily available, and adverse conditions, when liquidity sources may be limited or severely constrained. The purpose of the proposed rule's liquidity stress testing and buffer requirements would be to ensure that the holding company (or another entity within the consolidated organization that is not subject to transfer restrictions) has the ability to transfer liquid assets to a legal entity within the consolidated organization that has a liquidity need so that a liquidity crisis can be avoided.

Under the proposed rule, a systemically important insurance company would be required to conduct liquidity stress tests that, at a minimum, involve macroeconomic, sector-wide, and idiosyncratic events (for example, including natural and man-made catastrophes) affecting the firm's cash flows, liquidity position, profitability, and solvency. The liquidity stress tests should span the different types of liquidity events that a systemically important insurance company could face. This includes both a fast-moving scenario in which an event triggers many withdrawal requests and collateral calls as well as a more sustained scenario where the systemically important insurance company's liquidity deteriorates slowly over the course of a year or longer. In conducting its liquidity stress tests, a systemically important insurance company would be required under the proposal to take into account its current liquidity condition, risks, exposures, strategies, and activities, as well as its balance sheet exposures, off-balance sheet exposures, size, risk profile, complexity, business lines, organizational structure, and other characteristics that affect its liquidity risk profile. The proposal would require a systemically important insurance company to conduct its liquidity stress tests monthly, or more frequently as required by the Board.

In conducting its liquidity stress tests, a systemically important insurance company would be required to address the potential direct adverse effect of associated market disruptions on the company and incorporate the potential actions of counterparties, policyholders, and other market participants experiencing liquidity stresses that could adversely affect the company.

As explained above, for purposes of the proposed rule, liquidity risk would encompass risks relating to collateral posting requirements. By virtue of their hedging and non-insurance operations, insurers can have large and directional derivative positions with associated collateral requirements. A systemically important insurance company would be required by the proposal to account for such hedges in its liquidity stress testing to ensure that it would have sufficient sources of assets available for posting.

Effective liquidity stress testing should be conducted over a variety of different time horizons to capture rapidly developing events and other conditions and outcomes that may materialize in the near or long term. While some types of stresses can emerge quickly for systemically important insurance companies, such as collateral calls on derivatives positions, many insurance stresses take more time to develop and provide a slower draw on cash and funds relative to the stresses that affect other financial institutions. For instance, while a natural catastrophe might cause a large number of claims seeking reimbursement for property damage, these claims will typically be paid over a several year period as the properties are rebuilt and many claims are litigated. To ensure that a systemically important insurance company's stress testing captures such events, conditions, and outcomes, the proposed rule would require that a systemically important insurance company's liquidity stress scenarios use a minimum of four time horizons: 7 days, 30 days, 90 days, and one year. The proposal would also require systemically important insurance companies to include any other planning horizons that are relevant to its liquidity risk profile.

Under the proposal, a systemically important insurance company would be required to incorporate certain assumptions designed to ensure that its liquidity stress tests provide relevant information to support the establishment of the liquidity buffer. For stress tests less than the 90-day period used to set the liquidity buffer, cash-flow sources could not include any sales of assets that are not eligible for inclusion in the liquidity buffer, as defined below. Additionally, cash-flow sources should not include borrowings from sources such as lines of credit or the Federal Home Loan Bank. While these can provide valuable sources of liquidity, the allowance of off-balance sheet funding to decrease the liquidity buffer requirement would encourage firms to place undue reliance on these transactions, which may not be available when needed in times of stress. Additionally, the borrowings could serve to exacerbate systemic risk by spreading risk to other significant financial institutions. Systemically important insurance companies could incorporate into the stress tests other cash-flow sources, including future premiums, and would be expected to make conservative assumptions that are consistent with the stress scenario regarding the availability of these sources over the planning horizon.

In all liquidity stress tests, the proposal would require systemically important insurance companies to appropriately address assets in restricted accounts such as those in legally-insulated separate accounts and in any closed block.28 Changes in the value of these assets can affect the rest of the insurer's balance sheet through guarantees and hedging programs. Additionally, sales or purchases of large amounts of assets in these accounts can affect the markets more broadly. Consequently, separate account assets and closed block assets could be included as cash-flow sources only in proportion to the cash flow needs in these same accounts. Separate account assets have first priority to meet separate account commitments and would not be available to meet general account liquidity needs.

The proposed rule would require a systemically important insurance company to impose a discount to the fair market value of an asset that is used as a cash-flow source to offset projected funding needs in order to help account for credit risk and market volatility of the asset when there is market stress. The discounts would be required to appropriately reflect differences in credit and market volatilities across asset types. The proposed rule would require that sources of funding used to generate cash to offset projected funding needs be sufficiently diversified throughout each stress test time horizon.

The proposed rule further provides that liquidity stress testing must be tailored to, and provide sufficient detail to reflect, a systemically important insurance company's capital structure, risk profile, complexity, activities, size, and other appropriate risk-related factors. This requirement is intended to ensure that the proposed liquidity stress testing is tied directly to a systemically important insurance company's business profile and the regulatory environment in which the company operates; provides for the appropriate level of aggregation; captures all appropriate risk drivers, including internal and external influences; and incorporates other key considerations that may affect the company's liquidity position. In addition, a systemically important insurance company's liquidity stress testing scenarios should appropriately capture limitations on the transfer of funds.

The proposed rule would not allow a systemically important insurance company to assume for the purposes of stress testing that the company would delay payments under insurance contracts. Although many insurance contracts allow insurers to defer payments by up to six months at the election of either the company or their insurance regulator, the proposal would not allow firms to assume such deferrals in liquidity stress testing. Crediting stays would be inconsistent with preventing the failure or material financial distress of a systemically important insurance company. Stays are measures of last resort that systemically important insurance companies would be very hesitant to invoke for reputational reasons. Because of this, assuming claims payments would be delayed also may not be realistic. Additionally, a stay by a systemically important insurance company could have substantial adverse systemic implications.

The proposed rule would impose various governance requirements related to a systemically important insurance company's liquidity stress testing. First, a systemically important insurance company would be required to establish and maintain certain policies and procedures governing its liquidity stress testing practices, methodologies, and assumptions. Second, a systemically important insurance company would be required to establish and maintain a system of controls and oversight to ensure that its liquidity stress testing processes are effective, including by ensuring that each stress test appropriately incorporates conservative assumptions around its stress test scenarios and the other elements of the stress test process. In addition, the proposal would require that the assumptions be approved by the chief risk officer and subject to review by the independent review function. Third, the proposed rule would require a systemically important insurance company to maintain management information systems and data processes sufficient to enable it to collect, sort, and aggregate data and other information related to liquidity stress testing in an effective and reliable manner.

Question 14: Are the proposed stress testing horizons ranging from seven days to one year appropriate?

Question 15: How often should systemically important insurance companies be required to conduct stress tests? What are the costs and benefits of such a frequency?

Question 16: What changes, if any, should be made to the definition of available cash-flow sources for the liquidity stress tests? How should the proposed standard treat separate account and closed block assets?

Question 17: In what scenario, if any, would delaying payments to policyholders be effective in allowing a systemically important insurance company to continue operating as a going concern without adverse impact to the company's reputation, ability to attract and retain business, and cash flows? Should systemically important insurance companies be allowed to assume that they would delay payments to policyholders in liquidity stress testing (including for purposes of calculating the liquidity buffer requirement described below)? If so, under which scenarios and planning horizons would this be appropriate and what documentation, planning, and other requirements should be placed around this? Are there historical data to support an alternative approach to the one contained in the proposal?

Question 18: What other changes, if any, should be made to the proposed liquidity stress-testing requirements (including the stress scenario requirements and required assumptions) to ensure that analyses of stress testing will provide useful information for the management of a systemically important insurance company's liquidity risk? What alternatives to the proposed liquidity stress-testing requirements, including the stress scenario requirements and required assumptions, should the Board consider? What additional parameters for the liquidity stress tests should the Board consider defining?

The proposed rule would require a systemically important insurance company to maintain a liquidity buffer sufficient to meet net cash outflows for 90 days over the range of liquidity stress scenarios used in the internal stress testing. Although the Board requires large bank holding companies to use a 30-day period for the Dodd Frank Act section 165 liquidity buffer requirement under the Board's Regulation YY, this proposed 90-day period for systemically important insurance companies is consistent with the generally longer-term nature of insurance liabilities. The 90-day period represents an intermediate view between the length of a fast-moving liquidity scenario that transpires quickly over a month or less, and the length of a persistent liquidity scenario that could take longer than a year to resolve.

For the purposes of calculating the required buffer, the proposal would exclude intragroup transactions. Including intragroup outflows within the buffer calculation would result in double counting many transactions. For instance, if intragroup transactions were included when calculating the size of the buffer, a systemically important insurance company that uses a single legal entity to enter into derivative transactions for hedging could be penalized. Such a company would have to hold buffer assets not only for the derivative transaction with a third party, but also for any offsetting intra-group transactions that transfer the benefits of this hedge back to the legal entity with the hedged item. To account for the liquidity risks of intragroup transactions, this proposal instead places limitations on where the buffer can be held.

The proposal would limit the type of assets that may be included in the buffer to highly liquid assets that are unencumbered. Limitation of the buffer to highly liquid assets would ensure that the assets in the liquidity buffer can be converted to cash over a 90-day period with little or no loss of value. The proposal's definition of highly liquid assets is tailored to reflect the assets generally held by systemically important insurance companies and the 90-day stress test period proposed for a systemically important insurance company. Over a 90-day time period, the Board would expect that a wider variety of assets could be effectively liquidated than in a shorter period (e.g., 30 days).

For purposes of the proposed rule, highly liquid assets would include a range of assets, subject to the additional limitations discussed further below. Highly liquid assets would include securities backed by the full faith and credit of the U.S. government, and securities issued or guaranteed by a U.S. government sponsored enterprise if they are investment-grade as defined by 12 CFR part 1 and the claim is senior to preferred stock. Highly liquid assets would include securities of sovereign entities outside of the U.S. as well as some international organizations, including the Bank for International Settlements, the International Monetary Fund, and the European Central Bank, if the security would have a risk weight below 20 percent under 12 CFR part 217 or the security is issued by a sovereign entity in its own currency and the systemically important insurance company holds the security in order to meet its stressed net cash outflows in the sovereign's jurisdiction.

Investment-grade corporate debt would also be eligible if the issuer's obligations have a proven record as reliable sources of liquidity during stressed market conditions. In addition, highly liquid assets would include publicly traded common equity shares if they are included in the Russell 1000 Index, issued by an entity whose publicly traded common equity shares have a proven record as a reliable source of liquidity during stressed market conditions, and, if held by a depository institution, were not acquired in satisfaction of a debt previously contracted. Investment-grade general obligation securities issued or guaranteed by public sector entities would be eligible under the same limitations as corporate debt.

To be included as highly liquid assets, all assets other than securities issued or guaranteed by the U.S. Treasury would have to be liquid and readily-marketable. To be liquid and readily marketable under the proposal, the security must be traded in an active secondary market with more than two committed market makers. There must also be a large number of non-market maker participants on both the buying and selling sides of the transactions and there must also be timely and observable market prices. Further, trading volume must be high. These requirements would help ensure that the included assets could be quickly converted to cash.

Because of the concerns about wrong-way risk that correlates with the broader economy and exacerbates stress and because of the potential for increased systemic risk due to counterparty exposures, most instruments issued by financial institutions would be excluded from the definition of highly liquid assets. Bonds from banks or insurance companies may not be included within the buffer. Similarly bank deposits would not be eligible because of potential contagion. If a systemically important insurance company were to experience liquidity stress and withdraw its bank deposits, the stress event could be spread to other parts of the financial system as banks may be forced to liquidate assets in order to honor the withdrawals.

In addition to the enumerated assets, the proposal includes criteria that could be used to identify other assets to be included in the buffer as highly liquid assets. Specifically, the proposed definition of highly liquid assets includes any other asset that a systemically important insurance company demonstrates to the satisfaction of the Board (1) has low credit risk and low market risk, (2) is liquid and readily-marketable, and (3) is a type of asset that investors historically have purchased in periods of financial market distress during which market liquidity has been impaired.

The proposal also would limit the type of assets in the liquidity buffer to assets that are unencumbered so as to be readily available at all times to meet a systemically important insurance company's liquidity needs. Under the proposed rule, unencumbered would be defined to mean an asset that is (1) free of legal, regulatory, contractual, and other restrictions on the ability of a systemically important insurance company promptly to liquidate, sell, or transfer the asset, and (2) not pledged or used to secure or provide credit enhancement to any transaction.

Because of intercompany restrictions on the transfer of funds, the proposal would limit where a systemically important insurance company can hold assets in the liquidity buffer. Assets held at regulated entities could be included in the buffer up to the amount of their net cash outflows as calculated under the internal liquidity stress tests plus any additional amounts that would be available for transfer to the top-tier holding company during times of stress without statutory, regulatory, contractual, or supervisory restrictions. The proposal would also require that the top-tier holding company hold an amount of highly liquid assets sufficient to cover the sum of all stand-alone material entity net liquidity deficits. The stand-alone net liquidity deficit of each material entity would be calculated as that entity's amount of net stressed outflows over a 90-day planning horizon less the highly liquid assets held at the material entity. For the purposes of evaluating liquidity deficits of material entities, systemically important insurance companies would be required to treat inter-affiliate exposures in the same manner as third-party exposures.

To account for deteriorations in asset valuations when there is market stress, the proposed rule also would require a systemically important insurance company to impose a discount to the fair market value of an asset included in the liquidity buffer to reflect the credit risk and market volatility of the asset. Discounts relative to fair market value would be expected to appropriately reflect the 90-day forecast period used to calculate the buffer. Longer periods allow firms more time to liquidate assets strategically to minimize losses.

In addition, to ensure that the liquidity buffer is not concentrated in a particular type of highly liquid assets, the proposed rule provides that the pool of assets included in the liquidity buffer must be sufficiently diversified by instrument type, counterparties, geographic market, and other liquidity risk identifiers.

Question 19: Is 90 days the right planning horizon for calculation of the buffer? Why or why not?

Question 20: Do the proposed rule's stress testing and liquidity buffer requirements appropriately capture restrictions on the transferability of funds between legal entities within a consolidated organization? Why or why not?

Question 21: The Board invites comment on all aspects of the proposed definition of “highly liquid assets”. Does the definition appropriately reflect the range of assets that an insurer could use to meet cash outflows over the extended 90-day time horizon?

Question 22: Should the board include specific requirements that specify when an asset can be considered a source of liquidity during stress (e.g., less than a 20 percent drop in price within 30 days)? If so, what should those requirements be?

Question 23: Should bank deposits be eligible as highly liquid assets? Why or why not?

Question 24: What changes, if any, should be made to the proposal's guidance concerning the discounting of assets relative to their fair value? How should these discounts vary based on the length of the stress test's planning horizon?

Question 25: What changes, if any, should the Board make to the proposed definition of unencumbered to ensure that assets in the liquidity buffer will be readily available at all times to meet a systemically important insurance company's liquidity needs?

Question 26: The Board requests comment on all aspects of the proposed liquidity risk-management standard. What alternative approaches to liquidity risk management should the Board consider? Are the liquidity risk-management requirements of this proposal too specific or too narrowly defined?

To provide for reasonable time frames for systemically important insurance companies to develop and implement procedures, policies, and reporting, the Board is proposing to provide meaningful phase-in periods for these enhanced prudential standards. A company that is a systemically important insurance company on the effective date of the final rule would be required to comply with the corporate governance and risk-management standard and the liquidity risk-management standard of the proposed rule beginning on the first day of the fifth quarter following the effective date of the proposal. While the Board does not anticipate that, if the rule is adopted as proposed, systemically important insurance companies would be required to make extensive changes to their structures or risk governance frameworks, outside of certain improvements that the companies are already planning to implement, the five-quarter period would ensure that systemically important insurance companies would have at least one opportunity to make any needed changes at the board of directors level through a proxy vote. Systemically important insurance companies would be encouraged to comply earlier, if possible. For the liquidity risk-management standard, the five-quarter phase-in period would balance the need for this liquidity standard with the Board's expectation that more work would be required for the systemically important insurance companies to comprehensively project cash flows in a manner that supports the proposal's stress-testing requirement. A company that becomes a systemically important insurance company after the effective date of the proposed rule would be required to comply with the corporate governance and risk-management standard and the liquidity risk-management standard no later than the first day of the fifth quarter following the date on which the Council determined that the company should be supervised by the Board.

Question 27: Are the proposed transition measures and compliance dates appropriate? What aspects of the proposed rule present implementation challenges and why? The Board invites comments on the nature and impact of these challenges and whether the Board should consider implementing transitional arrangements in the rule to address these challenges.

In developing this proposal, the Board considered a variety of alternatives and considered an initial balancing of costs and benefits of the proposal. Based on the information currently available to the Board, the Board believes that the benefits of the proposal outweigh the relatively modest costs of the proposal. The Board notes that a number of the expected costs and benefits from the proposal, while real, are very difficult to measure or quantify. The Board invites comment and information regarding various alternatives, as well as regarding the costs and benefits of the alternatives and the Board's proposal.

The primary benefits of this proposal would be the results of improvement in the management and resiliency of affected companies that reduce the likelihood that a systemically important insurance company would fail or experience material financial distress. These improvements may also result in increased efficiencies at systemically important insurance companies through improvements in the identification of risks and resulting reductions in losses and costs of operation.

The systemically important insurance companies covered by this proposal are large, complex financial firms that the Council has determined the failure of which would likely cause risk to the financial stability of the United States. Benefits of a reduction in the probability of failure of one of these firms include avoiding: (1) The costs to the economy from the disruption of key markets or the creation of significant losses or funding problems for other firms with holdings similar to a systemically important insurance company; (2) the cost of such a failure to policyholders through lost payments and lost coverage; (3) the cost of an insurance failure to taxpayers and other insurers, who act as guarantors for large portions of a systemically important insurance company's obligations; and (4) the cost of a failure to a systemically important insurance company's creditors.

The corporate governance and risk-management provisions of the proposal are expected to have only modest initial and ongoing costs for the affected companies. Under the proposal, systemically important insurance companies would be required to maintain a risk committee of the board of directors that approves and periodically reviews the risk-management policies of the systemically important insurance company's global operations and oversees the operation of the systemically important insurance company's global risk-management framework. The systemically important insurance companies currently have board-level engagement on key risks, and any structural modifications to establish and operate a stand-alone risk committee of the board of the directors are likely to be modest.

Under the proposal, a systemically important insurance company's global risk-management framework would be required to include policies and procedures establishing risk-management governance, risk-management procedures, and risk control infrastructure for its global operations, as well as processes and systems for implementing and monitoring compliance with such procedures; identifying and reporting risks and risk-management deficiencies; establishing managerial and employee responsibility for risk management; ensuring the independence of the risk-management function; and integrating risk-management and associated controls with management goals and its compensation structure for its global operations. The systemically important insurance companies currently have both risk-management frameworks and policies already in place. They have already invested significant resources in building up their risk-management frameworks in recent years. The Board expects that these frameworks, along with the companies' planned improvements, would largely comply with the proposed standards. The proposal is designed to ensure that these policies and procedures are maintained and are developed as the risks within the firm change. The primary costs of maintaining and adapting these policies and procedures would be from the opportunity cost of management's time to make the changes to the framework, as well as the costs of establishing or improving new management information systems to assure the timely presentation of information to these senior level officials. These costs might also include additional staffing to administer the global risk-management framework.

Under the proposal, systemically important insurance companies also would be required to have a chief risk officer and a chief actuary. The systemically important insurance companies currently have both a chief risk officer and a chief actuary or co-chief actuaries. The proposal may require the companies to modify their reporting structures and compensation to ensure that the positions have sufficient stature and independence from individual profit centers in order to comply with the proposal. The costs associated with such changes could include, but may not be limited to, ongoing payroll and benefit costs and the opportunity cost of the time spent making the necessary changes. These costs are expected to be minimal.

Under the proposed liquidity risk-management standard, systemically important insurance companies would be required to meet key internal control requirements with respect to liquidity risk management. The companies currently have existing processes in place to oversee liquidity risk. These processes, along with planned improvements, would largely comply with the liquidity risk-management standard's internal control requirements. Some additional changes may be required pertaining to new product approval and to ensure periodic review of all significant products and activities for liquidity risk features. These costs are expected to be relatively small.

The proposed rule would also require systemically important insurance companies to generate comprehensive cash flow projections. Both companies have procedures in place to generate cash-flow projections. Additional work may be needed to ensure that all cash flows, including those in unregulated or run-off entities, are included within the projections, and to ensure that the cash-flow projections are timely and updated at the appropriate frequency. The additional frequency of updating might require systemically important insurance companies to either hire additional staff to run these projections or to build or buy new systems that can produce these comprehensive forecasts in a timely and efficient manner. Because these firms already have in place basic infrastructure to make these projections, any marginal costs to meet the minimum requirements under the proposal are expected to be relatively modest.

The proposed rule would also require systemically important insurance companies to maintain a contingency funding plan. Both systemically important insurance companies have plans in place to respond to a liquidity crisis, and both are working to develop these plans further. Some additional work on these plans may be required to meet the requirements of the proposed rule, such as quantitatively assessing cash-flow needs and sources across legal entities.

The proposed rule also would require systemically important insurance companies to conduct liquidity stress tests and require the systemically important insurance companies to maintain liquid assets sufficient to meet net cash outflows for 90 days over the range of liquidity stress scenarios used in the internal stress tests. Both of the systemically important insurance companies have systems in place to project the company's liquidity position under stressed conditions. However, the proposal may cause the systemically important insurance companies to update these systems to facilitate monthly testing and ensure that the scenarios include all exposures and entities within the systemically important insurance company. The costs associated with these improvements are expected to be modest within the context of the organizations and could include, but may not be limited to, the costs to recruit and hire staff, including ongoing payroll and benefits costs, and the costs of development and implementation of management information systems with appropriate data to support analysis and reporting on a monthly frequency.

In addition, systemically important insurance companies may need to make balance sheet adjustments in order to come into and maintain compliance with the proposed liquidity risk-management requirements, if adopted as proposed. While both systemically important insurance companies currently appear to maintain an adequate amount of liquidity on a consolidated basis, some movement of funds between legal entities may be required to provide appropriate responsiveness in times of stress.

The initial and ongoing costs of complying with the standard, if adopted as proposed, could affect the premiums and fees that the systemically important insurance companies charge. Insurance products are priced to allow insurers to recover their costs and earn a fair rate of return on their capital. In the long run, all costs of providing a policy are borne by policyholders.

Because the expected costs associated with implementing the proposal, if adopted, are not expected to be material within the context of the institutions' existing budgets, there is not expected to be a material change in the pricing of systemically important insurance companies' products from the proposed standards, if adopted as proposed. Moreover, the better identification and management of risk that is expected to result from the proposal may lead to improved efficiencies, fewer losses, and lower costs in the long term, which may offset the effects of the costs of compliance on premiums.

If premiums or fees increase on some or all products, it could discourage some potential customers from purchasing these products. However, the possibility of reduced financial intermediation or economic output in the United States related to the proposed rule's corporate governance and risk-management standard and liquidity risk-management standard appears unlikely.

Based on an initial assessment of available information, the benefits of the proposed standards are expected to outweigh the costs. Most significantly, the intent of the proposed rule is to reduce the probability of a systemically important insurance company failing or experiencing material financial distress. Even small changes in the probability of a systemically important firm failing can confer large expected benefits because of the enormous cost of financial crises. Additionally, the proposal would have an ancillary benefit of facilitating an orderly resolution of a systemically important insurance company, and could increase consumer confidence in the companies. Moreover, as explained below, improved risk management may improve efficiency by reducing losses and costs in the long term.

This proposal is intended to reduce the risk that a systemically important insurance company would experience material financial distress or fail. A reduction of this probability carries numerous direct and indirect benefits.

The most important benefit from a reduction in the probability of default of a systemically important insurance company is a decreased potential for a potential negative impact on the United States economy caused by the failure or material financial distress of a systemically important insurance company. The Council has determined that material financial distress at each of the systemically important insurance companies could cause an impairment of financial intermediation or of financial market functioning that would be sufficiently severe to inflict significant damage on the broader economy. A reduction in the probability of failure or material financial distress at both systemically important insurance companies would promote financial stability and concomitantly materially reduce the probability that a financial crisis would occur in any given year. The proposed rule would therefore advance a key objective of the Dodd-Frank Act and help protect the American economy from the substantial potential losses associated with a higher probability of financial crises.

In addition to the benefits to the broader economy, a reduction in a systemically important insurance company's default probability benefits its counterparties. The majority of funding for systemically important insurance companies comes from policyholders. Some of these policyholders would bear losses if the company were to fail. These losses can take the form of reduced payment for claims, reduced amounts available for withdrawal from policyholder accounts, or long delays.

The overall costs of these losses to policyholders extend beyond just their dollar value. Policyholders purchase insurance policies because they provide money when it is most needed. Insurance policies can replace lost wages when a policyholder is disabled or help a policyholder afford shelter after a natural catastrophe destroys his or her home and possessions. Other policyholders might not yet have experienced a loss event, but could be unable to obtain new coverage in the event a systemically important insurance company fails. For instance, an elderly policyholder who purchased a whole life contract many years ago would likely have difficulty obtaining a replacement policy.

Reducing the probability of a systemically important insurance company's failure or distress decreases the expected costs to policyholders, taxpayers, other counterparties, other insurance companies, and the financial system generally.

The proposal is also expected to benefit other creditors of systemically important insurance companies. In the event of a failure, the lenders and general creditors of a company also experience losses. While it is not the primary goal of this proposed regulation to protect these parties, they could potentially benefit.

The savings from a reduced probability of default would also have indirect benefits. They could also translate into lower borrowing costs for systemically important insurance companies. The lower costs could also affect insurance premiums. If systemically important insurance companies expect lower guaranty fund assessment costs, these savings could be passed on to policyholders in the form of lower premiums and fees. These savings are, however, unlikely to be material.

While the primary benefit of the proposed rule would be a reduction in the probability of a firm failing or experiencing material financial distress, the proposed rule is also expected to produce benefits in a resolution of a systemically important insurance company. Liquidity is valuable in resolutions, and the restrictions on the liquidity buffer that require the buffer to be held at the holding company to be down-streamed, could facilitate a variety of strategies for an orderly resolution.

The proposed rule may result in efficiencies at systemically important insurance companies through improved risk-management practices. The proposed rule is expected to improve systemically important insurance companies' internal controls and identification and management of risks that may arise through their activities and investments. For example, the increased internal controls and liquidity stress-testing requirements could result in a systemically important insurance company discovering that a product's liquidity risks are different than it previously estimated and thus result in the systemically important insurance company being able to price that product in a way that more accurately reflects its risks. If systemically important insurance companies are better able to manage risk, then over the long term, the proposed rule may result in decreased losses and related costs to systemically important insurance companies.

Question 28: The Board invites comment on all aspects of the foregoing evaluation of the costs and benefits of the proposed rule. Are there additional costs or benefits that the Board should consider? Would the magnitude of costs or benefits be different than as described above?

Section 722 of the Gramm-Leach-Bliley Act (Pub. L. 106-102, 113 Stat. 1338, 1471, 12 U.S.C. 4809) requires the Federal banking agencies to use plain language in all proposed and final rules published after January 1, 2000. The Board has sought to present the proposed rule in a simple and straightforward manner, and invites comment on the use of plain language.

Certain provisions of the proposed rule contain “collection of information” requirements within the meaning of the Paperwork Reduction Act (PRA) of 1995 (44 U.S.C. 3501-3521). In accordance with the requirements of the PRA, the Board 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 is 7100-NEW. The Board reviewed the proposed rule under the authority delegated to the Board by the OMB.

The proposed rule contains requirements subject to the PRA. The recordkeeping requirements are found in sections 252.164(e)(3), 252.164(f), 252.164(h), and 252.165(a)(7). These information collection requirements would be implemented pursuant to section 165 of the Dodd-Frank Act for systemically important insurance companies.

Comments are invited on:

(a) Whether the collections of information are necessary for the proper performance of the Board's functions, including whether the information has practical utility;

(b) The accuracy of the Board's estimate of the burden of the information collections, 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 collections 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.

All comments will become a matter of public record. Comments on aspects of this notice that may affect reporting, recordkeeping, or disclosure requirements and burden estimates should be sent to the addresses listed in the ADDRESSES section. A copy of the comments may also be submitted to the OMB desk officer: By mail to U.S. Office of Management and Budget, 725 17th Street NW., #10235, Washington, DC 20503 or by facsimile to 202-395-5806, Attention, Federal Reserve Desk Officer.

Title of Information Collection: Recordkeeping Requirements Associated with Enhanced Prudential Standards (Regulation YY).

Agency Form Number: Reg YY-1.

OMB Control Number: 7100—NEW.

Frequency of Response: Annual.

Affected Public: Businesses or other for-profit.

Respondents: Systemically important insurance companies.

Abstract: Section 165 of the Dodd-Frank Act requires the Board to implement enhanced prudential standards for nonbank financial companies that the Council has determined should be supervised by the Board. Section 165 of the Dodd-Frank Act also permits the Board to establish such other prudential standards for such companies as the Board determines are appropriate.

Current Actions: Pursuant to section 165 of the Dodd-Frank Act, the Board is proposing the application of enhanced prudential standards to certain nonbank financial companies that the Council has determined should be supervised by the Board. The Board is proposing corporate governance, risk-management, and liquidity risk-management standards that are tailored to the business models, capital structures, risk profiles, and systemic footprints of the nonbank financial companies with significant insurance activities.

Section 252.164(e)(3) would require a systemically important insurance company to adequately document its methodology for making cash flow projections and the included assumptions.

Section 252.164(f) would require a systemically important insurance company to establish and maintain a contingency funding plan that sets out the company's strategies for addressing liquidity needs during liquidity stress events and describes the steps that should be taken to ensure that the systemically important insurance company's sources of liquidity are sufficient to fund its normal operating requirements under stress events. To operate normally, a firm must have sufficient funding to pay obligations in the ordinary course as they become due and meet all solvency requirements for the writing of new and renewal policies. The contingency funding plan must be commensurate with the company's capital structure, risk profile, complexity, activities, size, and established liquidity risk tolerance. The company must update the contingency funding plan at least annually, and when changes to market and idiosyncratic conditions warrant. The contingency funding plan must include specified quantitative elements, an event management process that sets out the systemically important insurance company's procedures for managing liquidity during identified liquidity stress events, and procedures for monitoring emerging liquidity stress events. The procedures must identify early warning indicators that are tailored to the company's capital structure, risk profile, complexity, activities, and size.

Section 252.164(h)(1) would require a systemically important insurance company to establish and maintain policies and procedures to monitor assets that have been, or are available to be, pledged as collateral in connection with transactions to which it or its affiliates are counterparties and sets forth minimum standards for those procedures.

Section 252.164(h)(2) would require a systemically important insurance company to establish and maintain procedures for monitoring and controlling liquidity risk exposures and funding needs within and across significant legal entities, currencies, and business lines, taking into account legal and regulatory restrictions on the transfer of liquidity between legal entities.

Section 252.164(h)(3) would require a systemically important insurance company to establish and maintain procedures for monitoring intraday liquidity risk exposure of the systemically important insurance company if necessary for its business. These procedures must address how the management of the systemically important insurance company will (1) monitor and measure expected daily gross liquidity inflows and outflows, (2) identify and prioritize time-specific obligations so that the systemically important insurance company can meet these obligations as expected and settle less critical obligations as soon as possible, (3) coordinate the purchase and sale of derivatives so as to maximize the effectiveness of their hedging programs, (4) consider the amounts of collateral and liquidity needed to meet obligations when assessing the systemically important insurance company's overall liquidity needs, and (5) where necessary, manage and transfer collateral to obtain intraday credit.

Section 252.35(a)(7) would require a systemically important insurance company to establish and maintain policies and procedures governing its liquidity stress testing practices, methodologies, and assumptions that provide for the incorporation of the results of liquidity stress tests in future stress testing and for the enhancement of stress testing practices over time. The systemically important insurance company would establish and maintain a system of controls and oversight that is designed to ensure that its liquidity stress testing processes are effective in meeting the final rule's stress-testing requirements. The systemically important insurance company would maintain management information systems and data processes sufficient to enable it to effectively and reliably collect, sort, and aggregate data and other information related to liquidity stress testing.

Number of Respondents: 2 systemically important insurance companies.

Estimated Burden per Response: 200 hours (Initial set-up 160 hours).

Estimated Annual Burden: 720 hours (320 hours for initial set-up and 400 hours for ongoing compliance).

In accordance with section 3(a) of the Regulatory Flexibility Act 29 (RFA), the Board is publishing an initial regulatory flexibility analysis of the proposed rule. The RFA requires an agency either to provide an initial regulatory flexibility analysis with a proposed rule for which a general notice of proposed rulemaking is required or to certify that the proposed rule will not have a significant economic impact on a substantial number of small entities. Based on its analysis and for the reasons stated below, the Board believes that this proposed rule will not have a significant economic impact on a substantial number of small entities. Nevertheless, the Board is publishing an initial regulatory flexibility analysis. A final regulatory flexibility analysis will be conducted after comments received during the public comment period have been considered.

In accordance with section 165 of the Dodd-Frank Act, the Board is proposing to adopt Regulation YY (12 CFR 252 et seq.) to establish enhanced prudential standards for systemically important insurance companies.30 The enhanced standards include liquidity standards and requirements for overall risk-management (including establishing a risk committee) for companies that the Council has determined pose a grave threat to financial stability.

I. Introduction A. Background

Robust capital is an important safeguard to protect the safety and soundness of financial institutions; enhance the resilience of financial institutions to position them to better navigate periods of financial or economic stress; and mitigate threats to financial stability that might be posed by the activities, material financial distress, or failure of financial institutions. To help achieve these benefits, various provisions of Federal law require the Board and other Federal banking agencies to establish minimum capital standards for holding companies that own insured depository institutions (IDIs) and for financial firms that are designated by the FSOC for supervision by the Board. The capital standards developed by the Board take into account the overall risk profile and the size, scope, and complexity of the operations of the institution. Further, the law allows the Board to tailor the minimum capital requirements applicable to companies that both own an IDI and significantly engage in insurance activities as well as for systemically important insurance companies.

The Board's supervisory objectives in setting capital requirements for the consolidated institution focus on the safety and soundness of the company and its IDI and on enhancing financial stability, and complement the primary mission of state legal entity insurance supervisors, which tends to focus on the protection of policyholders.1 To achieve these objectives, the Board seeks comment on several approaches to designing a regulatory capital framework for supervised institutions significantly engaged in insurance activities that is intended to ensure that the institution has sufficient capital, commensurate with its overall institution-wide risk profile (1) to absorb losses and continue operations as a going concern throughout times of economic, financial, and insurance-related stress (e.g., morbidity, mortality, longevity, natural and man-made catastrophes); (2) to serve as a source of strength to any subsidiary depository institutions; 2 and (3) to substantially mitigate any threats to financial stability that the institution might pose.

This ANPR seeks comment on proposed approaches to regulatory capital requirements that are tailored to the risks of supervised insurance institutions, including both insurance depository institution holding companies and systemically important insurance companies.

The Board has broad authority to establish regulatory capital standards for savings and loan holding companies (SLHCs) and bank holding companies (BHCs) 3 under the Home Owners' Loan Act (HOLA) and Bank Holding Company Act, respectively.4 The Board's supervisory objectives for insurance depository institution holding companies include ensuring the safe and sound operation of the consolidated firms and subsidiary IDIs, and ensuring that holding companies can serve as a source of strength for any subsidiary IDIs.5 In addition, certain nonbank financial companies with significant insurance activities have been designated by the Council pursuant to section 113 of the Dodd-Frank Act 6 to be supervised by the Board and made subject to enhanced prudential standards. For these systemically important insurance companies, the Board is required under section 165 of the Dodd-Frank Act to establish enhanced prudential standards, including more stringent risk-based and leverage capital requirements, as well as stress tests.7

With respect to both insurance depository institution holding companies and systemically important insurance companies, the Board must establish minimum leverage capital requirements and minimum risk-based capital requirements that apply (1) on a consolidated basis, and (2) are at least as stringent as the generally applicable capital requirements that applied to IDIs at the time the Dodd-Frank Act was adopted, as well as current generally applicable IDI capital requirements.8 The Dodd-Frank Act has been amended to allow the Board to tailor these minimum capital requirements as they would apply to persons regulated by state or foreign insurance regulators.9

The Board currently supervises twelve insurance depository institution holding companies and two systemically important insurance companies. Collectively, these firms have approximately $2 trillion in assets and represent approximately one-quarter of the assets of the U.S. insurance industry. These institutions range in size from approximately $3 billion in total assets to about $700 billion in total assets, and engage in a wide variety of insurance and non-insurance activities. Some of the firms operate exclusively in the United States, and some have material international operations. These institutions have a variety of ownership structures, including stock and mutual forms of ownership. Some of these institutions prepare financial statements according to U.S. Generally Accepted Accounting Principles (U.S. GAAP), and some do not, preparing financial statements only according to U.S. Statutory Accounting Principles (SAP) filed with their relevant state insurance regulators. The insurance depository institution holding companies tend to have simpler structures, often have an operating company, rather than a holding company, as the top-tier parent, and have a relatively greater U.S. focus in their operations. By contrast, the systemically important insurance companies are relatively larger financial institutions with substantial international operations, comparatively complex organizational structures relative to other insurance companies, and non-insurance as well as insurance activities.

The Board aims to develop regulatory capital frameworks for insurance depository institution holding companies and systemically important insurance companies that are consistent with the Board's supervisory objectives and appropriately tailored to the business of insurance. The Board is seeking comment on different frameworks that could be applied to insurance depository institution holding companies and systemically important insurance companies. As described below, this ANPR outlines two conceptual frameworks, one of which may be more appropriate for large, complex, systemically important institutions, while the other may be more appropriate for generally less complex firms such as the current population of insurance depository institution holding companies.

The Board is also seeking comment on the criteria that should be used to determine which supervised institutions are subject to regulatory capital requirements that are tailored to the business of insurance. A supervised insurance institution could become subject to tailored regulatory capital rules based on the significance of these activities for the consolidated firm. The Board could apply a threshold based on a percentage of total consolidated assets attributable to insurance activities. For example, for purposes of determining whether an SLHC is significantly engaged in insurance activities and should be subject to capital requirements that are tailored to these risks, the Board is considering using the threshold in the Board's existing capital requirements (Regulation Q).10 Under this approach, an SLHC would be subject to the capital requirements as an insurance SLHC if it held 25 percent or more of its total consolidated assets in insurance underwriting subsidiaries (other than assets associated with insurance underwriting for credit risk).11 Further, the Board could define systemically important insurance companies as FSOC-designated nonbank financial companies with at least 40 percent of total consolidated assets related to insurance activities (as of the end of either of the two most recently completed fiscal years), or as otherwise ordered by the Board. These thresholds could reflect a level of insurance activity that is significant rather than incidental to the institution's activities.

The Board invites comment on all aspects of these frameworks, including whether these frameworks are workable, would enhance the resilience of these institutions, and would reduce risks to financial stability. The Board also invites comment and suggestions on other frameworks that may better achieve these purposes. In addition, the Board invites comment on the costs and benefits of these and alternate approaches, and on the various advantages and difficulties of each approach. To help the Board address specific issues raised by the regulatory capital frameworks discussed below, the Board also invites comment on the specific questions listed throughout this notice.

In developing and evaluating potential capital frameworks, the Board relied on its experience in supervision of financial firms and with the development and application of capital standards through normal and stressed periods; discussions with affected financial firms, including firms engaged in insurance activities; the purposes of and requirements in Federal law; and information and insights provided by other supervisors, including state insurance supervisors, among other things.

Insurance supervisors, insurance companies and others have argued that because liability structures, asset classes, and asset-liability matching of insurance companies differ markedly from those of a typical BHC, the capital framework (or frameworks) should be tailored to the business mix and risk profile of insurance depository institution holding companies and systemically important insurance companies. They have also contended that leverage limits based on the ratio of equity to total assets, which are an important backstop in a banking regulatory capital framework, may have less value as a risk metric for supervised institutions significantly engaged in insurance activities because they do not address the different liability structure that is inherent to the insurance business. The Board has flexibility to develop leverage and risk-based capital requirements that are tailored to appropriately reflect the risks of supervised institutions significantly engaged in insurance activities.12

At the same time, supervisors and commenters recognize that a capital framework also should take into account all material risk types (insurance and non-insurance) in these institutions. Capital standards that do not account for all types of material risks tend to be ineffective and incent riskier activity. In addition, to the greatest extent possible, the capital framework should take account of risks across the entire firm—in the holding company, in regulated subsidiaries, and in unregulated subsidiaries. The financial crisis demonstrated that risks of financial distress often spread across an organization from unregulated subsidiaries to regulated subsidiaries.13 Moreover, the framework should be as standardized as possible, rather than relying predominantly on a firm's internal capital models. Greater standardization will produce more consistent capital requirements, enhance comparability across firms, and promote greater transparency.14

The capital framework also should be based on U.S. regulatory and accounting standards and not foreign regulatory and accounting standards in order to best meet the needs of the U.S. financial system and insurance markets while reflecting the risks inherent in the business of insurance. The framework should strike a reasonable balance between simplicity and risk sensitivity. Achieving this balance will help ensure that risks are accurately captured while minimizing regulatory burden and increasing comparability and transparency across firms. The framework also should be executable in the short-to-medium term. Finally, the framework should contribute to the stability of the financial system and should serve as a good basis for a supervisory stress test regime to the extent these provisions apply to the regulated firm.

The Board invites comment on the considerations that should guide the development of a regulatory capital framework for insurance depository institution holding companies and systemically important insurance companies.

The remainder of this section will describe two potential regulatory capital frameworks for supervised institutions significantly engaged in insurance activities; discuss the strengths and weaknesses of each approach; and suggest ways in which each approach could be effectively applied. The Board invites comment on all aspects of each approach. The Board will then use these comments to develop a specific proposal, likely based on these two approaches, and invite public comment on that specific proposal.

The Board has traditionally set capital requirements for holding companies on a consolidated basis.15 Among other things, a consolidated capital standard deters firms from placing assets in a particular legal entity, where the assets may be subject to lower, or no, capital requirements. Many SLHCs that are supervised insurance institutions because they own depository institutions do not produce consolidated financial statements.16 This presents potential challenges to the development of consolidated capital requirements that would not impose undue burden on these institutions.

One approach that would accommodate this would aggregate capital resources and capital requirements across the different legal entities in the group to calculate combined qualifying and required capital. A firm's aggregate capital requirements generally would be the sum of the capital requirements at each subsidiary. This is a building block approach (BBA). The capital requirement for each regulated insurance or depository institution subsidiary would be based on the regulatory capital rules of that subsidiary's functional regulator—whether a state or foreign insurance regulator for insurance subsidiaries or a federal banking regulator for IDIs. The BBA would then build upon and aggregate legal entity (insurance, non-insurance financial, non-financial, and holding company) qualifying capital and required capital, subject to adjustments.

Under this approach, the regulatory capital requirements for a regulated insurance underwriting firm would be determined by reference to the rules of the appropriate state or foreign insurance supervisor for the firm. The regulatory capital requirement for each IDI generally would be determined under the Board's Regulation Q or under other capital rules applicable to IDIs.17 The regulatory capital requirement for any other regulated non-insurance or unregulated subsidiary legal entity, such as a mid-tier holding company, would also be determined under the Board's Regulation Q.

As discussed further below, BBA may require the use of several types of adjustments in the calculation of a firm's enterprise-wide capital requirement. Adjustments may be necessary to conform or standardize the accounting practices under SAP among U.S. jurisdictions, and between SAP and foreign jurisdictions. Similarly, adjustments may be necessary to eliminate inter-company transactions.

Additionally, the BBA may require consideration of cross-jurisdictional differences. As discussed below, this would be achieved through the use of scalars. Scalars may, for example, be appropriate to account for differences in stringency applied by different insurance supervisors, and to ensure adequate reflection of the safety and soundness and financial stability goals, as opposed to policyholder protection, that the Board is charged with achieving.

The ratio of aggregate qualifying capital to aggregate required capital would represent capital adequacy at a consolidated level. Represented in an equation, the BBA could be summarized as follows:

The key strengths of the BBA include the following: (1) It efficiently uses existing legal-entity-level regulatory capital frameworks; (2) it is an approach that could be developed and implemented expeditiously; (3) it would involve relatively low regulatory costs and burdens for the institutions; and (4) it would produce regulatory capital requirements that are tailored to the risks of each distinct jurisdiction and line of business of the institution.

The key weaknesses of the BBA include: (1) At the top-tier level, it is an aggregated, but not a consolidated, capital framework; (2) it would not discourage regulatory arbitrage within an institution due to inconsistencies across jurisdictional capital requirements and also may be vulnerable to gaming through techniques such as double leverage (i.e., when an upstream entity issues debt to acquire an equity stake in a downstream entity); (3) it would need to account for inter-company transactions, which may result in extensive adjustments; (4) it would require the Board to determine scalars regarding a large number of state and foreign insurance regulatory capital regimes; and (5) it likely would require legal-entity-level stress tests, presenting challenges to appropriate reflection of diversification and inter-company risk transfer mechanisms and other transactions.

The strengths of the BBA would appear to be maximized and its weakness minimized were the BBA to be applied to insurance depository institution holding companies, which generally are less complex, less international, and not systemically important. In this context, incremental safety and soundness benefits would appear to be complemented by the lower compliance costs due to the smaller number of scalars involved. In particular, the BBA is standardized, executable, applies U.S.-based accounting principles for U.S. legal entities, accounts for material insurance risks, strikes a balance between risk-sensitivity and simplicity, and is well-tailored to the business model and risks of insurance.18

For the systemically important insurance companies, the BBA may not capture the full set of risks these firms impose on the financial system without significant use of adjustments and scalars, thereby negating any potential burden reduction from the approach. These firms also tend to prepare financial statements under U.S. GAAP, thereby making a consolidated capital requirement less burdensome to compute. Accordingly, the BBA may not be appropriate for systemically important insurance companies.

The Board continues to analyze whether the BBA is appropriate as a regulatory capital framework and whether it may be appropriate for all insurance depository institution holding companies or only a subset of these firms. Specifically, the Board is considering whether larger or more complex insurance depository institution holding companies should be subject to a regulatory capital framework other than the BBA.

Further, the Board seeks comment on the following key issues regarding the design and implementation of the BBA.

Baseline capital requirements at the legal-entity level. The BBA framework would begin with the baseline capital requirements at each legal entity. For example, for state-regulated insurance entities, the BBA could use different triggering thresholds from the state risk-based capital framework (e.g., the Company Action Level, the Authorized Control Level), or some other level as the appropriate baseline capital requirement. For some regulated foreign insurance entities, the Board would need to decide whether the local minimum capital requirement, prescribed capital requirement, or some other requirement is the appropriate baseline. For subsidiary IDIs, the BBA could use the minimum common equity tier 1, tier 1, or total risk-based capital requirements under the standardized approach in the Board's Regulation Q, as well as the tier 1 leverage ratio. For unregulated subsidiaries, the BBA could use the risk-based capital or leverage requirements for depository institutions or some other, similarly stringent approach.

State-by-state and international variances in accounting or capital treatment for supervised institutions significantly engaged in insurance activities. The accounting practices for insurance companies can vary from state to state due to permitted and prescribed practices, and can result in significant differences in financial statements between similar entities filing SAP financial statements in different states. Regulators both within and outside of the U.S. have the authority to take actions with respect to insurance companies that may result in variances from standard accounting practices. The BBA would need to address international or state regulator approved variances in accounting or capital requirements for regulated insurance entities.

Inter-company transactions. Any approach to regulatory capital for a supervised institution significantly engaged in insurance activities that aggregates qualifying capital and required capital at different legal entities within the institution should address inter-company transactions. Although inter-company transactions are naturally eliminated in consolidated accounting and regulatory frameworks, in an aggregated framework like the BBA, some inter-company transactions could generate redundancies in capital requirements, while others could reduce the required capital of a legal entity without reducing the overall risk profile of the institution. The BBA should include a treatment for inter-company transactions between different legal entities in the same supervised institution.

Scalars. An important component of the BBA is that scalars would serve to bring jurisdictional capital frameworks to comparable levels of supervisory stringency. The BBA would need an appropriate scalar for each local regulatory capital regime, and therefore also would need a set of principles for determining those scalars. Any necessary scalars would be designed to reflect differences in supervisory purposes appropriate for insurance.

Consolidation of qualifying capital. Under one version of a BBA framework, an insurance depository institution holding company or systemically important insurance company generally would determine its aggregate qualifying capital position by summing the qualifying capital position at each of its legal entities. A weakness of this approach is that it could enable the supervised institution to engage in substantial double leverage—that is, the institution's top-tier legal entity could fund its equity investments in its subsidiaries by substantial borrowings. Such an institution could have substantial qualifying capital positions at each of its major subsidiaries (and thus a robust BBA capital ratio) but could have a weak consolidated capital position.

To address this limitation of a simple BBA, the Board is considering adopting a version of the BBA that would determine an institution's aggregate qualifying capital position on a uniform, consolidated basis. Under such an approach, the BBA would continue to draw upon capital requirements set by the local regulators of each legal entity, but would use a single definition of qualifying capital for supervised institutions and would apply that definition to the institution on a fully consolidated basis. To implement this version of the BBA, the Board would need to develop a definition of consolidated regulatory capital for supervised institutions significantly engaged in insurance activities, including rules to address minority interests.

The Board is also considering a consolidated approach (CA) to capital with risk segments and factors appropriate for supervised insurance institutions.

The CA is a proposed capital framework for supervised institutions significantly engaged in insurance activities that would categorize insurance liabilities, assets, and certain other exposures into risk segments; determine consolidated required capital by applying risk factors to the amounts in each segment; define qualifying capital for the consolidated firm; and then compare consolidated qualifying capital to consolidated required capital. Unlike the BBA, which fundamentally aggregates legal-entity-level qualifying capital and required capital, the CA would take a fully consolidated approach to qualifying capital and required capital. As distinguished from the Board's consolidated capital requirements for bank holding companies, the CA would use risk weights and risk factors that are appropriate for the longer-term nature of most insurance liabilities.

The foundation of the CA, for systemically important insurance companies, would be consolidated financial information based on U.S. GAAP, with adjustments for regulatory purposes. Application of the CA to insurance depository institution holding companies that do not file U.S. GAAP financial statements would require the development of a consolidated approach based on SAP. Initially, the CA could be simple in design, with broad risk segmentation, but could evolve over time to have an increasingly granular segmentation approach with greater risk sensitivity. Represented as an equation, the CA could be summarized as follows:

The CA has strengths and weaknesses as a regulatory capital framework. The key strengths of the CA include the following: (1) It has a simple and transparent factor-based design; (2) it covers all material risks of supervised institutions significantly engaged in insurance activities; (3) it is a fully consolidated framework that has the potential to reduce regulatory arbitrage opportunities and the risk of double leverage; (4) it would be relatively expeditious for the Board to develop and for institutions to implement, particularly in light of its broad risk segmentation as implemented initially; and (5) it would provide a solid basis upon which to build consolidated supervisory stress tests of capital adequacy for institutions subject to stress testing requirements.

The key weaknesses of the CA include the following: (1) The initially simple design of the CA would result in relatively crude risk segments and thus limited risk sensitivity, and (2) substantial analysis would be needed to design a set of risk factors for all the major segments of assets and insurance liabilities of supervised institutions significantly engaged in insurance activities. In addition, a separate SAP-based version of the CA would need to be developed for the insurance depository institution holding company population if CA were ever applied to an insurance depository institution holding company that only uses SAP.

Based on the Board's initial analysis of the CA's strengths and weaknesses and comparing the CA against the considerations set forth above, it appears that the CA may be an appropriate regulatory capital framework for systemically important insurance companies. The CA, as a consolidated capital framework, would reduce the opportunity for regulatory arbitrage and the potential for double leverage. The CA also would more easily enable supervisory stress testing and other macroprudential features for systemically important insurance companies.

The advantages of the CA are most salient for systemically important insurance companies that, by definition, are large, and internally and externally complex institutions. For insurance depository institution holding companies, which generally are smaller and less complex, these benefits may be outweighed by the additional implementation costs.

Further, the Board seeks comment on the following key issues regarding the design and implementation of the CA.

Definition of qualifying capital. Implementation of the CA would require the development of a uniform, consolidated definition of qualifying capital that is appropriate for all institutions subject to the CA.

Segmentation of exposures. Implementing the CA would require a framework for segmenting or disaggregating balance-sheet assets, balance-sheet insurance liabilities, and certain off-balance-sheet exposures. Appropriate segmentation would be important to ensure that similar risks face broadly similar capital requirements and that the capital regime produces an appropriate degree of risk sensitivity while minimizing the opportunities for regulatory arbitrage. This segmentation process would account for differences among insurance risks as well as between insurance risks and banking and other non-insurance, financial risks. While the initial version of the CA likely would have broad risk segments, the CA could evolve over time to become more risk sensitive. One option for implementing the CA for systemically important insurance companies would be to use the segmentation framework in the Board's proposed Consolidated Financial Statements for Insurance Systemically Important Financial Institutions.19

Exposure amounts. The CA would need to identify the exposure amounts of the various kinds of balance-sheet assets, balance-sheet insurance liabilities, and off-balance-sheet exposures of an institution. Although in many cases, the reported amount of a particular exposure may be appropriate for purposes of the CA, in other cases the financial information of an institution may require adjustments. For example, adjusting insurance liabilities may be necessary in order to include additional, relevant information, such as current assumptions, or to better match the valuation of related assets. Further, the CA would require the determination of the appropriate exposure amounts for derivatives and other off-balance-sheet items in order to accurately reflect the risk exposure in determining required capital.

Factors. The CA would involve a set of Board-determined factors to be applied to the exposure amounts of assets, insurance liabilities, and off-balance-sheet items in each risk segment. The factor for each risk segment would reflect the riskiness of the segment and the capital required to support that risk. Because of the different liability structures between insurance companies and banks, some of the applicable insurance risk factors may differ from the analogous risk factors that apply to banks.

Minimum ratio. The CA would require the establishment of a minimum ratio of consolidated qualifying capital to consolidated factor-weighted exposures in the CA. In addition, one or more definitions of capital adequacy (e.g., “well capitalized” or “adequately capitalized”) would be needed for early remediation and other supervisory purposes.

In developing the two general approaches discussed here, the Board considered a number of other potential regulatory capital frameworks that did not appear to meet the Board's supervisory objectives for supervised institutions significantly engaged in insurance activities. For example, consideration was given to applying a risk-based capital rule that is based solely on the Board's existing capital requirements for banking organizations (Regulation Q) to supervised institutions significantly engaged in insurance activities. Such an approach would not recognize the unique risks, regulation, and balance sheet composition of insurance firms. Although bank-like capital requirements may be appropriate for exposures that a supervised institution significantly engaged in insurance activities holds in a non-insurance subsidiary, an approach based solely on the Board's Regulation Q would not capture significant insurance risks. The Board is not aware of any major country that imposes bank capital requirements on insurance firms.

The Board also reviewed an approach that entirely excluded insurance subsidiaries and applied capital requirements only to the non-insurance parts of the supervised firm. This approach would, by definition, not capture all the material risks of the organization. While section 171 of the Dodd-Frank Act, as amended, permits the Board to exclude state and foreign regulated insurance entities in establishing minimum consolidated leverage and risk-based capital requirements, the parent holding company should be a source of capital strength to the entire entity, including to the subsidiary insurance companies and IDIs. To do this effectively, a consolidated capital requirement must take into account the risks within the consolidated organization, including insurance risks.

A capital approach based on the European Solvency II framework was considered, but would not appear to be appropriate for systemically important insurance companies and insurance depository institution holding companies in the United States.20 Use of a Solvency II-based capital framework would not adequately account for U.S. GAAP and may introduce excessive volatility due to discount rate assumptions. Moreover, use of a Solvency II-based approach would involve excessive reliance on internal models. Internal models make cross-firm comparisons difficult and can lack transparency to supervisors and market participants. Additionally, such an approach would not be executable in the short-to-medium term; the notable challenges of the Solvency II regime have resulted in significantly extended implementation periods in various European jurisdictions.

The Board also analyzed a potential regulatory capital framework for supervised institutions significantly engaged in insurance activities that is based on internal stress testing. This approach would rely on internal models, be highly novel and complex, would entail a large and lengthy construction project, and would require a substantial dedication of supervisory resources to superintend. The Board intends to continue exploration of internal stress testing as it builds its supervisory stress testing program for systemically important insurance companies and its broader supervision program for supervised institutions significantly engaged in insurance activities.

The Board is seeking information on all aspects of its approaches to insurance regulatory capital and invites comment on the appropriate consolidated capital requirements for systemically important insurance companies and insurance depository institution holding companies. In addition, the Board invites comment on all of the questions set forth in this ANPR, as well as other issues that commenters may wish to raise.

In connection with this ANPR, the Board will review all comments submitted and supplementary information provided, as well as information regarding insurance regulatory capital derived from the Board's regulatory and supervisory activities. Once the Board has completed its review, the Board anticipates that it will issue a notice of proposed rulemaking to establish a regulatory capital framework for supervised institutions significantly engaged in insurance activities.

The subject of the public hearing is the notice of proposed rulemaking (REG-127923-15) that was published in the Federal Register on Friday, March 4, 2016 (81 FR 11486).

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing that submitted written comments by June 20, 2016 must submit an outline of the topics to be addressed and the amount of time to be devoted to each topic by Monday, June 20, 2016.

A period of 10 minutes is allotted to each person for presenting oral comments. After the deadline for receiving outlines has passed, the IRS will prepare an agenda containing the schedule of speakers. Copies of the agenda will be made available, free of charge, at the hearing or in the Freedom of Information Reading Room (FOIA RR) (Room 1621) which is located at the 11th and Pennsylvania Avenue NW., entrance, 1111 Constitution Avenue NW., Washington, DC 20224.

Because of access restrictions, the IRS will not admit visitors beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section of this document.

On March 10, 2016, The Patriots Point Maritime Museum notified the Coast Guard that it will be conducting a fireworks display from 9 p.m. to 9:30 p.m. on July 4, 2016. The fireworks are to be launched from a barge along the bank of the Cooper River at Patriots Point in Charleston, SC. Hazards from firework displays include accidental discharge of fireworks, dangerous projectiles, and falling hot embers or other debris. The Captain of the Port Charleston (COTP) has determined that potential hazards associated with the fireworks to be used in this display would be a safety concern for anyone within a 500-yard radius of the barge.

The purpose of this rulemaking is to ensure the safety of vessels and the navigable waters within a 500-yard radius of the fireworks barge before, during, and after the scheduled event. The Coast Guard proposes this rulemaking under authority in 33 U.S.C. 1231.

The COTP proposes to establish a safety zone from 8:45 p.m. to 9:45 p.m. on July 4, 2016. The safety zone would cover all navigable waters within 500 yards of the barge located at Patriots Point on the Cooper River. The duration of the zone is intended to ensure the safety of vessels and these navigable waters before, during, and after the scheduled 9 p.m. to 9:30 p.m. fireworks display. No vessel or person would be permitted to enter the safety zone without obtaining permission from the COTP or a designated representative. The regulatory text we are proposing appears at the end of this document.

We developed this proposed rule after considering numerous statutes and Executive orders related to rulemaking. Below we summarize our analyses based on a number of these statutes and Executive orders and we discuss First Amendment rights of protestors.

Executive Orders 12866 and 13563 direct agencies to assess the costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits. Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility. This NPRM has not been designated a “significant regulatory action,” under Executive Order 12866. Accordingly, the NPRM has not been reviewed by the Office of Management and Budget.

This regulatory action determination is based on the size, location, duration, and time-of-day of the safety zone. Vessel traffic would be able to safely transit around this safety zone which would impact a small designated area of the Atlantic Ocean for less than 1 hour during the evening when vessel traffic is normally low. Moreover, the Coast Guard would issue a Broadcast Notice to Mariners via VHF-FM marine channel 16 about the zone, and the rule would allow vessels to seek permission to enter the zone.

The Regulatory Flexibility Act of 1980, 5 U.S.C. 601-612, as amended, requires Federal agencies to consider the potential impact of regulations on small entities during rulemaking. The term “small entities” comprises small businesses, not-for-profit organizations that are independently owned and operated and are not dominant in their fields, and governmental jurisdictions with populations of less than 50,000. The Coast Guard certifies under 5 U.S.C. 605(b) that this proposed rule would not have a significant economic impact on a substantial number of small entities.

While some owners or operators of vessels intending to transit the safety zone may be small entities, for the reasons stated in section IV.A above this proposed rule would not have a significant economic impact on any vessel owner or operator.

If you think that your business, organization, or governmental jurisdiction qualifies as a small entity and that this rule would have a significant economic impact on it, please submit a comment (see ADDRESSES) explaining why you think it qualifies and how and to what degree this rule would economically affect it.

Under section 213(a) of the Small Business Regulatory Enforcement Fairness Act of 1996 (Pub. L. 104-121), we want to assist small entities in understanding this proposed rule. If the rule would affect your small business, organization, or governmental jurisdiction and you have questions concerning its provisions or options for compliance, please contact the person listed in the FOR FURTHER INFORMATION CONTACT section. The Coast Guard will not retaliate against small entities that question or complain about this proposed rule or any policy or action of the Coast Guard.

This proposed rule would not call for a new collection of information under the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520).

A rule has implications for federalism under Executive Order 13132, Federalism, if it has a substantial direct effect on the States, on the relationship between the national government and the States, or on the distribution of power and responsibilities among the various levels of government. We have analyzed this proposed rule under that Order and have determined that it is consistent with the fundamental federalism principles and preemption requirements described in Executive Order 13132.

Also, this proposed rule does not have tribal implications under Executive Order 13175, Consultation and Coordination with Indian Tribal Governments, because it would not have a substantial direct effect on one or more Indian tribes, on the relationship between the Federal Government and Indian tribes, or on the distribution of power and responsibilities between the Federal Government and Indian tribes. If you believe this proposed rule has implications for federalism or Indian tribes, please contact the person listed in the FOR FURTHER INFORMATION CONTACT section.

The Unfunded Mandates Reform Act of 1995 (2 U.S.C. 1531-1538) requires Federal agencies to assess the effects of their discretionary regulatory actions. In particular, the Act addresses actions that may result in the expenditure by a State, local, or tribal government, in the aggregate, or by the private sector of $100,000,000 (adjusted for inflation) or more in any one year. Though this proposed rule would not result in such an expenditure, we do discuss the effects of this rule elsewhere in this preamble.

We have analyzed this proposed rule under Department of Homeland Security Management Directive 023-01 and Commandant Instruction M16475.lD, which guide the Coast Guard in complying with the National Environmental Policy Act of 1969 (42 U.S.C. 4321-4370f), and have made a preliminary determination that this action is one of a category of actions that do not individually or cumulatively have a significant effect on the human environment. This proposed rule involves a safety zone lasting less than 1 hour that would prohibit entry within 500 yards of the fireworks barge. Normally such actions are categorically excluded from further review under paragraph 34(g) of Figure 2-1 of Commandant Instruction M16475.lD. A preliminary environmental analysis checklist and Categorical Exclusion Determination are available in the docket where indicated under ADDRESSES. We seek any comments or information that may lead to the discovery of a significant environmental impact from this proposed rule.

The Coast Guard respects the First Amendment rights of protesters. Protesters are asked to contact the person listed in the FOR FURTHER INFORMATION CONTACT section to coordinate protest activities so that your message can be received without jeopardizing the safety or security of people, places, or vessels.

We view public participation as essential to effective rulemaking, and will consider all comments and material received during the comment period. Your comment can help shape the outcome of this rulemaking. If you submit a comment, please include the docket number for this rulemaking, indicate the specific section of this document to which each comment applies, and provide a reason for each suggestion or recommendation.

We encourage you to submit comments through the Federal eRulemaking Portal at http://www.regulations.gov. If your material cannot be submitted using http://www.regulations.gov, contact the person in the FOR FURTHER INFORMATION CONTACT section of this document for alternate instructions.

We accept anonymous comments. All comments received will be posted without change to http://www.regulations.gov and will include any personal information you have provided. For more about privacy and the docket, you may review a Privacy Act notice regarding the Federal Docket Management System in the March 24, 2005, issue of the Federal Register (70 FR 15086).

Documents mentioned in this NPRM as being available in the docket, and all public comments, will be in our online docket at http://www.regulations.gov and can be viewed by following that Web site's instructions. Additionally, if you go to the online docket and sign up for email alerts, you will be notified when comments are posted or a final rule is published.

For the reasons discussed in the preamble, the Coast Guard proposes to amend 33 CFR part 165 as follows:

The information presented in this document is organized as follows:

Entities potentially affected by this proposed rule include permit reviewing authorities responsible for the permitting of stationary sources of air pollution. This includes the EPA Regions, and both EPA-delegated air programs and EPA-approved air programs that are operated by state, local and tribal governments and that implement the federal NSR rules. Entities also potentially affected by this proposed rule include owners and operators of stationary sources that are subject to air pollution permitting under the Clean Air Act (CAA or Act).

1. Submitting CBI. Do not submit this information to the EPA through https://www.regulations.gov or email. Clearly mark the specific information that you claim to be CBI. For CBI in a disk or CD-ROM that you mail to the EPA, mark the outside of the disk or CD-ROM as CBI and then identify electronically within the disk or CD-ROM the specific information that is claimed as CBI. In addition to one complete version of the comment that includes information claimed as CBI, a copy of the comment that does not contain the information claimed as CBI must be submitted for inclusion in the public docket. Information so marked will not be disclosed except in accordance with procedures set forth in 40 Code of Federal Regulations (CFR) part 2.

2. Tips for preparing comments. When submitting comments, remember to:

• Identify the rulemaking by docket number and other identifying information (subject heading, Federal Register date and page number).

• Follow directions. The proposed rule may ask you to respond to specific questions or organize comments by referencing a CFR part or section number.

• Explain why you agree or disagree, suggest alternatives and substitute language for your requested changes.

• Describe any assumptions and provide any technical information and/or data that you used to support your comment.

• If you estimate potential costs or burdens, explain how you arrived at your estimate in sufficient detail to allow for it to be reproduced.

• Provide specific examples to illustrate your concerns wherever possible, and suggest alternatives.

• Explain your views as clearly as possible, avoiding the use of profanity or personal threats.

• Make sure to submit your comments by the comment period deadline identified.

To request a public hearing or information pertaining to a public hearing on this document, contact Ms. Pamela Long, Office of Air Quality Planning and Standards, U.S. Environmental Protection Agency, by phone at (919) 541-0641 or by email at [email protected].

In addition to being available in the docket, an electronic copy of this Federal Register document will be posted at https://www.epa.gov/nsr/nsr-regulatory-actions. The docket contains, among other things, a comparison file that reflects how the proposed regulatory revisions compare to the current rules.

The EPA is proposing to remove a date restriction by revising the permit rescission provision contained in its federal PSD permitting regulations. 40 CFR 52.21(w). This current provision authorizes the owner or operator of a stationary source that holds a PSD permit based on rules in effect on or before July 30, 1987, to request a rescission of their permit or a part of their permit. 40 CFR 52.21(w)(2).

Through this rulemaking action, we are proposing to remove the July 30, 1987, date from the 40 CFR 52.21(w)(2) provision. Experience has shown that there can be circumstances where a permit based on rules in effect after July 30, 1987, may qualify for rescissions under the criteria in paragraph (w)(3) of the current regulations. In one recent instance, the EPA determined a need for rescission authority after the Supreme Court of the United States (Supreme Court) determined that PSD permits were not required for new sources or modifications to existing sources that only emit greenhouse gases (GHGs). However, because of the date restriction in the current rule, the EPA had to revise the regulation in order to enable permits to be rescinded, consistent with the Supreme Court's ruling. Thus, the EPA is proposing to remove the July 30, 1987, date restriction in order to eliminate the need for such actions in the future. We believe that removal of the date is justified to enable the rule to cover other cases where a rescission of a permit may be appropriate under the criteria in paragraph (w)(3) of the current permit rescission provision.

Nevertheless, the EPA still intends to limit the rescission of permits to circumstances where the requirement for a source to meet the conditions of a major NSR permit is no longer present. Thus, we are not proposing to revise the criteria under which an owner or operator may qualify for rescission of an NSR permit. However, we are proposing to clarify that a rescission of a permit is not automatic; approval of a request for a rescission is contingent on an applicant's adequate demonstration that the permit is no longer needed and the permit reviewing authority's concurrence with the demonstration. Thus, a permit reviewing authority retains the discretion to deny a request for a permit rescission if it determines that the eligibility criteria are not satisfied.

We are proposing to add a similar permit rescission provision under the major nonattainment NSR rules that apply in Indian country at 40 CFR part 49. This part of the federal NSR program currently does not contain a provision addressing the rescission of major nonattainment NSR permits in Indian country. This rulemaking action also proposes to correct a cross-reference in the current rule provision.

The major NSR program contained in parts C and D of title I of the CAA is a preconstruction review and permitting program applicable to new major sources and major modifications at such sources. In areas meeting the National Ambient Air Quality Standards (NAAQS) (“attainment areas”) or for which there is insufficient information to determine whether the NAAQS are met (“unclassifiable areas”), the NSR requirements under part C of title I of the Act apply. We call this program the Prevention of Significant Deterioration program. In areas not meeting the NAAQS (“nonattainment areas”), the preconstruction permitting program is required under part D of the CAA. We call this program the Nonattainment NSR (NA NSR) program. Collectively, we also commonly refer to these two programs as the major NSR program. These rules are contained in 40 CFR 51.165, 51.166, 52.21 and 52.24 and 40 CFR part 51, appendices S and W.1 The CAA also requires that State Implementation Plans (SIP) include measures to assure that achievement of the NAAQS is not impeded by construction of other sources that are not subject to the major NSR requirements. We call this program “minor NSR.”

While the CAA establishes requirements for the permitting of construction of new major sources or modifications of such sources, it does not specify how long a permit is to remain in effect or whether there are circumstances under which an NSR permit may be invalidated or rescinded. See, e.g., CAA section 165. The EPA has interpreted this silence to mean that an NSR permit should remain in effect for as long as the new or modified source continues to operate. However, the absence of a statutory provision on the continuing viability of and need for a permit does not suggest that the EPA lacks the authority and discretion to rescind a permit under some circumstances, such as when a final court ruling clarifies the meaning of some part of the CAA. Over the years, the EPA has used this authority and discretion to rescind permits under limited circumstances.

40 CFR 52.21(w) authorizes an owner or operator of a source to request, and the EPA Administrator 2 to grant, a rescission of a PSD permit if the owner or operator shows that the PSD regulations do not apply.

The original intent of the 40 CFR 52.21(w) provision was to create a means by which a limited category of sources that received a permit under the EPA's 1978 PSD regulations could be relieved of the requirements of their permits, after the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit) determined that portions of those regulations were inconsistent with the CAA. The sources in question were ones that would no longer be considered “major” under our 1980 amendments to the PSD regulations, which were promulgated in response to the D.C. Circuit Court ruling.3 The original paragraph (w) only applied to permits issued under the regulations in effect between June 19, 1978 (the date the first PSD regulations were published in the Federal Register), and August 7, 1980 (the effective date of the PSD amendments that included the new paragraph (w)).

In 1987, the EPA revised 40 CFR 52.21(w) to change the effective date requirement to apply to permits that were issued based on rules in effect on or before July 30, 1987. See 52 FR 24672, 24689 (July 1, 1987). The EPA made this revision in concert with its amendments to the NAAQS for particulate matter (PM), which, among other things, transitioned the PM pollution indicator from total suspended particles to PM10. This revision of 40 CFR 52.21(w) effectively enabled rescission authority to apply to sources and modifications that were no longer major using the new PM10 indicator. Thus, the July 30, 1987, date stipulation that remains in 40 CFR 52.21(w) is an artifact of the 1987 regulatory revisions to transition to the revised PM10 indicator.

Following the changes made in 1987, 40 CFR 52.21(w) remained unchanged until almost three decades later when the EPA revised 40 CFR 52.21(w), in response to a Supreme Court decision, to expressly allow rescission of permits granted for sources based solely on the emissions of GHGs.4 See May 7, 2015; 80 FR 26183. This 2015 regulatory action did not revise or remove the July 30, 1987, date, but was a targeted effort to expeditiously authorize the rescission of PSD permits that were required solely based on GHG emissions.

However, in the preamble to that 2015 rule, the EPA signaled its intent to undertake a subsequent rulemaking action to apply the permit rescission provision to permits issued after July 30, 1987, and to eliminate the need to conduct targeted rulemakings in the future. 80 FR 26186.

The current regulations require that the Administrator provide adequate public notice of the final permit rescission determination. Thus, the provision does not require that the EPA provide advance notice of the permit rescission determination. However, we believe that public notice and comment procedures—similar to those used when proposing a draft permit—may be appropriate in certain circumstances. This could occur when a permit rescission determination is not straightforward (e.g., possible differences in interpretation over the change in the law that is the basis for the rescission request) or when there is increased public interest in the facility requesting a permit rescission. In these cases, while prior notice of the permit rescission determination is not required, the permit reviewing authority has discretion to provide notice of the rescission and to solicit comment (e.g., by way of a public announcement or public hearing) before finalizing a permit rescission determination. Having this additional public input could be very important if the rescission is controversial in nature. This is consistent with the approach the EPA has recommended recently in guidance on permit extensions.5

Furthermore, the EPA interprets 40 CFR 124.15 of its regulations to apply to a number of PSD permit actions, including permit rescissions.6 Thus, a decision to rescind a PSD permit is a “final permit decision” under 40 CFR 124.15. As a result, under 40 CFR 124.19, a decision to rescind a permit under 40 CFR 52.21(w) is subject to review by the EPA's Environmental Appeals Board. After this appeal procedure is exhausted, a permit rescission determination may, under CAA 307(b)(1), be subject to judicial review in the United States Court of Appeals for the appropriate circuit.

These proposed revisions are intended to provide greater flexibility and clarity for improved implementation of the permit rescission provision. The specific proposed changes are explained in this section, and we are requesting comment on all aspects of this proposal.

In this action, the EPA proposes to remove the date restriction of July 30, 1987, from the current 40 CFR 52.21(w) provision. This approach is consistent with our recent rule to authorize rescission of specific types of permits issued after July 30, 1987, in response to a decision by the Supreme Court regarding GHGs. If the EPA finalizes this proposed revision, rescission authority would extend to PSD permits issued after this date when the applicant shows that the requirements of 40 CFR 52.21 “would not apply to the source or modification.” In addition, the specific language in paragraphs (w)(2) and (w)(3) that the EPA added in 2015 to accommodate the rescission of certain types of GHG PSD permits would no longer be required, so we are concurrently proposing in this action to delete the GHG permit rescission language adopted in the 2015 rulemaking.

As explained in the “Background” section of this preamble, the creation of the original rescission provision was aimed at addressing a specific need with regard to responding to the D.C. Circuit Court decision in Alabama Power. 7 In 1987, the EPA recognized another circumstance in which rescission of permits may be justified—the change of the PM indicator to PM10. In 2015, the EPA identified an additional need to extend the rescission authority beyond its original scope after the Supreme Court decision regarding GHGs. Thus, over the years, the EPA has periodically found a need to expand the rescission provision through a regulatory action beyond its original scope as new circumstances have arisen. These and other experiences since 1980 have shown that there is a periodic need to utilize PSD permit rescission authority. We would expect this pattern to continue in the event of additional court decisions that narrow the scope of sources required to obtain a PSD permit. Where a source obtained a PSD permit in reliance on the EPA regulations that a court subsequently determined to be unnecessary or inappropriate, the EPA would expect to conclude that 40 CFR 52.21 “would not apply to the source or modification.” Furthermore, the EPA recognizes there could be circumstances not previously considered by the EPA that may lead a source to request a rescission of their permit and a permit reviewing authority to grant the request.

The EPA is not proposing to change the criteria under which an owner or operator may qualify for rescission of an NSR permit. Requests for permit rescission are very case-specific and require an in-depth evaluation of the source, the rules in place at the time, and the court decisions or other events affecting the source before it can be shown that the requirements of 40 CFR 52.21 “would not apply to the source or modification.”

Thus, we are proposing to eliminate the date restriction so that the EPA—and other permitting authorities that implement 40 CFR 52.21(w)—may in the future consider, on a case-by-case basis, whether a source that requests a permit rescission is eligible for rescission of its permit. The regulatory change we are proposing is limited in nature, and the EPA continues to believe that rescission is appropriate only in limited circumstances. This is because the EPA views the role of the NSR program to authorize the construction and initial operation of a source or a modification and, assuming the source was constructed as originally permitted, there should be very few cases in which the original authorization should be rescinded.

While we are proposing to retain the criteria under which a rescission is authorized, we are also proposing to clarify that the rescission of a permit requires an exercise of discretion by the permit reviewing authority. In this action, the EPA proposes to revise 40 CFR 51.21(w)(3) to make it clear that the provision does not create a mandatory duty on the Administrator to grant a rescission request.

The 1980 preamble speaks of the EPA needing “adequate information with which to make a sound decision” to rescind a permit. It also states that it “will have the expertise and objectivity necessary to check adequately whether the permittee has applied the intricate applicability rules correctly.” August 7, 1980; 45 FR 52682. Thus, the responsible authority at the permitting agency has always had the authority to grant or deny a rescission request based on an analysis of the request for a permit rescission and a determination of whether it is appropriate to grant or deny the request to rescind the permit. The EPA believes that it is appropriate to view the existing 40 CFR 52.21(w)(3) provision as a whole, including the last phrase “. . . if the application shows that this section would not apply to the source or modification.” We believe that the second phrase conditions the first phrase (“The Administrator shall grant an application for rescission”) on the fact that an adequate demonstration must be made by the permit applicant.

Thus, the EPA is proposing to replace the word “shall” with the word “may” in this provision, without making any other revision to 40 CFR 52.21(w)(3). This revision is intended to make clear that the Administrator may deny a permit rescission request if he or she does not concur with the analysis by the permit applicant that 40 CFR 52.21 “would not apply to the source or modification.” The EPA does not believe this changes the meaning or intent of the existing provision, but rather clarifies the approvability of the request by the Administrator.

We are proposing to correct the first paragraph of (w), which has an incorrect cross reference. Paragraph (w)(1) currently references 40 CFR 52.21 paragraph (s), but 40 CFR 52.21(s) pertains to environmental impact statements and does not address the expiration of a permit.

We are therefore proposing to revise the reference in paragraph (w)(1) to refer to paragraph (r), which addresses permit expiration. 40 CFR 52.21(r)(2)

This action also proposes to add a provision to 40 CFR 49.172 to provide rescission authority for major NA NSR permits in Indian country. The EPA proposes that the provision added to 40 CFR 49.172 would be similar to the provision at 40 CFR 52.21(w) and would reflect the public notice requirements included in that rule. The EPA believes it is appropriate to allow rescission of NA NSR permits in Indian country in limited, case-specific circumstances for the same reasons it is appropriate to allow rescission of PSD permits in narrow circumstances.

Creating a rescission provision in 40 CFR part 49 for major NA NSR permits in Indian country would ensure that all federal programs for major source permitting have rescission authority. PSD permits issued to sources in Indian country are federal permits and consequently subject to 40 CFR 52.21, so they would be subject to the same revisions to 40 CFR 52.21 that are being proposed in this action.

In the case of sources in the Outer Continental Shelf (OCS), the EPA's OCS air regulations at 40 CFR 55 establish the applicable requirements, which include federal air pollution preconstruction permit requirements. 40 CFR part 55 refers to rescinding a preconstruction permit issued to an OCS source and incorporates by reference 40 CFR 52.21. Thus, any regulatory revisions to 40 CFR 52.21(w) would automatically apply to applicable permit requirements incorporated in part 55. See 40 CFR 55.6(b)(5) and 55.13(d). As a result, the EPA does not see a need to revise the Part 55 permitting regulations.

While the EPA's regulations for SIP-approved programs in 40 CFR 51.165 and 51.166 do not include provisions for permit rescissions, we have previously stated that we would approve such provisions if states were to adopt them.8 In addition, this rule is not intended to alter minor source construction permit requirements that may apply in the place of major NSR permit conditions that are no longer applicable to a source modification.

Consequently, we are proposing that the rules on rescinding preconstruction permits would only reside in the federal major NSR program rules at 40 CFR parts 49 and 52 (and, by extension, part 55 as noted previously). The EPA has previously explained that other permit reviewing authorities are free to adopt our rescission rule provisions or propose their own and request approval by the EPA.

We note that a forthcoming EPA rule has proposed to amend the second sentence of paragraph (w)(4) of 40 CFR 52.21 to remove the mandatory newspaper notice requirement and to require electronic noticing of rescission determinations. See December 29, 2015; 80 FR 81234. We are not taking comment on these separately proposed revisions to paragraph (w)(4) of 40 CFR 52.21 in this rule proposal, and we direct the reader to that separate rulemaking for further information with regard to the noticing of permit rescissions. In this action, the EPA is not proposing to revise 40 CFR 52.21(w)(4) in the permit rescission provision.

Upon promulgating this action, the rule would become effective within 30 days for permit reviewing authorities that implement the federal program rules at 40 CFR parts 49 and 52. This includes the EPA Regions and other permit reviewing authorities that are delegated authority by the EPA to issue PSD permits on behalf of the EPA (via a delegation agreement) and permit reviewing authorities that have their own PSD rules approved by the EPA in a SIP and the SIP incorporates by reference 40 CFR 52.21(w) and automatically updates when the federal rules are amended. Since this action is not amending 40 CFR part 51, there are no implementation requirements for permit reviewing authorities that implement the part 51 regulations through an approved SIP.

We do not believe that these proposed revisions and additions to the rescission of federal major NSR permits would have any effect on environmental justice communities.

This action is not a significant regulatory action and was therefore not submitted to the Office of Management and Budget (OMB) for review.

This action does not impose any new information collection burden under the PRA. OMB has previously approved the information collection activities contained in the existing regulations and has assigned OMB control numbers 2060-0003 for the PSD and NA NSR permit programs. We believe that the burden associated with rescinding federal NSR permits is already accounted for under the approved information collection requests.

I certify that this action will not have a significant economic impact on a substantial number of small entities under the RFA. This action will not impose any requirements on small entities. Entities potentially affected directly by this proposal include state, local and tribal governments, and none of these governments would qualify as a small entity. Other types of small entities are not directly subject to the requirements of this action.

This action does not contain any unfunded federal mandate as described in UMRA, 2 U.S.C. 1531-1538, and does not significantly or uniquely affect small governments. The action imposes no enforceable duty on any state, local or tribal governments or the private sector.

This action does not have federalism implications. It will not have substantial direct effects on the states, on the relationship between the national government and the states, or on the distribution of power and responsibilities among the various levels of government.

This action does not have tribal implications as specified in Executive Order 13175. Specifically, these proposed revisions do not affect the relationship or distribution of power and responsibilities between the federal government and Indian tribes. Thus, Executive Order 13175 does not apply to this action.

The EPA interprets Executive Order 13045 as applying only to those regulatory actions that concern environmental health or safety risks that the EPA has reason to believe may disproportionately affect children, per the definition of “covered regulatory action” in section 2-202 of the Executive Order. This action is not subject to Executive Order 13045 because it does not concern an environmental health risk or safety risk.

This action is not subject to Executive Order 13211 because it is not a significant regulatory action under Executive Order 12866.

This rulemaking does not involve technical standards.

The EPA believes the human health or environmental risk addressed by this action will not have potential disproportionately high and adverse human health or environmental effects on minority, low-income or indigenous populations because it does not affect the level of protection provided to human health or the environment.

The statutory authority for this action is provided by 42 U.S.C. 7401, et seq.

For the reasons stated in the preamble, title 40, chapter I of the Code of Federal Regulations is proposed to be amended as follows:

I. General Information A. How is this Federal Register notice organized?

The information presented in this preamble is organized as follows:

Entities potentially affected by this proposed rulemaking include federal, state, local and tribal air pollution control agencies that administer title V operating permit programs 1 and owners and operators of emissions sources in all industry groups who hold or apply for title V operating permits.

Do not submit CBI to the EPA through http://www.regulations.gov or email. Clearly mark the part or all of the information that you claim to be CBI. For CBI information in a disk or CD-ROM that you mail to the EPA, mark the outside of the disk or CD-ROM as CBI and then identify electronically within the disk or CD-ROM the specific information that is claimed as CBI. In addition to one complete version of the comment that includes information claimed as CBI, a copy of the comment that does not contain the information claimed as CBI must be submitted for inclusion in the public docket. Information so marked will not be disclosed except in accordance with procedures set forth in 40 CFR part 2.

When submitting comments, remember to:

• Identify the rulemaking by docket number and other identifying information (subject heading, Federal Register date and page number).

• Follow directions. The agency may ask you to respond to specific questions or organize comments by referencing a Code of Federal Regulations (CFR) part or section number.

• Explain why you agree or disagree; suggest alternatives and substitute language for your requested changes.

• Describe any assumptions and provide any technical information and/or data that you used.

• If you estimate potential costs or burdens, explain how you arrived at your estimate in sufficient detail to allow for it to be reproduced.

• Provide specific examples to illustrate your concerns, and suggest alternatives.

• Explain your views as clearly as possible, avoiding the use of profanity or personal threats.

• Make sure to submit your comments by the comment period deadline identified.

If anyone contacts the EPA requesting a public hearing on or before June 29, 2016, the EPA will hold a hearing. If requested, further details concerning a public hearing for this proposed rule will be published in a subsequent Federal Register document. For updates and additional information on a public hearing, please check the EPA's Web page at https://www.epa.gov/title-v-operating-permits/current-regulations-and-regulatory-actions.

In addition to being available in the docket, an electronic copy of this Federal Register document will be posted at https://www.epa.gov/title-v-operating-permits/current-regulations-and-regulatory-actions.

The EPA has promulgated permitting regulations for the operation of major and certain other sources of air pollutants under title V of the CAA. These regulations are codified in 40 CFR parts 70 and 71, which contain the requirements for state operating permit programs and the federal operating permit program, respectively. These regulations currently contain identical provisions setting forth an affirmative defense to enforcement actions brought for noncompliance with technology-based emission limitations under specific “emergency” circumstances. See 40 CFR 70.6(g) and 71.6(g).

In this action, the EPA is proposing to remove the emergency affirmative defense provisions in 40 CFR 70.6(g) and 71.6(g) because they are inconsistent with the EPA's current interpretation of the CAA's enforcement structure and recent court decisions from the U.S. Court of Appeals for the D.C. Circuit. These provisions have never been required elements of state operating permit programs. The removal of these provisions is consistent with other recent EPA actions involving affirmative defenses and would help harmonize the enforcement and implementation of emission limitations across different CAA programs.

If the EPA takes final action to remove these provisions from 40 CFR 70.6(g), it may be necessary for any states that have adopted similar affirmative defense provisions into their part 70 operating permit programs to revise their program regulations to remove these provisions. In addition, the EPA expects that these states would coordinate revisions of individual operating permits that contain similar provisions.

In 1990, Congress amended the CAA and established, among other things, title V of the CAA, which contains a national operating permit program for certain stationary sources of air pollution. See CAA sections 501-503, Public Law 101-549 (1990) (codified at 42 U.S.C. 7661-7661b). Shortly thereafter, and pursuant to CAA section 502(b), the EPA promulgated regulations implementing title V of the CAA. The first set of regulations, finalized in 1992 and codified at 40 CFR part 70 (the part 70 regulations), governs state operating permit programs and provides for states to develop and submit to the EPA programs for issuing operating permits for major and certain other stationary sources of air pollution.2 Pursuant to CAA section 502(d)(3), the EPA promulgated a second set of regulations in 1996, found at 40 CFR part 71 (the part 71 regulations), which outlines the federal operating permit program.3 Both sets of regulations contain identical affirmative defense provisions, which are addressed by this action.

Title V of the CAA does not contain any provisions concerning an affirmative defense mechanism for emergencies. When the EPA first proposed its part 70 regulations in 1991, the agency did not include any such provisions.4 However, the EPA received comments specifically requesting that the part 70 regulations make some provision for “emergencies” or “upsets” caused by the failure of emission control equipment. In promulgating the final part 70 regulations for state operating permit programs, the EPA included § 70.6(g), which contains an affirmative defense for “emergencies.” 5 When the EPA promulgated its part 71 regulations in 1996, it adopted an identical provision in § 71.6(g), in order to maintain consistency between the state and federal operating permit programs.6 The text of sections 70.6(g) and 71.6(g) has not changed since initially promulgated.

The title V emergency provisions establish an affirmative defense. A stationary source of air pollution can assert this affirmative defense in an enforcement case to avoid liability for noncompliance with technology-based emission limits contained in the source's title V permit. In order to use this affirmative defense and avoid liability, the source must demonstrate that any excess emissions occurred as the result of an “emergency,” as defined in the regulations, and make a number of other demonstrations specified in the regulations. See 40 CFR 70.6(g) and 71.6(g). These title V affirmative defense provisions apply in addition to, and independently from, any emergency or upset provisions contained in other applicable CAA requirements.

Sections 70.6(g) and 70.4(b)(16) form the basis for similar affirmative defense provisions contained in state operating permit programs and for similar provisions contained in individual state-issued operating permits. Section 71.6(g) provides the authority to include this emergency provision in operating permits issued by the EPA or by states with delegated authority under part 71.

Such emergency affirmative defense provisions are not required program elements. States have never been obligated to include the § 70.6(g) affirmative defense provision in their part 70 operating permit programs; instead, the provision has always been discretionary.7 Similarly, although the emergency affirmative defense provision is located within the “Permit Content” section of the part 70 and part 71 regulations, the EPA does not consider the provision to be a required permit term.8 Thus, the EPA considers the emergency provision to be a discretionary element of both state permitting programs as well as individual operating permits.

The EPA has considered the most appropriate ways to account for excess emissions during different modes of source operation, such as startup and shutdown, and emissions during emergencies, upsets, and malfunctions for more than 40 years. The EPA's policies regarding the emergency affirmative defense provisions in its part 70 and 71 regulations have been shaped by a number of factors, including the structure of the CAA, federal court decisions, experience with similar provisions in other EPA programs, and recommendations from stakeholders. This section summarizes some of the more relevant and recent legal, regulatory, and policy considerations informing the EPA's current policy on affirmative defense provisions, including the D.C. Circuit's opinion in NRDC v. EPA and the EPA's recent experience with affirmative defenses for startup, shutdown, and malfunction (SSM) events in State Implementation Plans (SIPs).

In the 2014 NRDC v. EPA 9 case, the United States Court of Appeals for the D.C. Circuit vacated an affirmative defense provision applicable to malfunction events. In 2010, the EPA included an affirmative defense within its National Emission Standards for Hazardous Air Pollutants (NESHAP) for Portland cement facilities, promulgated under CAA section 112.10 This provision created an affirmative defense that sources could assert in civil enforcement proceedings when violations of emission limitations occurred because of qualifying unavoidable malfunctions. The D.C. Circuit held that this affirmative defense provision exceeded the EPA's statutory authority and that only the courts have the authority to decide whether to assess penalties for violations in civil suits. As the court explained:

The D.C. Circuit therefore concluded that the EPA lacked the authority to create an affirmative defense in private civil suits that would purport to alter the jurisdiction of the court to assess civil penalties for violations. Although this case was based on EPA regulations promulgated under CAA section 112, the court's holding was not based on section 112, but rather on sections 304(a) and 113(e)(1). Therefore, and as discussed further in Section IV of this document, the EPA interprets the decision to be relevant to all similar affirmative defense provisions, such as those found in part 70 and part 71, that may interfere with the authority of courts to assess penalties or to impose other remedies authorized in CAA section 113(b) in civil enforcement suits. This proposed rulemaking seeks to ensure that the EPA's part 70 and part 71 regulations are consistent with the enforcement structure of the CAA in accordance with the reasoning of the NRDC v. EPA decision.12

The EPA has also reconsidered affirmative defense provisions similar to those involved in the NRDC v. EPA case in other recent regulatory actions. On June 15, 2015, the EPA issued a “SIP Call” (the SSM SIP Call) finding that certain SIP provisions in 36 states are substantially inadequate to meet CAA requirements.13 Many of the deficient SIP provisions at issue in the SSM SIP call are affirmative defense type provisions, and some of them are analogous to the emergency affirmative defense in part 70 and part 71. Although the agency's SSM policy for SIP provisions is not directly at issue in this proposal, certain aspects of the SSM SIP Call are especially relevant and are discussed in this subsection.

After the EPA initially proposed the SSM SIP Call,14 the D.C. Circuit issued its opinion in NRDC v. EPA. That decision, which concerned the legal basis for an affirmative defense provision in the EPA's own regulations, caused the EPA to reconsider the legal basis for any affirmative defense provisions contained in SIPs.15 The EPA concluded that the logic of the court in NRDC v. EPA extends beyond CAA section 112 to affirmative defense provisions contained in SIPs. Therefore, the EPA clarified and revised its interpretation of CAA requirements with respect to affirmative defense provisions for SSM events. The agency explained that “the enforcement structure of the CAA, embodied in section 113 and section 304, precludes any affirmative defense provisions that would operate to limit a court's jurisdiction or discretion to determine the appropriate remedy in an enforcement action. These provisions are not appropriate under the CAA, no matter what type of event they apply to, what criteria they contain or what forms of remedy they purport to limit or eliminate.” 16 The EPA explained that “[a]ffirmative defense provisions by their nature purport to limit or eliminate the authority of federal courts to determine liability or to impose remedies through factual considerations that differ from, or are contrary to, the explicit grants of authority in section 113(b) and section 113(e).” 17 The EPA's interpretation of the CAA's enforcement structure and the NRDC v. EPA decision, as set forth in the final SSM SIP Call, is relevant to the current rulemaking. Section IV of this document further discusses this interpretation in the context of the part 70 and part 71 emergency provisions.

Following this interpretation, the EPA directed states to remove specifically identified provisions containing affirmative defenses from their SIPs. Some of these SSM provisions were similar to the emergency provisions in the EPA's part 70 and part 71 regulations. In the final SSM SIP Call, the EPA indicated that provisions modeled after the §§ 70.6(g) and 71.6(g) emergency affirmative defense provisions—including provisions that were more narrowly defined—were no longer consistent with the EPA's interpretation of the CAA and could not be included in SIPs.18 For example, the EPA found that an Arkansas SIP provision establishing an affirmative defense for emergencies, which may have been modeled after the EPA's title V regulations, was substantially inadequate to meet CAA requirements.19 The EPA also discussed the potential conflict between the SSM policy applicable to SIP provisions and the part 70 and part 71 emergency provisions, but noted that it was not taking action to revise the title V regulations in the SSM SIP Call rulemaking.20 In the final SSM SIP Call, however, the EPA indicated that it was considering whether such changes may be necessary and how best to make such changes.

Since 2014, the EPA has removed or omitted affirmative defense provisions in numerous regulations throughout other CAA program areas following the NRDC v. EPA case. Specifically, in newly issued and revised New Source Performance Standards (NSPS), emission guidelines for existing sources, and NESHAP regulations, the EPA has either omitted new affirmative defense provisions or removed existing affirmative defense provisions.21 This proposed rulemaking for the part 70 and part 71 regulations is thus consistent with these related efforts in other CAA program areas and ensures that title V operating permits do not contain additional affirmative defenses that could interfere with the EPA's efforts to remove these impermissible provisions from specific underlying applicable requirements.

This proposed rulemaking is responsive to a number of concerns and related actions, including those discussed in Section III of this document. The EPA considers this proposed rulemaking important to ensure that the EPA's title V regulations are consistent with the enforcement structure envisioned by Congress in the 1990 CAA amendments. This action is intended to respond to the reasoning of the D.C. Circuit's recent opinion in NRDC v. EPA, which the EPA interprets to extend to the affirmative defense provisions in the part 70 and part 71 regulations. This proposed rule also follows from similar regulatory actions in other CAA program areas, including the recent SSM SIP Call and various NSPS and NESHAP regulations. The EPA considers the proposed removal of the emergency affirmative defense provisions from the title V regulations necessary to maintain a consistent interpretation of the CAA throughout different CAA programs, including section 110 SIPs, section 111 NSPS and existing source guidelines, and section 112 NESHAPs.

Finally, this proposed action follows from the EPA's stated intentions to revisit the emergency affirmative defense provisions promulgated in 1992 and seeks to provide clarity in response to stakeholder concerns.22 The EPA initially sought to clarify the scope of the emergency provisions over the course of multiple actions in 1995 and 1996. However, the EPA ultimately indicated that it would reevaluate the part 70 and part 71 emergency affirmative defense provisions—including whether these provisions may need to be eliminated—in a subsequent rulemaking.23 The EPA again discussed the title V emergency provisions in the SSM SIP Call, where the agency acknowledged the potential conflict between the SSM policy applicable to SIP provisions and the part 70 and part 71 emergency provisions, but indicated that it would potentially make changes to the title V affirmative defense provisions in a subsequent rulemaking.24 As contemplated in the prior title V rulemakings and in the more recent SSM SIP Call, the EPA is now considering the appropriate changes to parts 70 and 71 and proposing to remove the title V emergency affirmative defenses provisions.

The EPA is proposing to remove the emergency provisions located at 40 CFR 70.6(g) and 71.6(g). The agency has not identified any other viable option for reconciling these affirmative defense provisions with the enforcement structure of the CAA, in accordance with the reasoning of the NRDC v. EPA decision. The implications of this proposed removal on the federal operating permit program, state operating permit programs, and on individual sources subject to title V operating permits are discussed in Section V of this document.

This action is proposed pursuant to CAA sections 502(b) and 502(d)(3), 42 U.S.C. 7661a(b) & (d)(3), which direct the Administrator of the EPA to promulgate regulations establishing state operating permit programs and give the Administrator authority to establish a federal operating permit program.

The EPA proposes to remove the affirmative defense provisions from the part 70 and 71 regulations in order to ensure that the federal and state title V operating permit programs operate within the bounds established by Congress in the 1990 CAA Amendments. Regarding these boundaries, the D.C. Circuit's opinion in NRDC v. EPA is instructive as to the enforcement structure envisioned by Congress, as well as the role of affirmative defense provisions within the EPA's regulations implementing the CAA. As discussed in Section III.B.1 of this document, the court in NRDC v. EPA determined that an affirmative defense provision promulgated by the EPA for the Portland cement industry under CAA section 112 exceeded the agency's statutory authority. In doing so, the D.C. Circuit based its holding on CAA sections 304(a) and 113(e)(1).

CAA section 304(a) grants “any person” the right to “commence a civil action . . . against any person . . . who is alleged to have violated (if there is evidence that the alleged violation has been repeated) or to be in violation of . . . an emission standard or limitation” under the CAA. 42 U.S.C. 7604(a). Section 304(a) also provides that “[t]he [federal] district courts shall have jurisdiction, without regard to the amount in controversy or the citizenship of the parties, to enforce such an emission standard or limitation . . . and to apply any appropriate civil penalties.” Id. CAA section 113(e)(1) establishes a number of factors that courts must consider when determining the amount of any penalties assessed in civil actions under section 304(a). See 42 U.S.C. 7413(e)(1).

The D.C. Circuit indicated that these statutory provisions precluded the EPA from promulgating affirmative defense provisions that a source could use in civil enforcement suits. The court did not remand the regulation to the EPA for better explanation of the legal basis for an affirmative defense; the court instead vacated the affirmative defense and indicated that there could be no valid legal basis for such a provision because it contradicted fundamental requirements of the CAA concerning the authority of courts in judicial enforcement of CAA requirements. As the court explained:

The D.C. Circuit's holding in NRDC v. EPA is especially pertinent here.27 Like the Portland cement NESHAP at issue in the NRDC v. EPA case, the provisions at issue in this proposal are also regulations promulgated by the EPA to implement programs under the CAA. The affirmative defense for malfunctions in the Portland cement NESHAP and the affirmative defense for emergencies in the EPA's part 70 and part 71 regulations are functionally similar provisions that operate in essentially identical ways to establish affirmative defenses in civil enforcement actions. Moreover, the EPA believes that the reasoning of the court's decision in NRDC v. EPA applies more broadly than to the specific facts of the case for several reasons. The EPA notes that the court's decision did not turn upon the specific provisions of CAA section 112. Although the court only evaluated the legal validity of an affirmative defense provision created by the EPA in conjunction with specific standards applicable to manufacturers of Portland cement, the court based its decision upon the provisions of sections 113 and 304 that pertain to enforcement of CAA requirements more broadly, including to emission limits in title V permits. Sections 113 and 304 pertain to administrative and judicial enforcement generally and are in no way limited to enforcement of emission limitations promulgated by the EPA under section 112. Thus, the EPA does not think that the mere fact that the court only addressed the legality of an affirmative defense provision in this particular context means that the court's interpretation of sections 113 and 304 does not also apply more broadly. To the contrary, the EPA sees no reason why the logic of the court concerning sections 113 and 304 would not apply to the title V emergency affirmative defense provisions, as well.

In light of the court's decision, the EPA now interprets the enforcement structure of the CAA, embodied in section 113 and section 304, to preclude affirmative defense provisions that would operate to limit a court's authority or discretion to determine the appropriate remedy in an enforcement action. CAA section 304(a) grants the federal district courts the jurisdiction to determine liability and to impose penalties in enforcement suits brought by citizens. Similarly, section 113(b) provides courts with explicit jurisdiction to determine liability and to impose remedies of various kinds, including injunctive relief, compliance orders, and monetary penalties, in judicial enforcement proceedings. These grants of jurisdiction come directly from Congress, and the EPA is not authorized to alter or eliminate this authority under the CAA or any other law. With respect to monetary penalties, CAA section 113(e) explicitly includes the factors that courts and the EPA are required to consider in the event of judicial or administrative enforcement for violations of CAA requirements, including title V permit provisions. Because Congress has already given federal courts the authority to determine what monetary penalties are appropriate in the event of judicial enforcement for a violation of a title V permit provision, neither the EPA nor states can alter or eliminate that authority by superimposing restrictions on the authority and discretion granted by Congress to the courts. Affirmative defense provisions by their nature purport to limit or eliminate the authority of federal courts to determine liability or to impose remedies through factual considerations that differ from, or are contrary to, the explicit grants of authority in section 113(b) and section 113(e). Therefore, these provisions are not appropriate under the CAA, no matter what type of event they apply to, what criteria they contain, or what forms of remedy they purport to limit or eliminate. This is true for regulations promulgated under CAA sections 111 and 112, SIP provisions approved by the EPA, and regulations promulgated under title V of the CAA. Thus, just as the EPA revisited affirmative defenses in SIP provisions in light of the NRDC v. EPA opinion, the EPA is reevaluating its interpretation of the CAA relative to the emergency affirmative defense provisions contained in its part 70 and part 71 regulations, and is proposing to remove those provisions because they are not consistent with the CAA's enforcement structure.

Since the 2014 NRDC v. EPA decision, and in order to ensure consistency with the CAA's enforcement structure, the EPA has been omitting new affirmative defense provisions and removing existing affirmative defense provisions throughout many CAA program areas that establish emission limitations contained in title V permits. However, the title V emergency affirmative defense provisions apply regardless of whether there is an affirmative defense also found in the underlying applicable requirements. See 40 CFR 70.6(g)(5) and 71.6(g)(5). As a result, sources could seek to assert this affirmative defense in title V enforcement cases for noncompliance with emission limitations derived from applicable requirements that do not otherwise contain such an affirmative defense for emergencies. The continued existence of the title V emergency affirmative defense provisions thus contradicts and compromises the EPA's on-going efforts to ensure that underlying regulations are applied consistently with the CAA.

The EPA maintains that the part 70 and part 71 emergency affirmative defense provisions are affirmative defenses to enforcement actions and are not “exemptions” from otherwise applicable emissions limitations. However, as an alternative but additional justification, to the extent that the emergency affirmative defense provisions in part 70 and part 71 could be interpreted to establish an exemption or exclusion from emission limits (rather than merely an affirmative defense to penalties in the event of a violation), these provisions would still run contrary to the CAA's requirements and require removal. As previously noted,28 under Sierra Club v. Johnson, 29 the CAA requires that emission limitations must apply continuously and cannot contain exemptions, conditional or otherwise. Therefore, even if characterized as an exemption or exclusion from otherwise applicable limits, the emergency affirmative defense provisions would, nonetheless, run afoul of the CAA and Sierra Club v. Johnson, and should, on that alternative basis, be removed.

This section discusses the actions that the EPA anticipates state, local, and tribal permitting authorities 30 would need to take (if this proposed rule is finalized in substantially the same form) in order to ensure that their operating permit programs are consistent with the proposed revisions to the EPA's part 70 regulations and the CAA's enforcement structure. The EPA welcomes comments on how best to address the implementation consequences of the proposed removal of 40 CFR 70.6(g).

As discussed in Section III.A of this document, the section 70.6(g) emergency provision has never been a required element of part 70 operating permit programs. For states that have not adopted the section 70.6(g) emergency provision, or any similar affirmative defense provision, into their part 70 operating permit programs, no further action would be required to comply with this rule as proposed. However, we expect that as a result of this rulemaking, it may be necessary for states that have adopted an affirmative defense in their part 70 programs to take the actions described in the following subsections.

The EPA's existing part 70 regulations provide for state program revisions if part 70 is revised and the EPA determines that such conforming changes are necessary. See 40 CFR 70.4(a) and 70.4(i). Therefore, as a result of this proposed regulatory action to remove 40 CFR 70.6(g) and 71.6(g), state operating permit programs that contain an emergency affirmative defense may have to take appropriate actions to remain consistent with the CAA and the EPA's part 70 regulations. As discussed in more detail in the following subsections, the EPA is requesting comment on whether revisions to certain approved state programs may be necessary if the EPA removes 40 CFR 70.6(g) and 71.6(g).

Affirmative defense provisions included within a state's part 70 (title V) program regulations—including provisions that are narrower in scope or more stringent than 40 CFR 70.6(g)—will generally implicate the same concerns that prompted the EPA to propose removing 70.6(g) and 71.6(g) from the agency's regulations. The EPA expects that state programs containing provisions that mirror the exact language of 70.6(g) would need to be revised if this proposed rule is finalized, as would state programs that have provisions that do not exactly mirror the language of 40 CFR 70.6(g), but nonetheless provide for title V affirmative defenses.31 In any case, the EPA invites comment on whether it may be necessary for states to revise programs containing any provisions that (1) purport to establish an affirmative defense to enforcement actions 32 and (2) are included within the state's part 70 (title V) program regulations. Anytime the phrases “affirmative defense” or “emergency affirmative defense” are used within this section, these phrases are intended to refer to all such provisions meeting these criteria. These criteria are intended to encompass provisions that initially would have been approved by the EPA as consistent with 40 CFR 70.6(g) and 70.4(b)(16). This action would not directly affect any affirmative defense provisions arising under other CAA applicable requirements, or state-only provisions outside of each state's approved part 70 operating permit programs.

The EPA has begun to compile a tentative list of affirmative defense provisions within state programs that may eventually need to be removed. The EPA is including this list in the docket for this proposed rulemaking (EPA-HQ-OAR-2016-0186) for informational purposes only; this list is not an official determination as to the adequacy or inadequacy of any program provisions. The EPA seeks comment on whether there are additional title V affirmative defense provisions in state regulations or statutes that we have not yet identified, and whether any such provisions would or would not remain appropriate as part of a state's approved title V program if this proposed rule is finalized.

Because the EPA believes that a large number of part 70 programs contain provisions resembling those that the agency proposes to eliminate, the EPA anticipates that it will be necessary for states to initiate conforming revisions to remove any affirmative defense provisions from their approved title V operating permit programs if the EPA removes 40 CFR 70.6(g). The EPA seeks comment on this approach and on other possible approaches to ensure that state programs are consistent with the CAA and the EPA's part 70 regulations. However, the EPA does not anticipate that it would be appropriate for states to retain affirmative defense provisions within their approved part 70 programs. For example, if a state decided, in lieu of a program revision, to exercise its discretion to omit or remove affirmative defense provisions from all future title V operating permits, the state's approved part 70 program would still contain regulations inconsistent with the EPA's part 70 regulations and the CAA. Further, if an emergency provision remained in a state's approved program, a source could potentially attempt to invoke the provision as an affirmative defense during an enforcement proceeding, notwithstanding its absence from the source's individual title V permit. This result could undermine the enforcement of certain permit limitations and would be inconsistent with the enforcement structure of the CAA.

Although the EPA expects that most states would elect to remove the emergency affirmative defense provisions from their part 70 program regulations, states could nonetheless choose to retain such affirmative defense provisions within their permitting regulations as state-only requirements in certain circumstances. In that case, states would have to ensure and make clear to the EPA that any remaining affirmative defense provisions are only available for alleged noncompliance with permit requirements arising solely from state law. Ideally, this would involve an amendment to state regulations to explicitly clarify the limited applicability of any remaining affirmative defense provisions; such a clarifying amendment could also effectively serve as an appropriate revision to the state's part 70 program. The EPA solicits comment on whether and to what extent it would be appropriate for states to retain state-only affirmative defense provisions if this proposed rule is finalized.

Finally, states may also choose to remove any other provisions that reference 40 CFR 70.6(g) or similar state affirmative defense provisions in order to ensure clarity. These could include, but are not limited to, state regulations that incorporate by reference 40 CFR 70.6(g), as well as any associated definitions, recordkeeping, or reporting requirements relating to the affirmative defense provisions affected by this rulemaking. States may also wish to retain a portion of the emergency provisions, such as the definition of “emergency” or certain reporting requirements, for purposes of supporting other regulations that do not involve an affirmative defense. This could be appropriate as long as any remaining provisions could not be interpreted to provide an affirmative defense to federally applicable requirements.

If this proposed rule is finalized, the EPA expects that it would be necessary for any states with approved part 70 operating permit programs that contain emergency affirmative defense provisions to remove any such provisions and submit program revisions to the EPA within 12 months after the final rule's effective date. For many programs, the EPA does not anticipate that additional state legislative authority will be required to enact these revisions. Therefore, the EPA believes that 12 months will be ample time for many states to make such a straightforward and narrow program revision. However, the EPA is considering whether it may be appropriate to provide individual states up to 24 months to submit program revisions if a state demonstrates that additional legislative authority is necessary to enact the program revisions.

If this proposed rule is finalized, the EPA expects that state program revisions submitted to the agency should include a redline version of the specific changes made to the state's part 70 regulations to remove any emergency affirmative defense provisions. States may, but need not, include as part of their program revision submittals any other unrelated revisions to state program regulations.33 Each state should also include a brief statement of the legal authority that authorized this removal, which could take various forms depending on the specific circumstances of each state. Finally, to address how the program revisions would be implemented with respect to individual permits, each state should also include a schedule for the planned removal of these provisions from individual title V operating permits, as well as a description of the mechanism(s) that the state plans to use to remove these existing provisions. Further discussion of how these program revisions should be implemented in individual permits is presented in Section V.A.3 of this document.

The EPA is specifically requesting comment on these program revision time frames and procedures from permitting authorities whose approved part 70 programs contain affirmative defense provisions. The EPA solicits additional comments from states with title V program provisions that may also be contained within SIPs as to any additional revisions that may be necessary if this rule is finalized.

The eventual finalization of this rule would not have an automatic impact on sources currently operating under a title V permit, and any minimal resource burden to revise permits would likely be spread over many years. After a state makes any necessary revisions to its title V program, the EPA expects that revisions to operating permits to remove emergency affirmative defense provisions would generally occur in the ordinary course of business as the state issues new permits or reviews and revises existing permits. The options presented in the following subsections would afford states with the maximum flexibility to implement these changes while ensuring predictability for sources operating under title V permits.

In order to implement program revisions that may be necessary if this rule is finalized as proposed, it may be necessary for states to remove title V emergency affirmative defense provisions that are currently included in any state-issued permits.34 Alternatively, states may choose to allow sources to retain affirmative defense provisions in their permits as state-only provisions. Any such remaining affirmative defense provisions must be clearly labeled within each permit as not applicable for federal law purposes to ensure that they are not available in enforcement actions for noncompliance with any federally-enforceable emission limitations, as required by 40 CFR 70.6(b)(2).

The EPA anticipates that states would have the flexibility to remove emergency provisions from title V permits through a number of different existing mechanisms, either through changes to individual permits or perhaps to multiple permits through more streamlined processes. As previously noted, if the proposed action is finalized, any necessary program revision submittals should reflect the planned schedule and mechanism for these permit changes. The EPA expects that states will follow the guidelines discussed in this preamble, but will consider other plans for revising title V permits that would not cause undue delay.

First, states could require that permit applications address the removal of emergency provisions during the next periodic permit renewal, permit modification, or permit reopening, including those that occur as the result of other rulemakings. States using these mechanisms should ensure that these changes occur at the first possible occasion; in other words, the first situation in which the permitting authority must act on an individual permit after state program revisions are approved by the EPA. Moreover, because states have never been required by federal law to include these provisions in state-issued title V permits, the EPA also encourages states to exercise their discretion to cease including emergency affirmative defense provisions as early as practicable. In many cases, there will be no reason for states to wait for the EPA to take final action on this proposal to begin implementing this suggestion.35

Additionally, sources may apply for a permit modification from their permitting authority at any time. The EPA anticipates that the removal of an emergency affirmative defense would not trigger the significant modification procedures under 40 CFR 70.7(e)(4), and—depending on the regulations in each state's approved title V program—could be implemented using minor modification procedures. Finally, depending on the unique structure of each state's operating permit program, some states may also be able to remove these provisions from multiple existing permits in a single action, via mechanisms such as general permits or permits-by-rule. The EPA is requesting comment on how states could use existing permitting options to remove emergency affirmative defense provisions from title V permits in a more streamlined and expeditious manner.

Overall, the EPA believes that addressing the omission or removal of emergency affirmative defense provisions from permits according to the existing state program mechanisms described in this subsection affords states sufficient flexibility to implement these changes and provides certainty to facilities operating under title V permits. Under the approaches currently being considered, the EPA anticipates that the removal of affirmative defense provisions from permits should generally occur in the ordinary course of business and should require essentially no additional burden on states or sources. The timing for these changes may coincide with similar changes to operating permits based on revised SIP provisions following the SSM SIP Call or changes to other applicable requirements, and it may be convenient and efficient for states to make all necessary changes to title V permits at the same time.

Although the title V operating permit program is typically implemented by state and local permitting authorities through EPA-approved part 70 programs, in certain circumstances the EPA has assumed direct permitting authority over sources through its part 71 program. The EPA administers the part 71 federal program in most areas of Indian country (however, one tribe—the Southern Ute Tribe—has an approved part 70 program, and another—the Navajo Nation—has been delegated part 71 implementation authority),36 on the Outer Continental Shelf (where there is no state permitting authority), as well as for specific sources where the EPA has determined that a state has not adequately implemented its part 70 program or satisfied an EPA objection to a permit.

In some cases where the EPA administers its part 71 program, the EPA has included in its federally-issued operating permits the emergency affirmative defense provision found in 40 CFR 71.6(g). If 40 CFR 71.6(g) is removed, the federal (including delegated) program rules would no longer include regulatory authority for incorporating this emergency affirmative defense in permits. Therefore, in order to ensure that part 71 programs are implemented consistent with the proposed revisions to the part 71 regulations, the EPA or delegated permitting authority should remove emergency affirmative defense provisions that are currently included in title V permits at the next permit action following the effective date of the final rule. Because the EPA has always considered the emergency provisions to be discretionary permit terms, the EPA has omitted emergency affirmative defense provisions from part 71 permits that it has issued since the D.C. Circuit's 2014 NRDC v. EPA decision. The EPA plans to continue to exercise its discretion to not include emergency affirmative defense provisions in future EPA-issued operating permits.

The legal rights and obligations of individual sources potentially subject to enforcement proceedings would not be adversely affected by the removal of emergency affirmative defense provisions from their title V permits.37 The absence of an affirmative defense provision in a source's title V permit does not mean that all exceedances of emission limitations in a title V permit will automatically be subject to enforcement or automatically be subject to imposition of particular remedies. Pursuant to the CAA, all parties with authority to bring an enforcement action to enforce title V permit provisions (i.e., the state, the EPA, or any parties who qualify under the citizen suit provision of CAA section 304) have enforcement discretion that they may exercise as they deem appropriate in any given circumstances. For example, if the excess emissions caused by an emergency occurred despite proper operation of the facility, and despite the permittee taking all reasonable steps to minimize excess emissions, then these parties may decide that no enforcement action is warranted. In the event that any party decides that an enforcement action is warranted, then it has enforcement discretion with respect to what remedies to seek from the court for the violation (e.g., injunctive relief, compliance order, monetary penalties, or all of the above), as well as the type of injunctive relief and/or amount of monetary penalties sought.38

Further, courts have the discretion under section 113 to decline to impose penalties or injunctive relief in appropriate cases. In the event of an enforcement action for an exceedance of an emission limit in a title V permit, a source can elect to assert any common law or statutory defenses that it determines are supported, based upon the facts and circumstances surrounding the alleged violation. Under sections 304(a) and 113(b), courts have authority to impose injunctive relief, issue compliance orders, assess monetary penalties or fees and award any other appropriate relief. Under section 113(e), courts are required to consider the enumerated factors when assessing monetary penalties, including the source's compliance history, good faith efforts to comply the duration of the violation, and “such other factors as justice may require.” If the exceedance of the emission limitation occurs due to an emergency, the source retains the ability to defend itself in an enforcement action and to oppose the imposition of particular remedies or to seek the reduction or elimination of monetary penalties, based on the specific facts and circumstances of the emergency event. Thus, elimination of an emergency affirmative defense provision that purported to take away the statutory jurisdiction of the court to exercise its authority to impose remedies does not disarm sources in potential enforcement actions. Sources would retain all of the equitable arguments they previously could have made; they must simply make such arguments to the reviewing court as envisioned by Congress in section 113(b) and section 113(e). Congress vested the courts with the authority to judge how best to weigh the evidence in an enforcement action and determine appropriate remedies.

The eventual removal of such impermissible emergency affirmative defense provisions from state operating permit programs and individual title V permits will likely be necessary to preserve the enforcement structure of the CAA, to preserve the authority of courts to adjudicate questions of liability and remedies in judicial enforcement actions, and to preserve the potential for enforcement by states, the EPA, and other parties under the citizen suit provision as an effective deterrent to violations. In turn, this deterrent encourages sources to be properly designed, maintained, and operated and, in the event of violation of permitted emission limitations, to take appropriate action to mitigate the impacts of the violation. In this way, as intended by the existing enforcement structure of the CAA, sources can mitigate the potential for enforcement actions against them and the remedies that courts may impose upon them in such enforcement actions, based upon the facts and circumstances of the event.

The EPA believes the human health or environmental risk addressed by this proposed action would not have potential disproportionately high and adverse human health or environmental effects on minority, low-income or indigenous populations because it would not adversely affect the level of protection provided to human health or the environment. This action simply proposes to remove emergency affirmative defense provisions from the EPA's operating permit program regulations. If the proposed rule is finalized, it may also be necessary for state, local and tribal permitting authorities to remove similar affirmative defense provisions from program regulations and from individual title V operating permits. None of these changes would alter the obligations of sources to comply with the emission limits and other standards contained within title V operating permits. However, this proposed rulemaking could encourage sources to comply with the terms of their operating permits at all times to the maximum extent practicable. This could potentially result in improved air quality for communities living near sources of air pollution as well as the broader population. Thus, this proposed rulemaking will not adversely affect the level of protection to human health or the environment for any populations.

This action is not a significant regulatory action and was therefore not submitted to the Office of Management and Budget (OMB) for review.

This action does not impose any new information collection burden under the PRA. OMB has previously approved the information collection activities contained in the existing regulations and has assigned OMB control numbers 2060-0243 (for part 70 state operating permit programs) and 2060-0336 (for part 71 federal operating permit program). In this action, the EPA is proposing to remove certain provisions from the EPA's regulations, which if finalized could result in the removal of similar provisions from state, local, and tribal operating permit programs and individual permits. Consequently, states could eventually be required to submit program revisions to the EPA outlining any necessary changes to their regulations and their plans to remove provisions from individual permits. However, this proposed action will not involve any requests for information, recordkeeping or reporting requirements, or other requirements that would constitute an information collection under the PRA.

I certify that this action will not have a significant economic impact on a substantial number of small entities under the RFA. This proposed action will not impose any requirements on small entities. Entities potentially affected directly by this proposal include state, local, and tribal governments, and none of these governments would qualify as a small entity. Other types of small entities, including stationary sources of air pollution, are not directly subject to the requirements of this action.

This action does not contain an unfunded mandate of $100 million or more as described in UMRA, 2 U.S.C. 1531-1538, and does not significantly or uniquely affect small governments. The action imposes no enforceable duty on any state, local or tribal governments or the private sector.

This action does not have federalism implications. It will not have substantial direct effects on the states, on the relationship between the national government and the states, or on the distribution of power and responsibilities among the various levels of government.

This action has tribal implications. However, it will neither impose substantial direct compliance costs on federally recognized tribal governments, nor preempt tribal law. One tribal government (the Southern Ute Indian Tribe) currently administers an approved part 70 operating permit program, and one tribal government (the Navajo Nation) currently administers a part 71 operating permit program pursuant to a delegation agreement with the EPA. These tribal governments may be required to take actions if this proposed rule is finalized, including program revisions (for part 70 programs) and eventual permit revisions, but these actions will not require substantial compliance costs. The EPA solicits comment from affected tribal governments on the implications of this proposed rulemaking.

The EPA interprets Executive Order 13045 as applying only to those regulatory actions that concern environmental health or safety risks that the EPA has reason to believe may disproportionately affect children, per the definition of “covered regulatory action” in section 2-202 of the Executive Order. This action is not subject to Executive Order 13045 because it does not concern an environmental health risk or safety risk.

This action is not subject to Executive Order 13211 because it is not a significant regulatory action under Executive Order 12866.

This rulemaking does not involve technical standards.

The EPA believes the human health or environmental risk addressed by this action will not have potential disproportionately high and adverse human health or environmental effects on minority, low-income or indigenous populations because it does not affect the level of protection provided to human health or the environment. The results of this evaluation are contained in Section VI of this document titled, “Environmental Justice Considerations.”

The statutory authority for this proposed action is provided in CAA sections 502(b) and 502(d)(3), 42 U.S.C. 7661a(b) & (d)(3), which direct the Administrator of the EPA to promulgate regulations establishing state operating permit programs and give the Administrator the authority to establish a federal operating permit program. Additionally, the Administrator determines that this action is subject to the provisions of CAA section 307(d), which establish procedural requirements specific to rulemaking under the CAA. CAA section 307(d)(1)(V) provides that the provisions of CAA section 307(d) apply to “such other actions as the Administrator may determine.” 42 U.S.C. 7607(d)(1)(V).

For the reasons stated in the preamble, title 40, chapter I of the Code of Federal Regulations is proposed to be amended as follows: