The correct answer is option 'D' - Application layer.

Proxy firewalls are a type of network security device that sit between an internal network and the internet. They operate at the application layer of the OSI (Open Systems Interconnection) model, which is the highest layer of the model.

- Understanding the OSI model:
The OSI model is a conceptual framework that describes how different network protocols and technologies interact to provide network services. It is divided into seven layers, each responsible for specific functions. The layers, from bottom to top, are: Physical, Data Link, Network, Transport, Session, Presentation, and Application.

- Proxy firewalls:
Proxy firewalls act as intermediaries between client devices on an internal network and the internet. They receive requests from client devices and forward them to the appropriate destination, while also inspecting the traffic for potential threats.

- Operating at the Application layer:
Proxy firewalls operate at the Application layer of the OSI model. This layer deals with the protocols and processes that enable user applications to access network services. It provides services such as file transfer, email, web browsing, and remote login.

- Filtering capabilities:
By operating at the Application layer, proxy firewalls can inspect and filter traffic based on application-specific criteria. They can analyze the content of network packets, including the data payload, to determine whether to allow or block the traffic.

- Granular control:
Proxy firewalls offer granular control over network traffic because they can understand and interpret the application-layer protocols. They can enforce security policies based on specific application characteristics, such as blocking specific websites or restricting certain types of file downloads.

- Additional security features:
Proxy firewalls also provide additional security features such as authentication, content filtering, and encryption. They can authenticate users before allowing them to access certain applications or services. They can also scan for malicious content or viruses within network traffic.

- Advantages of proxy firewalls:
Proxy firewalls offer several advantages over other types of firewalls. They can provide enhanced security by inspecting traffic at the application layer. They also offer better performance and scalability since they can cache and optimize content for clients.

In conclusion, proxy firewalls operate at the Application layer of the OSI model. They provide granular control and additional security features by inspecting and filtering traffic based on application-specific criteria.