[Federal Register Volume 66, Number 92 (Friday, May 11, 2001)]
[Proposed Rules]
[Pages 24186-24219]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-11610]



[[Page 24185]]

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Part II





Federal Reserve System





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12 CFR Parts 223 and 250



Transactions Between Banks and Their Affiliates; Proposed Rule



Applicability of Section 23A of the Federal Reserve Act to the Purchase 
of Securities From Certain Affiliates; Final Rule Loans and Extensions 
of Credit Made by a Member Bank to a Third Party; Final Rule



Application of Sections 23A and 23B of the Federal Reserve Act to 
Derivative Transactions With Affiliates and Intraday Extensions of 
Credit to Affiliates; Interim Rule

  Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed 
Rules  

[[Page 24186]]


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FEDERAL RESERVE SYSTEM

12 CFR Part 223

[Regulation W; Docket No. R-1103]


Transactions Between Banks and Their Affiliates

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Board of Governors of the Federal Reserve System (Board) 
is proposing a new rule (Regulation W) to implement comprehensively 
sections 23A and 23B of the Federal Reserve Act. The proposed rule 
would combine statutory restrictions on transactions between a bank and 
its affiliates with numerous existing and proposed Board 
interpretations and exemptions in an effort to simplify compliance with 
sections 23A and 23B.

DATES: Comments must be submitted on or before August 15, 2001.

ADDRESSES: Comments should refer to Docket No. R-1103 and should be 
sent to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551 (or mailed electronically to 
[email protected]). Comments addressed to Ms. Johnson 
also may be delivered to the Board's mail room between the hours of 
8:45 a.m. and 5:15 p.m. weekdays and, outside of those hours, to the 
Board's security control room. Both the mail room and the security 
control room are accessible from the Eccles Building courtyard 
entrance, located on 20th Street, NW., between Constitution Avenue and 
C Street, NW. Members of the public may inspect comments in Room MP-500 
of the Martin Building between 9 a.m. and 5 p.m. weekdays, except as 
provided in section 261.14 of the Board's Rules Regarding Availability 
of Information (12 CFR 261.14).

FOR FURTHER INFORMATION CONTACT: Pamela G. Nardolilli, Senior Counsel 
(202/452-3289), or Mark E. Van Der Weide, Counsel (202/452-2263), Legal 
Division; or Michael G. Martinson, Associate Director (202/452-3640), 
or Molly S. Wassom, Associate Director (202/452-2305), Division of 
Banking Supervision and Regulation; Board of Governors of the Federal 
Reserve System, 20th Street and Constitution Avenue, NW., Washington, 
DC 20551.

SUPPLEMENTARY INFORMATION:

Introduction

    Sections 23A and 23B of the Federal Reserve Act are two of the most 
important statutory protections against a bank suffering losses because 
of its transactions with affiliates and, correspondingly, are two of 
the most effective means of limiting the ability of a bank to transfer 
to its affiliates the subsidy arising from the bank's access to the 
Federal safety net. Although sections 23A and 23B of the Federal 
Reserve Act each explicitly grant the Board broad authority to issue 
regulations to administer the section,\1\ the Board has never issued a 
regulation fully implementing either section. Instead, banks seeking 
guidance on how to comply with sections 23A and 23B have relied on a 
series of Board interpretations and informal staff guidance. Banks have 
increasingly sought guidance from the Board on section 23A issues in 
recent years as a result of the increasing scope of activities 
conducted by modern financial holding companies and the growing 
complexities of the U.S. financial markets.
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    \1\ 12 U.S.C. 371c(f), 371c-1(e).
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    The Board now believes that adoption of a comprehensive regulation 
implementing sections 23A and 23B would be appropriate for several 
reasons. First, the new regulatory framework established by the Gramm-
Leach-Bliley Act (``GLB Act'') \2\ emphasizes the importance of 
sections 23A and 23B as a means to protect banks from losses in 
connection with the newly authorized affiliates under the GLB Act. In 
addition, the GLB Act amended section 23A in several important respects 
and requires the Board to address by rule under section 23A the credit 
exposure arising from derivative transactions and intraday credit 
extensions.
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    \2\ Pub. L. No. 106-102, 113 Stat. 1338 (1999).
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    Moreover, the Board believes that adoption of a comprehensive 
regulation would simplify the interpretation and application of 
sections 23A and 23B, ensure that the statute is consistently 
interpreted and applied, and minimize burden to the extent consistent 
with the statute's goals. Finally, issuing a proposed regulation would 
allow the public an opportunity to comment on Board and staff 
interpretations of sections 23A and 23B, many of which were adopted 
without the benefit of a public comment process.
    The proposed regulation would supersede outdated Board and staff 
interpretations concerning sections 23A and 23B and would incorporate 
other existing interpretations. In addition, the regulation would 
incorporate the results of the Board's earlier proposals to clarify the 
scope of the attribution rule, expand the section 23A(d)(6) exemption 
for purchases of readily marketable assets, and, consistent with the 
GLB Act, extend the coverage of section 23A to subsidiaries of a bank 
engaged in activities that the bank cannot conduct directly.\3\ 
Finally, the proposed regulation would answer questions that have 
arisen frequently in the Board's administration of the statutory 
provisions and in their enforcement by each of the Federal banking 
agencies.
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    \3\ See 63 FR 32766, June 16, 1998; 62 FR 37744, July 15, 1997.
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    The Board emphasizes that Regulation W is a proposed rule and 
expects to make changes to the rule to reflect public comments as 
appropriate. Until Regulation W is finalized, all previously issued 
valid Board interpretations and staff opinions regarding sections 23A 
and 23B will remain in full force and effect. After the Board issues 
the regulation in final form, any Board interpretations or staff 
opinions on the statute that are inconsistent with the regulation will 
be deemed superseded by the rule.

Background

    As noted above, sections 23A and 23B of the Federal Reserve Act are 
designed to limit the risks to a bank (and the Federal deposit 
insurance funds) from transactions between the bank and its affiliates 
and to limit the ability of a bank to transfer to its affiliates the 
subsidy arising from the bank's access to the Federal safety net. 
Section 23A achieves these goals in three major ways. First, it limits 
a bank's ``covered transactions'' with any single ``affiliate'' to no 
more than 10 percent of the bank's capital and surplus, and 
transactions with all affiliates combined to no more than 20 percent of 
capital and surplus. ``Covered transactions'' include purchases of 
assets from an affiliate, extensions of credit to an affiliate, 
investments in securities issued by an affiliate, guarantees on behalf 
of an affiliate, and certain other transactions that expose the bank to 
an affiliate's credit or investment risk. A bank's ``affiliates'' 
include, among other companies, any companies that control the bank, 
any companies under common control with the bank, and certain 
investment funds that are advised by the bank or an affiliate of the 
bank.
    Second, the statute requires all transactions between a bank and 
its affiliates to be on terms and conditions that are consistent with 
safe and sound banking practices, and prohibits a bank from purchasing 
low-quality assets from its affiliates. Finally, the statute requires 
that a bank's extensions of credit to

[[Page 24187]]

affiliates and guarantees on behalf of affiliates be appropriately 
secured by a statutorily defined amount of collateral.
    Section 23B protects a bank by requiring that certain transactions 
between the bank and its affiliates occur on market terms; that is, on 
terms and under circumstances that are substantially the same, or at 
least as favorable to the bank, as those prevailing at the time for 
comparable transactions with unaffiliated companies. Section 23B 
applies this restriction to any covered transaction (as defined in 
section 23A) with an affiliate as well as certain other transactions, 
such as the sale of securities or other assets to an affiliate and the 
payment of money or furnishing of services to an affiliate.
    Section 23A originally was enacted as part of the Banking Act of 
1933 and applied only to banks that were members of the Federal Reserve 
System (``member banks''). Since 1933, Congress has amended the statute 
several times, including a comprehensive revision in 1982.\4\ Congress 
also amended the Federal Deposit Insurance Act in 1966 to extend 
section 23A to cover insured nonmember banks.\5\ In 1989, Congress 
further extended the coverage of section 23A to insured savings 
associations.\6\ Congress enacted section 23B of the Federal Reserve 
Act as part of the Competitive Equality Banking Act of 1987,\7\ and has 
subsequently expanded its scope to cover the same set of depository 
institutions as are covered by section 23A. Consequently, sections 23A 
and 23B now apply to all insured depository institutions and uninsured 
member banks.
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    \4\ Garn-St Germain Depository Institutions Act of 1982, Pub. L. 
No. 97-320, Sec. 410, 96 Stat. 1515 (1982) (codified at 12 U.S.C. 
371c).
    \5\ Pub. L. No. 89-485, Sec. 12(c), 80 Stat. 242 (1966) 
(codified at 12 U.S.C. 1828(j)).
    \6\ Financial Institutions Reform, Recovery, and Enforcement Act 
of 1989, Pub. L. No. 101-73, Sec. 301, 103 Stat. 342 (1989) 
(codified at 12 U.S.C. 1468) (``FIRREA'').
    \7\ Pub. L. No. 100-86, Sec. 102, 101 Stat. 552, 564 (1987) 
(codified at 12 U.S.C. 371c-1).
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    As part of its comprehensive revision of section 23A in 1982, 
Congress amended the statute to exempt transactions between a bank and 
its subsidiaries.\8\ In 1982, a subsidiary of a bank generally was 
permitted to engage only in activities that its parent bank could 
conduct. Since 1982, however, some subsidiaries of banks have begun to 
engage in activities impermissible to the banks themselves.\9\ In 1997, 
to address these subsidiaries, the Board issued for comment a proposal 
to extend sections 23A and 23B to transactions between a bank and a 
subsidiary of the bank engaged in activities not permissible for the 
bank to engage in directly.\10\ Consistent with this proposal, the GLB 
Act recently amended the Federal Reserve Act so that sections 23A and 
23B would apply to transactions between a bank and its ``financial 
subsidiaries.'' Section 23A, as amended by the GLB Act, defines a 
financial subsidiary as any subsidiary of a bank that would be a 
financial subsidiary of a national bank under section 5136A of the 
Revised Statutes of the United States.\11\ This statutory provision 
defines a financial subsidiary of a national bank as a subsidiary of an 
insured depository institution that engages in activities that are not 
permissible for a national bank to engage in directly (unless a 
national bank is authorized by the express terms of a Federal statute 
(other than the GLB Act) to own or control the subsidiary). The GLB Act 
provides that a financial subsidiary of a bank is considered an 
``affiliate'' of the bank for purposes of sections 23A and 23B and 
requires, with certain limited exceptions, that any covered 
transactions between a bank and its financial subsidiaries comply with 
the same quantitative, collateral, and other restrictions imposed by 
sections 23A and 23B on other affiliates.
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    \8\ Section 23A excludes from the definition of ``affiliate'' 
most subsidiaries of a bank. See 12 U.S.C. 371c(b)(2)(A).
    \9\ See 12 U.S.C. 24a, 1464(c)(4)(B), and 1831a; 12 CFR 5.39 and 
362.4.
    \10\ 62 FR 37744, July 15, 1997.
    \11\ See 12 U.S.C. 24a.
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    The GLB Act also establishes certain special rules for financial 
subsidiaries. For example, the GLB Act extends the restrictions of 
sections 23A and 23B to investments by a bank's affiliate in securities 
issued by any financial subsidiary of the bank. The GLB Act also 
authorizes the Board to extend sections 23A and 23B to loans and other 
extensions of credit made by a bank's other affiliates to any financial 
subsidiary of the bank, if the Board determines that such action is 
necessary or appropriate to prevent evasions of the Federal Reserve Act 
or the GLB Act. Finally, the GLB Act provides that the 10 percent 
restriction on covered transactions with any individual affiliate does 
not apply to transactions between a bank and any individual financial 
subsidiary of the bank.\12\ The proposed regulation addresses these 
provisions of the GLB Act.
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    \12\ Covered transactions between a bank and any of its 
financial subsidiaries would count toward the bank's 20 percent 
limit for covered transactions with all affiliates in the aggregate.
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    In addition, the GLB Act requires the Board to adopt, by May 12, 
2001, final rules to address as a covered transaction the credit 
exposure arising out of derivative transactions between banks and their 
affiliates and intraday extensions of credit by banks to their 
affiliates.\13\ Concurrently with proposed Regulation W, the Board is 
issuing interim final rules that address these credit exposures to 
affiliates as covered transactions under section 23A, in accordance 
with this statutory requirement, by requiring banks to adopt policies 
and procedures to manage the credit exposures. The interim final rules 
also require banks to ensure that their intraday extensions of credit 
to an affiliate and their derivative transactions with affiliates 
comply with the market terms requirement of section 23B.
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    \13\ GLB Act section 121(e)(3) (codified at 12 U.S.C. 
371c(f)(3)).
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    The proposed Regulation W sets forth a more comprehensive proposal 
on the treatment of intraday extensions of credit under section 23A 
than is contained in the interim final rules and includes a detailed 
request for comment on the appropriate treatment of credit exposure 
arising from bank-affiliate derivative transactions under section 23A. 
If, after further analysis and review of the comments received on this 
regulation and the interim final rule on derivatives, the Board 
believes that additional measures are needed to address credit exposure 
on derivative transactions under section 23A, the Board will develop a 
specific proposal and seek comment on that proposal.

Explanation of Proposed Rule

I. Format of Regulation

    The proposed Regulation W seeks to provide users with a single, 
comprehensive reference tool for complying with and analyzing issues 
arising under sections 23A and 23B. Accordingly, the regulation 
includes Board interpretations of the sections and also restates the 
statutory definitions, restrictions, and exemptions. Although including 
the statutory language lengthens the text of the regulation, the Board 
believes that eliminating the need to cross-reference the statute 
should make understanding and using the regulation easier.
    The regulation first sets forth, in subpart B, the principal 
restrictions and requirements imposed by section 23A. Next, in subpart 
C, the regulation discusses the appropriate valuation and timing 
principles for covered

[[Page 24188]]

transactions. Subpart D discusses the appropriate treatment under 
section 23A for transactions with financial subsidiaries, bank-
affiliate derivative transactions, and certain bank-affiliate merger 
and acquisition transactions. Subpart E sets forth available exemptions 
from certain of the restrictions and requirements of section 23A. 
Subpart F lays out the operative provisions of section 23B. Subpart G 
discusses the application of the statutory provisions and rule to U.S. 
branches and agencies of foreign banks. Subpart H provides a 
comprehensive glossary of the terms used in the regulation and sections 
23A and 23B.
    The proposed regulation also includes examples illustrating how 
several of the rule's provisions would apply in particular 
circumstances. The examples included in the rule are considered part of 
the rule and compliance with an example, to the extent applicable, 
would constitute compliance with the rule. Each example included in the 
rule illustrates only the scope and application of the particular topic 
addressed by the example and does not illustrate any other topic or 
issue that may arise under the rule.
    The Board requests comment on the proposed format of the 
regulation, including the Board's decision to restate and reorganize 
the statutory provisions and include examples in the rule. The Board 
also requests comment on whether additional examples should be added to 
the rule and, if so, in what areas. In addition, the Board requests 
comment on whether there are additional methods for making the 
regulation more user-friendly or for reducing unnecessary regulatory 
burden.

II. Scope of Regulation

    As proposed, Regulation W applies to all ``banks.'' As noted above, 
although sections 23A and 23B apply by their terms only to member 
banks, the Federal Deposit Insurance Act subjects insured nonmember 
banks to the restrictions of sections 23A and 23B as if they were 
member banks. Referring to banks (rather than member banks) should 
clarify the scope of the regulation for the reader. By using the 
defined term ``bank,'' the Board does not intend to expand the scope of 
sections 23A and 23B beyond member banks and insured nonmember banks. 
\14\
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    \14\ The regulation implements sections 23A and 23B of the 
Federal Reserve Act. The regulation does not contain or implement 
statutory or regulatory restrictions on transactions between banks 
and their affiliates that may be applicable under other provisions 
of law, including that may apply to banks subject to prompt 
corrective action under section 38 of the Federal Deposit Insurance 
act (12 U.S.C. 1831o).
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    The Home Owners' Loan Act (``HOLA'') also subjects insured savings 
associations to sections 23A and 23B as if they were member banks. HOLA 
imposes several restrictions on transactions between an insured savings 
association and certain of its affiliates that are not contained in 
section 23A \15\ and provides the Office of Thrift Supervision 
(``OTS'') with authority to impose additional restrictions on 
transactions between an insured savings association and its 
affiliates.\16\ In light of the stricter regulatory regime governing 
transactions between an insured savings association and its affiliates 
and in light of a request by the OTS that the proposed Regulation W not 
specifically cover such institutions, the proposed rule does not apply 
by its terms to savings associations. The Board notes, however, that 
because insured savings associations are subject to sections 23A and 
23B as if they were member banks, any parallel regulation adopted by 
the OTS to govern transactions with affiliates must be at least as 
strict on insured savings associations as Regulation W is on banks.
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    \15\ HOLA prohibits an insured savings association from (i) 
making loans or extending credit to any affiliate unless that 
affiliate is engaged solely in activities that the Board has 
determined to be permissible under section 4(c) of the Bank Holding 
Company Act (12 U.S.C. 1843(c)); and (ii) purchasing or investing in 
shares issued by an affilate other than a subsidiary of the savings 
association.
    \16\ 12 U.S.C. 1468(a)(4).
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III. General Provisions of Section 23A--Subpart B

    Subpart B of the proposed regulation sets forth the principal 
restrictions of section 23A. These restrictions include:
    (i) the quantitative limits on covered transactions by a bank with 
any individual affiliate and all affiliates in the aggregate;
    (ii) the requirement that all transactions with an affiliate be on 
terms and conditions that are consistent with safe and sound banking 
practices;
    (iii) the collateral requirements for extensions of credit and 
similar transactions with an affiliate;
    (iv) the prohibition on the purchase of low-quality assets from an 
affiliate; and
    (v) the attribution rule, which provides that any transaction with 
any person that is not an affiliate will be considered a transaction 
with an affiliate to the extent that the proceeds of the transaction 
are used for the benefit of, or transferred to, that affiliate.
    Subpart B also incorporates previous Board and staff 
interpretations of these provisions. In addition, the subpart includes 
a few new interpretations of the statute's quantitative limits, 
collateral requirements, and attribution rule. These clarifications of 
the statute are discussed below.
A. Quantitative Limits--223.2 and 223.3
    Section 23A(a)(1) provides that a bank may engage in a covered 
transaction with an affiliate only if, upon consummation of the 
proposed transaction, the aggregate amount of the bank's covered 
transactions (i) with any single affiliate would not exceed 10 percent 
of the bank's capital stock and surplus and (ii) with all affiliates 
would not exceed 20 percent of the bank's capital stock and 
surplus.\17\ Sections 223.2 and 223.3 of the proposed regulation set 
forth these quantitative limits. The quantitative limits of Regulation 
W (consistent with section 23A) only prohibit a bank from engaging in a 
new covered transaction if the bank would be in excess of the 10 or 20 
percent thresholds after consummation of the new transaction. The 
regulation (consistent with section 23A) generally does not require a 
bank to unwind existing covered transactions if the bank exceeds the 10 
or 20 percent limits because its capital declined or a pre-existing 
covered transaction increased in value.
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    \17\ 12 U.S.C. 371c(a)(1).
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    Section 23A(a)(1)(A) states that a bank ``may engage in a covered 
transaction with an affiliate only if * * * in the case of any 
affiliate,'' the aggregate amount of covered transactions of the bank 
will not exceed 10 percent of the capital stock and surplus of the 
bank. Regulation W makes clear that this limitation prevents a bank 
from engaging in a new covered transaction with an affiliate if the 
aggregate amount of covered transactions between the bank and any 
affiliate (not only the particular affiliate with which the bank 
proposes to engage in the new covered transaction) would be in excess 
of 10 percent of the bank's capital stock and surplus after 
consummation of the new transaction. This interpretation of the section 
is consistent with the statutory language and would have the salutary 
effect of encouraging banks with covered transactions in excess of the 
10 percent threshold with any affiliate to reduce those transactions 
before expanding the scope or extent of the bank's relationships with 
other affiliates.
B. Collateral Requirements--223.5
    Section 223.5 of the proposed regulation sets forth the collateral 
requirements established by section

[[Page 24189]]

23A(c) for loans and extensions of credit to an affiliate, and 
guarantees, acceptances, and letters of credit issued on behalf of an 
affiliate (collectively, ``credit transactions''). As a general matter, 
section 23A requires any credit transaction by a bank with an affiliate 
to be secured with a statutorily prescribed amount of collateral. The 
required collateral varies from 100 percent of the value of the credit 
extended (when the collateral is a deposit account or U.S. government 
securities) to 130 percent of the credit extended (when the collateral 
is stock, leases, or certain other ``real or personal property'').\18\
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    \18\ 12 U.S.C. 371c(c)(1).
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    1. Deposit account as collateral--223.5(b)(1)(iv). Under section 
23A(c)(1)(A)(iv), a bank may satisfy the collateral requirements of the 
statute by securing a credit transaction with an affiliate with a 
segregated, earmarked deposit account maintained with the bank in an 
amount equal to 100 percent of the credit extended. The proposed 
regulation clarifies that to satisfy the statute's ``earmarked'' 
requirement, the account must exist for the sole purpose of securing 
the credit extended and be so identified.
    2. Ineligible collateral--223.5(c). The purpose of section 23A's 
collateral requirements is to ensure that banks that engage in credit 
transactions with an affiliate have legal recourse, in the event of 
affiliate default, to tangible assets with a value at least equal to 
the amount of the credit extended. The statute recognizes that certain 
types of assets are not appropriate to serve as collateral for credit 
transactions with an affiliate. In particular, the statute provides 
that low-quality assets and securities issued by an affiliate are not 
eligible collateral for such covered transactions.\19\
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    \19\ 12 U.S.C. 371c(c)(3) and (4).
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    In light of the purposes of section 23A, the Board believes that 
intangible assets (as defined by generally accepted accounting 
principles (``GAAP''))--including mortgage servicing assets and other 
servicing assets--are not acceptable collateral to secure credit 
transactions with an affiliate. Intangible assets are particularly hard 
to value, and a bank may have significant difficulty in collecting and 
selling such assets in a reasonable period of time. For these reasons, 
Board staff opined in 1987 that mortgage servicing rights may not be 
used to satisfy the collateral requirements of section 23A.\20\ The 
Board believes that these reasons continue to justify the exclusion of 
mortgage servicing assets, as well as other intangible assets, from the 
types of collateral eligible to satisfy the requirements of section 
23A. The Board seeks comment on whether banks should be permitted to 
use any particular types of intangible assets to meet section 23A's 
collateral requirements.
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    \20\ See Letter dated Aug. 31, 1987, from Michael Bradfield, 
General Counsel of the Board, to Gail Runnfeldt.
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    In addition, the Board does not consider guarantees and letters of 
credit to be eligible collateral for section 23A purposes. These 
agreements are not balance sheet assets under GAAP and, accordingly, 
would not constitute ``real or personal property'' under section 23A. 
Moreover, section 23A(c) requires that credit transactions be 
``secured'' by collateral. A credit transaction between a bank and an 
affiliate supported only by a guarantee or letter of credit from a 
third party would not appear to meet the statutory requirement that the 
credit transaction be secured by collateral.
    As noted above, section 23A prohibits a bank from accepting 
securities issued by an affiliate as collateral for an extension of 
credit to an affiliate. The Board also proposes to clarify that 
securities issued by the bank itself are not eligible collateral to 
secure a credit transaction with an affiliate. If the bank were forced 
to foreclose on such a credit transaction, the bank may be unwilling to 
liquidate its own securities promptly to recover on the credit 
transaction because the sale might depress the price of the bank's 
outstanding securities or result in a change in control of the bank. In 
addition, to the extent that a bank is unable or unwilling to sell its 
own securities acquired through foreclosure, the transaction may result 
in a reduction in the bank's capital, thereby offsetting any potential 
benefit provided by the collateral. The Board seeks comment on whether 
this exclusion should apply to debt and equity securities issued by the 
bank or whether the exclusion should apply only to bank-issued equity 
securities.
    3. Perfection and priority required--223.5(d). To ensure that the 
bank has good access to the assets serving as collateral for its 
transactions with affiliates, the proposed regulation also provides 
that a bank's security interest in any collateral required by section 
23A must be perfected in accordance with applicable law. This 
requirement is consistent with court decisions on the issue \21\ and 
ensures that the bank has the legal right to realize on the collateral 
in case of default, including one resulting from the affiliate's 
insolvency, liquidation, or similar circumstances.
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    \21\ See Fitzpatrick v. FDIC, 765 F.2d 569 (6th Cir. 1985).
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    For similar reasons, the proposed regulation requires that a bank 
either must obtain a first priority security interest in the required 
collateral or must deduct from the amount of collateral obtained by the 
bank the lesser of (i) the amount of any security interests in the 
collateral that are senior to that obtained by the bank or (ii) the 
amount of any credits secured by the collateral that are senior to that 
of the bank. For example, if a bank lends $100 to an affiliate and 
takes as collateral a second lien on a parcel of real estate worth 
$200, the arrangement would only satisfy the collateral requirements of 
section 23A if the affiliate owed the holder of the first lien $70 or 
less (a credit transaction secured by real estate must be secured at 
130 percent of the amount of the transaction).
    4. Undrawn portion of an extension of credit--223.5(g). Section 23A 
requires that the ``amount'' of an extension of credit be secured by 
the statutorily prescribed levels of collateral. Board staff 
traditionally has advised that a bank that provides a line of credit to 
an affiliate must secure the full amount of the line of credit 
throughout the life of the credit. That is, staff has not viewed 
section 23A as permitting a bank to satisfy the collateral requirements 
of section 23A by securing only the portion of a credit line that has 
been drawn down by the affiliate. The Board acknowledges that this 
treatment may be too strict for some lines of credit. Accordingly, the 
regulation provides that the collateral requirements of section 23A do 
not apply to the undrawn portion of an extension of credit to an 
affiliate so long as the bank does not have any legal obligation to 
advance additional funds under the credit facility until the affiliate 
has posted the amount of collateral required by the statute with 
respect to the entire drawn portion of the extension of credit.\22\ In 
such credit arrangements, securing the undrawn portion of the credit 
line is unnecessary from a safety and soundness perspective because the 
affiliate can never require the bank to advance additional funds 
without posting the additional collateral required by section 23A. If a 
bank voluntarily advanced additional funds under such a credit 
arrangement without obtaining the additional collateral required under 
section 23A to secure the entire drawn amount (despite

[[Page 24190]]

its lack of legal obligation to make such an advance), the Board would 
view this action as a violation of the collateral requirements of the 
statute.
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    \22\ This proposed treatment would not apply to guarantees, 
acceptances, and letters of credit issued on behalf of an affiliate, 
which must be fully collateralized at inception.
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C. Prohibition on the Purchase of Low-Quality Assets--223.6
    Section 223.6 of the proposed regulation restates the statute's 
general prohibition on a bank purchasing low-quality assets from an 
affiliate.\23\ This section also provides an exception to the general 
prohibition, which is based on a long-standing staff 
interpretation.\24\ The exception allows a bank that purchased a loan 
participation from an affiliate to renew its participation in the loan, 
or provide additional funding under the existing participation, even if 
the underlying loan has become a low-quality asset, so long as certain 
criteria are met. These renewals or additional credit extensions may 
enable both the affiliate and the participating bank to avoid or 
minimize potential losses. It would be inconsistent with the purposes 
of section 23A to bar a participating bank from using sound banking 
judgment to take the necessary steps (consistent with the criteria 
established in the rule) to protect itself from harm in such a 
situation.
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    \23\ 12 U.S.C. 371c(a)(3). Section 23A does not prohibit an 
affiliate from donating a low-quality asset to a bank, so long as a 
bank provides no consideration for the asset.
    \24\ See Letter dated Aug. 10, 1984, from Michael Bradfield, 
General Counsel of the Board, to Margie Goris.
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    The exception is available only if the underlying loan was not a 
low-quality asset at the time the bank purchased its participation, and 
the proposed transaction does not increase the bank's proportional 
share of the credit facility. The transaction also must be approved by 
the bank's board of directors, and the bank must provide its 
appropriate Federal banking agency with 20 days' prior notice of the 
transaction. The notice requirement represents an additional condition 
to the exception that is not contained in the staff's outstanding 
interpretive letter on the exception. The Board proposes to add this 
condition at the request of a Federal banking agency that expressed an 
interest in monitoring these transactions.
    The Board believes that this exception allows banks appropriate 
flexibility to resolve problems associated with a troubled loan 
participation.
D. Attribution Rule--223.7
    Section 23A(a)(2) provides that any transaction between a bank and 
a third party is deemed to be a transaction with an affiliate to the 
extent that the proceeds of the transaction are used for the benefit 
of, or transferred to, that affiliate.\25\ For example, a bank's loan 
to a customer for the purpose of purchasing securities from the 
inventory of a broker-dealer affiliate of the bank would be a covered 
transaction under section 23A. This ``attribution rule'' was included 
in section 23A to prevent a bank from evading the restrictions in the 
section by using intermediaries and to limit the exposure that a bank 
has to customers of affiliates of the bank. Section 223.7 of the 
proposed regulation restates this provision and provides interpretive 
guidance and exemptions on the following topics.
---------------------------------------------------------------------------

    \25\ 12 U.S.C. 371c(a)(2).
---------------------------------------------------------------------------

    1. Agency and riskless principal transactions--223.7(b)(1) and (2). 
In June 1998, the Board proposed several exemptions for covered 
transactions between a bank and its securities affiliates (the ``1998 
Proposal'').\26\ In the 1998 Proposal, the Board proposed to exempt 
from section 23A loans by a bank to an unaffiliated customer who uses 
the proceeds to purchase securities through a broker-dealer affiliate 
of the bank that is acting solely in an agency or riskless-principal 
capacity. The Board is adopting an expanded form of this exemption in a 
separate final rule issued concurrently with Regulation W. The 
exemptive aspects of the final rule also are contained in Regulation W, 
and the Board asks for further comment on the exemption. In particular, 
the Board asks whether the riskless principal exemption should be 
expanded to cover purchases of assets other than securities.
---------------------------------------------------------------------------

    \26\ 63 FR 32766, June 11, 1998, and 63 FR 32768, June 11, 1998.
---------------------------------------------------------------------------

    2. Preexisting Lines of Credit--223.7(b)(3). In the 1998 Proposal, 
the Board also proposed an exemption from section 23A for extensions of 
credit by a bank to an unaffiliated customer that uses the credit to 
purchase securities underwritten by or held in the inventory of a 
broker-dealer affiliate of the bank when that extension of credit was 
made pursuant to a preexisting line of credit (the ``Preexisting Line 
of Credit Exemption''). The Board is adopting this exemption 
substantially as proposed in another separate final rule issued 
concurrently with Regulation W. The exemption is also included in 
Regulation W, thus allowing an opportunity for further comment on the 
exemption.
    3. General Purpose Credit Cards--223.7(b)(4). Section 23A's 
attribution rule, by its terms, would cover an extension of credit by a 
bank to a nonaffiliate where the proceeds of the extension of credit 
are used by the nonaffiliate to purchase products or services from an 
affiliate of the bank. Regulation W would exempt such an extension of 
credit from the attribution rule if the extension is made pursuant to a 
general purpose credit card issued by the bank to the nonaffiliate. The 
regulation defines a general purpose credit card as a credit card 
issued by a bank, if (i) the card may be used to buy products or 
services from a nonaffiliate of the bank, (ii) the card is widely 
accepted by merchants that are not affiliates of the bank, and (iii) 
less than 25 percent of the aggregate amount of products and services 
purchased with the card by all cardholders are products or services 
purchased from affiliates of the bank (see Sec. 223.26(n)). In these 
circumstances, the funding benefit received by the affiliate from the 
unaffiliated borrower's use of the general purpose credit card is 
likely to be minimal, and a bank's decision to issue a general purpose 
credit card (and make loans pursuant to such credit card) to an 
unaffiliated borrower likely would be based on independent credit 
standards unrelated to any possible affiliate transaction. Extensions 
of credit to unaffiliated borrowers pursuant to special purpose credit 
cards (that is, credit cards that may only be used or are substantially 
used to buy goods or services from affiliates of the bank), however, 
would continue to be subject to the attribution rule because the 
affiliate would be a significant and intended beneficiary of the bank's 
credit extensions pursuant to the cards.

IV. Valuation and Timing Principles Under Section 23A--Subpart C

    Subpart C of the proposed regulation sets forth the rules that 
banks must use to calculate the value of covered transactions for 
purposes of determining compliance with the quantitative limits and 
collateral requirements of section 23A. This subpart also sets forth 
several rules that banks must employ to determine when a transaction 
becomes or ceases to be a covered transaction. Although most of these 
valuation and timing rules are consistent with previous advice given by 
Board staff on these issues, certain of the principles represent new 
positions. The rules are discussed below.
A. Credit Transactions--223.8
    The regulation provides generally that a credit transaction 
initially must be valued at the amount of funds provided by the bank 
to, or on behalf of, the affiliate plus any additional amount that the 
bank could be required to provide to, or on behalf of, the affiliate. 
For example, a $100 term loan is a $100

[[Page 24191]]

covered transaction, a $300 revolving credit facility is a $300 covered 
transaction (regardless of how much of the facility the affiliate has 
drawn down), and a guarantee backstopping a $500 debt issuance of the 
affiliate is a $500 covered transaction.
    The regulation also would make clear that a bank has entered into a 
credit transaction with an affiliate at the time during the day that 
the bank becomes legally obligated to make the extension of credit to, 
or issue the guarantee, acceptance, or letter of credit on behalf of, 
an affiliate. This timing rule represents a departure from the industry 
practice of complying with section 23A only with respect to overnight 
positions. The rule is consistent, however, with the regulation's 
proposal to incorporate intraday credit extensions into section 23A, as 
described below. This timing rule also clarifies that a covered 
transaction occurs at the moment that the bank executes a legally 
valid, binding, and enforceable credit agreement or guarantee document, 
and does not occur only when a bank funds a credit facility or makes 
payment on a guarantee.
    Under section 23A and the proposed regulation, a bank has made an 
extension of credit to an affiliate if the bank purchases from a third 
party a loan previously made to an affiliate of the bank. The 
regulation refers to this type of transaction as an ``indirect'' credit 
transaction. In these circumstances, the bank must value the credit 
transaction at the price paid by the bank for the loan plus any 
additional amount that the bank could be required to provide to, or on 
behalf of, the affiliate under the terms of the credit agreement.
    For example, if a bank pays a third party $90 for a $100 term loan 
that the third party previously made to an affiliate of the bank 
(because, for example, the loan was at a fixed rate and has declined in 
value due to a rise in the general level of interest rates), the 
covered transaction amount is $90 rather than $100. The lower covered 
transaction amount reflects the fact that the bank's maximum loss on 
the transaction is $90 rather than the original principal amount of the 
loan. If a bank pays a third party $70 for a $100 line of credit to an 
affiliate of which $70 had been drawn down by the affiliate, the 
covered transaction amount would be $100 (the $70 purchase price paid 
by the bank for the credit plus the remaining $30 that the bank could 
be required to lend under the credit line). For these indirect credit 
transactions, the regulation deems a bank to engage in a covered 
transaction at the moment during the day that the bank acquires the 
credit transaction from the third party.
    Although a bank's purchase of, or investment in, a debt security 
issued by an affiliate is considered an ``extension of credit'' under 
the regulation, these transactions are not valued like other extensions 
of credit. The valuation rules for purchases of, and investments in, 
the debt securities of an affiliate are set forth in section 223.10 of 
the rule, which is discussed in Part IV.C. below.
    Banks sometimes lend money to, or issue guarantees on behalf of, 
unaffiliated companies that later become affiliates of the bank. The 
regulation provides that credit transactions with a nonaffiliate become 
covered transactions at the time that the nonaffiliate becomes an 
affiliate of the bank. The Board does not believe that section 23A 
should be read to prevent the affiliation or to require that the 
indebtedness be reduced to meet the applicable section 23A quantitative 
limits before the affiliation occurs or thereafter. The bank must 
ensure, however, that any such credit transaction satisfies the 
collateral requirements of section 23A promptly after the nonaffiliate 
becomes an affiliate. The bank also must include the amount of any such 
transaction in the aggregate amount of its covered transactions for 
purposes of determining whether any future covered transactions would 
comply with the quantitative limits of section 23A.
    In cases where the bank entered into the credit transaction with 
the nonaffiliate in contemplation of the nonaffiliate becoming an 
affiliate of the bank, however, there is an additional requirement. In 
such cases, the bank must, at or prior to the time the nonaffiliate 
becomes an affiliate, reduce the aggregate amount of its covered 
transactions with affiliates if necessary so as not to exceed the 
quantitative limits of section 23A. The regulation provides an example 
of how section 23A applies in these circumstances.
B. Asset Purchases--223.9
    Regulation W provides that a purchase of assets by a bank from an 
affiliate initially must be valued at the total amount of consideration 
given by the bank in exchange for the asset. This consideration can 
take any form, and the regulation makes clear that it would include an 
assumption of liabilities by the bank.\27\ The regulation also 
indicates that an asset purchase remains a covered transaction for a 
bank for as long as the bank holds the asset, and that the value of the 
covered transaction after the purchase may be reduced to reflect 
amortization or depreciation of the asset, to the extent that such 
reductions are consistent with GAAP and are reflected on the bank's 
financial statements.\28\
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    \27\ The purchase by a bank of a security issued by an affiliate 
is addressed in Part IV.C. below, and the purchase by a bank of any 
other note or obligation of an affiliate is addressed in Part IV.A. 
above.
    \28\ The Board also has determined to treat certain bank-
affiliate merger and acquisition transactions as constructive asset 
purchases. These transactions are discussed in Part V.A. below.
---------------------------------------------------------------------------

    In contrast with credit transactions, an asset purchase from a 
nonaffiliate that later becomes an affiliate generally does not become 
a covered transaction for the purchasing bank. However, as set forth in 
the proposed rule, if a bank purchases assets from a nonaffiliate in 
contemplation of the nonaffiliate becoming an affiliate of the bank, 
the asset purchase becomes a covered transaction at the time the 
nonaffiliate becomes an affiliate. In addition, the bank must ensure 
that the aggregate amount of the bank's covered transactions (including 
any such asset purchase from the nonaffiliate) would not exceed the 
quantitative limits of section 23A at the time that the nonaffiliate 
becomes an affiliate.
    The regulation provides several examples designed to assist banks 
in valuing purchases of assets from an affiliate.
C. Purchases of and Investments in Securities Issued by an Affiliate--
223.10
    Section 23A includes as a covered transaction a bank's purchase of, 
or investment in, securities issued by an affiliate. Regulation W would 
require a bank to value a purchase of, or investment in, securities 
issued by an affiliate (other than a financial subsidiary, which is 
subject to special rules under the GLB Act) at the greater of the 
bank's purchase price or carrying value of the securities.\29\ Under 
the rule, a bank that pays no consideration in exchange for affiliate 
securities must nevertheless value the covered transaction at no less 
than the bank's carrying value for the securities.\30\ In addition, 
under the rule, if the bank's carrying value of the affiliate 
securities increased or decreased after the bank's initial investment 
(due to profits or losses at the affiliate), the amount of the bank's 
covered transaction would increase or decrease to reflect the bank's 
changing financial exposure to the

[[Page 24192]]

affiliate, but could not decline below the amount paid by the bank for 
the securities.
---------------------------------------------------------------------------

    \29\ The valuation rule for investments in securities issued by 
a financial subsidiary is discussed in Part V.B.2. below.
    \30\ Carrying value refers to the amount at which the securities 
are carried on the GAAP financial statements of the bank.
---------------------------------------------------------------------------

    The Board believes several considerations support the approach 
contained in the proposed regulation. First, the approach is generally 
consistent with GAAP, which would require the bank to reflect its 
investment in securities issued by an affiliate at carrying value 
throughout the life of the investment, even if the bank paid no 
consideration for the securities.
    Second, the definition of covered transaction in section 23A 
includes both a ``purchase of'' and an ``investment in'' securities 
issued by an affiliate. Accordingly, the statute by its terms appears 
to cover situations where a bank purchases securities of an affiliate 
and situations where a bank receives affiliate securities and pays no 
consideration. If the rule permitted banks to value these transactions 
only at purchase price, the ``investment in'' language of the statute 
would be rendered superfluous. The Board believes, moreover, that the 
statute's ``investment in'' language indicates that Congress was 
concerned with a bank's continuing exposure to an affiliate through an 
ongoing investment in securities issued by the affiliate. The best way 
to give effect to this concern and the ``investments in'' prong of the 
statutory definition is to base the value of a bank's investment in the 
securities of an affiliate on the bank's actual financial exposure to 
the investment (as reflected on the bank's GAAP financial statements), 
even if the bank paid nothing to acquire the securities.
    Third, amendments to section 23A made by the GLB Act indicate that 
the value of an investment in the securities of an affiliate under 
section 23A should reflect increases (or decreases) in the value of the 
securities caused by earnings (or losses) at the affiliate. In 
particular, the GLB Act defines a financial subsidiary of a bank as an 
affiliate of the bank, but specifically provides that the section 23A 
value of a bank's investment in the securities of a financial 
subsidiary does not include retained earnings of the subsidiary. The 
negative implication from this provision is that the section 23A value 
of a bank's investment in other affiliates includes the affiliates' 
retained earnings, which would be reflected in the bank's carrying 
value of the investment under the proposed valuation rule.
    Finally, this valuation rule is consistent with the purposes of 
section 23A--limiting the financial exposure of banks to their 
affiliates and promoting safety and soundness. The proposed rule would 
require a bank to revalue upwards the amount of an investment in 
affiliate securities only when the bank's exposure to the financial 
condition of the affiliate has increased (as reflected on the bank's 
financial statements) and the bank's capital has increased to reflect 
the higher value of the investment. In these circumstances, the 
valuation rule merely reflects the bank's greater financial exposure to 
the affiliate and promotes safety and soundness by reducing the bank's 
ability to engage in additional transactions with an affiliate as the 
bank's exposure to that affiliate increases.
    As noted above, the proposed rule provides that the section 23A 
value of a bank's investment in affiliate securities can be no less 
than the amount paid by the bank for the securities, even if the 
carrying value of the securities declines below that amount. The Board 
believes that this approach, although not consistent with GAAP, is 
reasonable because it establishes as a floor the amount of funds 
actually paid by the bank for the affiliate securities. Using the 
bank's purchase price for the securities as a floor for valuing the 
covered transaction also limits the ability of a bank to provide 
additional funding to an affiliate as the affiliate approaches 
insolvency. If the regulation were to value investments in securities 
issued by an affiliate strictly at carrying value, then the bank could 
lend more funds to the affiliate as the affiliate's financial condition 
worsened, because the carrying value of the affiliate's securities also 
would decline and thereby increase the bank's ability to provide 
additional funding under section 23A. This type of increasing support 
for an affiliate in distress is precisely what section 23A was intended 
to restrict.
    The regulation provides several examples designed to assist banks 
in valuing purchases of and investments in the securities of an 
affiliate.
D. Posting Securities Issued by an Affiliate as Collateral--223.11
    Section 23A defines as a covered transaction a bank's acceptance of 
securities issued by an affiliate as collateral for a loan or extension 
of credit to any person or company.\31\ This type of covered 
transaction has two classes: one in which the only collateral for the 
loan is affiliate securities; and another in which the loan is secured 
by a combination of affiliate securities and other collateral. Section 
23A does not explain how these different types of covered transactions 
should be valued for purposes of determining compliance with the 
quantitative limits of the statute.
---------------------------------------------------------------------------

    \31\ 12 U.S.C. 371c(b)(7)(D). This covered transaction only 
arises when the bank's loan is to a nonaffiliate. Under section 23A, 
the securities issued by an affiliate are not acceptable collateral 
for a loan or extension of credit to any affiliate. See 12 U.S.C. 
371c(c)(4). Moreover, if the proceeds of a loan that is secured by 
an affiliate's securities are transferred to an affiliate by the 
third party borrower (for example, to purchase assets or securities 
from the inventory of an affiliate), the loan should be treated as a 
loan to the affiliate. The loan must then be secured with collateral 
in an amount and of a type that meets the requirements of section 
23A for loans by a bank to an affiliate.
---------------------------------------------------------------------------

    As a general rule, Regulation W would value covered transactions of 
the first class, where the credit extension is secured exclusively by 
affiliate securities, at the full amount of the extension of credit. 
This approach reflects the difficulty of measuring the actual value of 
typically untraded and illiquid affiliate securities, and 
conservatively assumes that the value of the securities is equal to the 
full value of the loan that the securities collateralize. This position 
also reflects the traditional advice given by Board staff on this 
issue. Regulation W proposes an exception to the general rule where the 
affiliate securities held as collateral have a ready market. In that 
case, the transaction may be valued at the fair market value of the 
affiliate securities. The exception grants relief from staff's 
traditional position in those circumstances where the value of the 
affiliate securities is independently verifiable by reference to 
transactions occurring in a liquid market.\32\
---------------------------------------------------------------------------

    \32\ In either case, the transaction must comply with section 
23B; that is, the bank must obtain the same amount of affiliate 
securities as collateral on the credit extension that the bank would 
obtain if the collateral were not affiliate securities.
---------------------------------------------------------------------------

    Regulation W would value covered transactions of the second class, 
where the credit extension is secured by affiliate securities and other 
collateral, at the lesser of (i) the total value of the extension of 
credit minus the fair market value of the other collateral and (ii) the 
fair market value of the affiliate securities (if the securities have a 
ready market). Until 1999, staff advised banks to value this class of 
covered transactions at the total amount of the extension of credit. In 
January 1999, the staff modified its position on mixed collateral loans 
to permit banks to value these transactions in a manner similar to the 
proposed rule.\33\
---------------------------------------------------------------------------

    \33\ See Letter dated January 21, 1999, from J. Virgil 
Mattingly, General Counsel of the Board, to Bruce Moland. This 
letter set forth an opinion of Board staff that, for purposes of 
applying the quantitative limits in section 23A, such mixed-
collateral loans should be valued at the lesser of (1) the total 
amount of the loan less the fair market value of nonaffiliate 
collateral (if any), or (2) the fair market value of the affiliate's 
securities that are used as collateral.
---------------------------------------------------------------------------

    The Board believes that in situations in which a loan is secured by 
securities

[[Page 24193]]

of an affiliate and other collateral, it is reasonable to reflect the 
fair market value of the other collateral in determining whether, and 
to what extent, the loan should count towards the bank's section 23A 
quantitative limits. Under the proposed method of calculation for 
mixed-collateral loans, if a loan is fully secured by nonaffiliate 
collateral with a fair market value that equals or exceeds the loan 
amount, then the loan would not be included in the bank's quantitative 
limits for purposes of section 23A. If the loan is not fully secured by 
other collateral, then the maximum amount that the bank must count 
against its quantitative limits is the difference between the full 
amount of the loan and the fair market value of the nonaffiliate 
collateral. This methodology takes account of the bank's reliance on 
the value of nonaffiliate collateral in a loan transaction, while also 
recognizing that a portion of the loan may be supported by securities 
issued by an affiliate.
    The approach taken in Regulation W, however, is different from that 
of the 1999 interpretation in two respects. First, although the 1999 
interpretation allows banks to use the fair market value of the 
affiliate securities as an upper limit on the value of the transaction 
regardless of the liquidity of the affiliate securities, the regulation 
only would allow banks to use the value of the affiliate securities as 
an upper limit if the affiliate securities have a ready market. If the 
affiliate securities do not have a ready market, a bank could 
understate the market value of the securities in order to shrink the 
size of the covered transaction. Second, the regulation's ready market 
requirement would replace an implicit condition of the 1999 
interpretation that only a small amount of the total collateral could 
be affiliate securities. The valuation rule in Regulation W would apply 
regardless of the amount of affiliate collateral.
    The Board also notes that, under section 23A, a loan that is 
secured with any amount of an affiliate's securities must be consistent 
with safe and sound banking practices.\34\
---------------------------------------------------------------------------

    \34\ 12 U.S.C. 371c(a)(4).
---------------------------------------------------------------------------

V. Other Considerations under Section 23A--Subpart D

    Subpart D of the proposed rule would provide guidance to banks on 
three issues under section 23A: (i) merger and acquisition transactions 
between a bank and an affiliate; (ii) financial subsidiaries of a bank; 
and (iii) derivative transactions between a bank and an affiliate.
A. Bank-affiliate Merger and Acquisition Transactions--223.12
    Section 23A includes a purchase of assets from an affiliate and the 
purchase of, or investment in, securities issued by an affiliate within 
the definition of covered transaction. In the past, the Board has been 
required to apply these provisions to transactions where a bank 
directly or indirectly acquires an affiliate. There are three principal 
methods by which a bank acquires an affiliate. The first method is 
where a bank (or one of its subsidiaries that is not treated as an 
affiliate of the bank under section 23A (an ``operations subsidiary'')) 
directly purchases or otherwise acquires the affiliate's assets and 
assumes the affiliate's liabilities. In this case, the transaction is 
treated as a purchase of assets, and the covered transaction amount is 
equal to the amount paid by the bank for the affiliate's assets plus 
the amount of any liabilities assumed by the bank in the transaction.
    The second method is where a bank (or its operations subsidiary) 
acquires an affiliate by merger. Because a merger with an affiliate 
generally results in the bank acquiring all the assets of the affiliate 
and assuming all the liabilities of the affiliate, this transaction is 
effectively equivalent to the purchase and assumption transaction 
described in the previous paragraph. Accordingly, the merger 
transaction also is treated as a purchase of assets, and the covered 
transaction amount is again equal to the amount paid by the bank for 
the affiliate's assets (if any) plus the amount of any liabilities 
assumed by the bank in the transaction.
    The third method involves the contribution or sale of an 
affiliate's shares by the affiliate's parent to the bank (or its 
operations subsidiary). The Board previously has treated these 
transactions as a purchase of assets covered by section 23A where the 
bank paid consideration for the shares or the affiliate whose shares 
were contributed to the bank had liabilities to any affiliate of the 
bank.\35\
---------------------------------------------------------------------------

    \35\ See, e.g., Letter dated June 11, 1999, from Robert deV. 
Frierson, Associate Secretary of the Board, to Mr. Robert L. 
Anderson. Some institutions have argued that this treatment is too 
strict and that a covered transaction should be deemed to occur in 
connection with a share contribution only if there is a net transfer 
of value from the bank to the affiliate (that is, if the liabilities 
of the transferred company exceed the value of the assets of the 
company). In many internal reorganizations, the Board has found that 
the value of the assets of the transferred company was uncertain. In 
addition, the transactions often were motivated by funding problems 
at the transferred affiliate and by a desire to use the bank's 
resources to alleviate those funding needs. Soon after consummating 
such reorganizations, bank funds typically were used to pay down 
liabilities that the transferred company had to the parent holding 
company of the bank.
---------------------------------------------------------------------------

    The proposed rule does not alter the treatment of the first two 
types of transaction described above. The proposed rule does provide, 
however, a new treatment, which is consistent with the structure of 
section 23A, for the third type of transaction. The rule provides that 
the acquisition by a bank of securities issued by a company that was an 
affiliate of the bank before the acquisition is treated as a purchase 
of the assets of the company if (i) as a result of the transaction, the 
company becomes a subsidiary of the bank and ceases to be an affiliate 
of the bank; and (ii) the company has liabilities, or the bank gives 
cash or any other consideration in exchange for the securities. The 
rule also provides that such transactions must be valued initially at 
the sum of (i) the total amount of consideration given by the bank in 
exchange for the securities; and (ii) the total liabilities of the 
company whose securities have been acquired by the bank through the 
contribution or purchase. In effect, the rule requires banks to treat 
these sorts of share donations and purchases in the same manner as if 
the bank had purchased the assets of the transferred company at a 
purchase price equal to the liabilities of the transferred company 
(plus any separate consideration paid by the bank for the shares).
    This treatment for affiliate share transfers would be consistent 
with the approach that section 23A takes on subsidiaries of banks and 
with economic and marketplace realities. Section 23A treats banks and 
their operations subsidiaries as a single unit. Transactions between a 
bank and its operations subsidiaries are not treated as covered 
transactions between a bank and an affiliate under section 23A; rather, 
they are treated as transactions entirely inside the bank. Similarly, a 
transaction between a bank's operations subsidiary and an affiliate of 
the bank is treated as a covered transaction between the bank itself 
and an affiliate under section 23A. Ignoring the separate corporate 
form of subsidiaries of banks and treating the assets and liabilities 
of subsidiaries of banks as assets and liabilities of the bank itself 
is, therefore, consistent with the structure of section 23A. 
Accordingly, under section 23A, these share transfers in which an 
affiliate of a bank becomes a subsidiary of the bank are properly 
viewed as a purchase of an affiliate's assets and an assumption of an 
affiliate's liabilities by the bank.

[[Page 24194]]

    The proposed treatment for affiliate share transfers is also 
consistent with the Board's supervisory experience. The Board has found 
that banks often operate their consolidated organizations--because of 
capital requirements, financial reporting requirements, and 
reputational risk concerns--as if the assets and liabilities of 
subsidiaries were actually assets and liabilities of the bank itself. 
Banks often attempt to shore up their subsidiaries in times of 
financial stress, despite the limited liability inhering in the 
corporate form. Accordingly, the Board proposes to treat the assets and 
liabilities of a subsidiary of a bank as assets and liabilities of the 
bank itself for purposes of section 23A.\36\
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    \36\ Affiliate share transfers to a bank often are functionally 
equivalent to transactions in which a bank directly acquires the 
assets and assumes the liabilities of an affiliate, because a bank 
can usually merge the newly acquired subsidiary into itself. As 
noted above, in a direct acquisition of assets and assumption of 
liabilities, the covered transaction amount would be equal to the 
total amount of liabilities assumed by the bank.
---------------------------------------------------------------------------

    The proposed rule only imposes asset purchase treatment on 
affiliate share transfers where the company whose shares are being 
transferred to the bank was an affiliate of the bank before the 
transfer. If the transferred company were not an affiliate prior to 
transfer, it would not be appropriate to treat the share transfer as a 
purchase of the assets of an affiliate. Similarly, the rule only 
requires asset purchase treatment for share transfers where the 
transferred company becomes a subsidiary and not an affiliate of the 
bank through the transfer. If the company were not a subsidiary of the 
bank after the transfer (because, for example, the bank acquired less 
than 25 percent of a class of voting securities of the company) or if 
the company were an affiliate of the bank after the transfer (because, 
for example, the bank's holding company continued to own 25 percent or 
more of a class of voting securities of the company or because the 
company became a financial subsidiary of the bank after the transfer), 
the Board does not believe it would be appropriate to treat the 
liabilities of the company as the liabilities of the bank for purposes 
of section 23A. In those circumstances, section 23A would not treat the 
bank and the transferred company as a single unit.
    The Board solicits comment on whether this method of treating 
affiliate share transfers is appropriate.
    The Board notes that it has granted numerous section 23A 
exemptions, on a case-by-case basis, for transactions involving the 
transfer (by merger, purchase and assumption transaction, or otherwise) 
by a holding company of one of its nonbank subsidiaries to a subsidiary 
bank.\37\ The Board typically has approved such exemptions only if 
certain conditions are met, including (i) the transfer of the affiliate 
must be the result of a one-time corporate reorganization, (ii) the 
entity transferring the shares to the bank must provide certain 
assurances concerning the quality of the assets being transferred, 
(iii) the disinterested directors of the bank must approve the 
transaction in advance, (iv) the transfer must not include any low-
quality assets, and (v) the bank's appropriate Federal banking agency 
and the Federal Deposit Insurance Corporation must inform the Board 
that they have no objection to the transaction. Banks may continue to 
apply to the Board for such case-by-case exemptions.
---------------------------------------------------------------------------

    \37\ See, e.g., Travelers Group Inc. and Citicorp, 84 Federal 
Reserve Bulletin 985, 1013-14 (1998) and Letter dated November 14, 
1996, from William W. Wiles, Secretary of the Board, to John Byam.
---------------------------------------------------------------------------

    The proposed regulation also contains a regulatory exemption for 
certain merger and acquisition transactions that result in the transfer 
of an affiliate to a bank. Section 223.12(d) of the regulation provides 
an exemption from the requirements of section 23A (other than the 
safety and soundness requirement) for transactions in which, for 
example, a bank holding company acquires the stock of an unaffiliated 
company and, immediately after consummation of the acquisition, 
transfers the shares of the acquired company to the holding company's 
subsidiary bank. Although these transactions technically would be 
subject to the asset purchase treatment discussed in this section--and 
the bank would be required to value the covered transaction at the 
total amount of the liabilities of the acquired company (plus any 
consideration paid by the bank for the company)--the Board believes 
that it would be inappropriate to treat this transaction as a covered 
transaction. If the bank had acquired the unaffiliated company 
directly, there would be no covered transaction, and the mere fact that 
the bank's holding company owned the target company for a moment in 
time does not change the fundamental nature of the transaction.
    Accordingly, the regulation exempts these ``step'' transactions as 
long as certain conditions are met. First, the bank must acquire the 
target company immediately after the company becomes an affiliate (by 
being acquired by the bank's holding company, for example). To the 
extent that the bank acquires the target company some time after the 
company becomes an affiliate, the transaction looks less like a single 
transaction in which the bank acquires the target company and more like 
two separate transactions, the latter of which involves the bank 
acquiring assets from an affiliate. Second, the bank must acquire the 
entire ownership position in the target company that its holding 
company acquired. If the bank were to acquire less than all the shares 
or assets of the target company that its holding company acquired, the 
transaction again would not, in effect, involve the purchase of the 
company by the bank. Finally, the entire transaction must comply with 
the market terms requirement of section 23B.
B. Financial Subsidiaries--223.13
    As noted above, the GLB Act amended section 23A to treat a 
financial subsidiary of a bank as an affiliate of the bank and to 
establish several special rules that apply to transactions with 
financial subsidiaries. The proposed regulation combines all of the 
special rules that apply to transactions with financial subsidiaries in 
a single section.
    1. Applicability of the 10 percent quantitative limit to 
transactions with a financial subsidiary--223.13(a). First, consistent 
with the GLB Act, the regulation provides that the 10 percent 
quantitative limit in section 23A does not apply with respect to 
covered transactions between a bank and any individual financial 
subsidiary of the bank. Accordingly, a bank's aggregate amount of 
covered transactions with any individual financial subsidiary may 
exceed 10 percent of the bank's capital stock and surplus. A bank's 
covered transactions with its financial subsidiaries, however, are 
subject to the statutory and regulatory 20 percent quantitative limit. 
Thus, a bank may not engage in a covered transaction with any affiliate 
(including a financial subsidiary) if the bank's aggregate amount of 
covered transactions with all affiliates (including financial 
subsidiaries) would exceed 20 percent of the bank's capital stock and 
surplus.
    2. Valuation of investments in the securities of a financial 
subsidiary--223.13(b). Because financial subsidiaries of a bank are 
considered affiliates of the bank for purposes of section 23A, 
purchases of and investments in the securities of a financial 
subsidiary are covered transactions under the statute. The GLB Act 
provides that a bank's investment in its financial subsidiary, for 
purposes of section 23A, shall not include the retained earnings of the

[[Page 24195]]

financial subsidiary.\38\ In light of this statutory provision, the 
regulation contains a special valuation rule for investments in the 
securities of a financial subsidiary. Such investments must be valued 
at the greater of (i) the price paid by the bank for the securities; 
and (ii) the carrying value of the securities on the financial 
statements of the bank (determined in accordance with GAAP but without 
reflecting the bank's pro rata share of any earnings retained or losses 
incurred by the financial subsidiary after the bank's acquisition of 
the securities).\39\
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    \38\ GLB Act section 121(b)(1) (codified at 12 U.S.C. 
371c(e)(3)(B)).
    \39\ The regulation also makes clear that if a financial 
subsidiary is consolidated with its parent bank under GAAP, the 
carrying value of the bank's investment in the financial subsidiary 
shall be determined based on parent-only financial statements of the 
bank.
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    This valuation rule differs from the general ``investment in the 
securities of an affiliate'' valuation rule only in that the financial 
subsidiary rule requires, consistent with the GLB Act, that the 
carrying value of the investment be computed without consideration of 
the retained earnings or losses of the financial subsidiary since the 
time of the bank's investment. As a result of this rule, the covered 
transaction amount for a bank's investment in the securities of its 
financial subsidiary would not increase except in the event that the 
bank made an additional capital contribution to the subsidiary or 
purchased additional securities of the subsidiary.
    The regulation provides several examples designed to assist banks 
in valuing purchases of and investments in securities issued by a 
financial subsidiary.
    3. Anti-evasion rules--223.13(c). Section 23A generally applies 
only to transactions between a bank and an affiliate of the bank and 
transactions between a bank and a third party where some benefit of the 
transactions accrues to an affiliate of the bank. The statute generally 
does not apply to transactions between two affiliates. The GLB Act 
establishes two special anti-evasion rules, however, that govern 
transactions between a financial subsidiary of a bank and another 
affiliate of the bank.\40\ First, the GLB Act provides that any 
purchase of, or investment in, the securities of a bank's financial 
subsidiary by an affiliate of the bank will be deemed to be a purchase 
of, or investment in, such securities by the bank itself. Second, the 
GLB Act authorizes the Board to deem a loan or other extension of 
credit made by a bank's affiliate to any financial subsidiary of the 
bank to be an extension of credit by the bank to the financial 
subsidiary, if the Board determines that such action is necessary or 
appropriate to prevent evasions of the Federal Reserve Act or the GLB 
Act.
---------------------------------------------------------------------------

    \40\ GLB Act section 121(b)(1) (codified at 12 U.S.C. 
371c(e)(4)).
---------------------------------------------------------------------------

    The proposed regulation incorporates both of these provisions.\41\ 
The regulation also exercises the Board's authority under the second 
anti-evasion rule by stating that an extension of credit to a financial 
subsidiary of a bank by an affiliate of the bank would be treated as an 
extension of credit by the bank itself to the financial subsidiary if 
the extension of credit is treated as regulatory capital of the 
financial subsidiary. An example of the kind of credit extension 
covered by this provision would be a subordinated loan to a financial 
subsidiary that is a securities broker-dealer where the loan is treated 
as capital of the subsidiary under the SEC's net capital rules. The 
Board believes that such treatment is appropriate in these 
circumstances because the extension of credit by the affiliate has a 
similar effect on the subsidiary's regulatory capital as an equity 
investment by the affiliate, which is treated as a covered transaction 
by the terms of the GLB Act (as described above).
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    \41\ The proposed regulation also provides an exception to the 
anti-evasion rules for transactions between a bank's financial 
subsidiary and another affiliate if the other affiliate is itself a 
bank or savings association subject to section 23A. In that event, 
the anti-evasion rules are not needed because the transaction will 
count as a covered transaction for the affiliated bank or savings 
association. Without this exception, the same transaction would 
double count as a covered transaction both for the parent bank of 
the financial subsidiary and for the other affiliated institution.
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    The Board may find certain other extensions of credit by an 
affiliate to a financial subsidiary to be covered transactions under 
section 23A on a case-by-case basis. The Board seeks comment on the 
appropriateness of considering other classes of credit extensions by an 
affiliate to a financial subsidiary as extensions of credit by the bank 
to the financial subsidiary.
C. Derivative Transactions--223.14
    As noted above, the GLB Act requires the Board to address as 
covered transactions under section 23A credit exposure arising out of 
derivative transactions between banks and their affiliates.
    Determining the appropriate treatment for derivative transactions 
under section 23A is a complex and important endeavor. In light of the 
complexities of the subject matter and in light of the May 12, 2001, 
statutory schedule in the GLB Act, the Board is taking two steps to 
address credit exposure on bank-affiliate derivative transactions under 
sections 23A and 23B. First, the Board is publishing an interim rule, 
concurrently with Regulation W, that (i) requires, under section 23A as 
amended by the GLB Act, that a bank establish and maintain policies and 
procedures reasonably designed to manage the credit exposure arising 
from the bank's derivative transactions with affiliates and (ii) 
clarifies that bank-affiliate derivative transactions are subject to 
the market terms requirement of section 23B. The policies and 
procedures must at a minimum provide for monitoring and controlling the 
credit exposure arising from the bank's derivative transactions with 
each affiliate, and all affiliates in the aggregate, and ensuring that 
the bank's derivative transactions with affiliates comply with section 
23B.
    The second step that the Board is taking to address the credit 
exposure arising from bank-affiliate derivative transactions under 
section 23A is contained in this section of the preamble to Regulation 
W. This section sets forth a set of questions regarding the appropriate 
treatment of these transactions under section 23A. In connection with 
the interim rule and proposed Regulation W, the Board solicits public 
comment on the most appropriate treatment under section 23A of the 
credit exposure arising from bank-affiliate derivative transactions.
    In deciding how to address under section 23A credit exposure 
arising from derivative transactions, the initial question to be 
answered is how to define the term ``derivative transaction.'' The 
Board's interim rule on bank-affiliate derivatives defines the term by 
reference to the definition of ``derivative contract'' in the capital 
guidelines of the Federal banking agencies (``Capital 
Guidelines'').\42\ The definition contained in the Capital Guidelines 
covers swaps, forwards, options, and other similar contracts on an 
interest rate, currency, equity, or commodity. The interim rule 
supplements the definition contained in the Capital Guidelines by also 
including ``any similar derivative contract, including credit 
derivative contracts.'' This supplementation recognizes that derivative 
instruments evolve in response to the needs of the financial 
marketplace.
---------------------------------------------------------------------------

    \42\ 12 CFR part 225, appendix A.III.E.1.a-d.
---------------------------------------------------------------------------

    Other options would include defining derivative transaction by 
reference to the definition of ``qualified financial contract'' or 
``swap agreement'' in the

[[Page 24196]]

Federal Deposit Insurance Act \43\ or to borrow from definitions 
contained in the Bankruptcy Code. Another option would involve taking a 
broad, functional approach that defines a derivative transaction as ``a 
bilateral contract the value of which derives from the value of some 
underlying security, financial instrument, rate, index, event, 
commodity, or other asset or indicator.'' Although such a broad 
definition may be somewhat overinclusive and more ambiguous in scope 
than a targeted definition, it also may provide the Board with more 
flexibility in responding to market trends.
---------------------------------------------------------------------------

    \43\ See 12 U.S.C. 1821(e)(8)(D)(i) and (vi).
---------------------------------------------------------------------------

    The remainder of this section seeks comment on a set of questions 
regarding how the Board should address bank-affiliate derivative 
transactions under section 23A.
    First, the Board notes that some derivative transactions--like deep 
in-the-money options or swaps with an exchange of principal on 
different dates--are the functional equivalent of a loan, which is an 
explicit type of covered transaction under section 23A. Although the 
Board is not aware that banks and their affiliates are entering into 
these types of derivative transactions, the Board expects that it may 
need to address these derivatives separately from the other types of 
derivatives because of their functional equivalence to an existing type 
of covered transaction under the statute. In this regard, the Board 
solicits comment on how to determine when a derivative transaction is 
(or contains an aspect that is) the functional equivalent of a loan by 
a bank to an affiliate. The Board believes that it may be appropriate 
to treat such a derivative transaction (or the relevant part of the 
transaction that functions as a loan) as a loan from the bank to the 
affiliate for purposes of section 23A.
    The Board requests comment on whether and how Regulation W should 
provide additional guidance for banks on identifying derivative 
transactions that are, or have aspects that are, the functional 
equivalent of a loan. The Board understands that the Internal Revenue 
Service has adopted a regulation that requires financial institutions, 
for tax purposes, to recharacterize as loans portions of certain swap 
and other derivative transactions based on the significance of any 
nonperiodic payments provided for under the terms of the 
transaction.\44\ The Board requests comment on whether the standards 
used by the Internal Revenue Service to determine the inherent loan 
elements of a swap transaction also would be appropriate for the Board 
to use for section 23A purposes. The Board also solicits comment on 
whether the regulation should treat the entirety of a bank-affiliate 
derivative transaction as a loan under section 23A if any portion of 
the transaction is the functional equivalent of a loan or should impose 
loan treatment only on that portion of the transaction that functions 
as a loan.
---------------------------------------------------------------------------

    \44\ 26 CFR 1.446-3.
---------------------------------------------------------------------------

    The Board also asks for public comment on whether Regulation W 
should provide a separate treatment for any other specific types of 
derivatives. In particular, the Board seeks comment on whether a credit 
derivative between a bank and an affiliate in which the bank provides 
credit protection to the affiliate with respect to the affiliate's 
assets should be treated as a covered transaction and made subject to 
all the requirements of section 23A. Such a credit derivative generates 
risks for the bank that closely resemble the risks incurred by a bank 
when it purchases assets from an affiliate. The Board notes that a 
credit derivative transaction between a bank and an unaffiliated 
company that references the obligations of an affiliate of the bank and 
is the functional equivalent of a guarantee by the bank on behalf of 
the affiliate is a guarantee by the bank on behalf of an affiliate for 
purposes of section 23A.
    Second, the Board asks whether banks should be required to adopt 
any specific policies and procedures with respect to their derivative 
transactions with affiliates. These policies and procedures might 
include provisions that require a bank to adopt the following ``best 
practices'': (i) entering into a legally enforceable bilateral netting 
agreement with each of its affiliated derivatives counterparties; (ii) 
revaluing its derivative transactions with affiliates on a daily basis; 
and (iii) collateralizing its net mark-to-market credit exposure on 
derivative transactions with affiliates. The Board asks for comment on 
the appropriateness of requiring these types of policies and procedures 
and on whether additional policies or procedures should be required to 
ensure that a bank's derivative transactions with affiliates are 
conducted safely and soundly.
    Third, the Board solicits comment on whether banks should be 
required to disclose to Federal bank supervisors or the public, on a 
quarterly or other periodic basis, their net credit exposure to 
affiliates on derivative transactions. The Board solicits comment on 
the types of disclosures that banks reasonably could be required to 
provide with respect to their derivative transactions with affiliates 
in order to assist the Federal banking agencies in monitoring and 
supervising such transactions.
    Fourth, the Board invites comment on whether any final rule 
addressing bank-affiliate derivatives should impose a quantitative 
limit on the aggregate amount of a bank's net credit exposure on such 
transactions. The rule could require that the aggregate amount of a 
bank's net credit exposure on derivative transactions with affiliates 
not exceed some percentage of the capital stock and surplus of the 
bank, unless the bank obtains the prior approval of its appropriate 
Federal banking agency. Such a separate limit for derivatives would be 
in addition to the general 20 percent limit for covered transactions 
with all affiliates under section 23A. The Board asks for comment on 
whether 10 percent of the bank's capital stock and surplus would be an 
appropriate size for a separate cap on net derivatives credit exposure 
that a bank has to affiliates. Instead of establishing a separate 
limit, the rule could require that a bank incorporate its net credit 
exposure arising from derivative transactions with affiliates into its 
overall section 23A quantitative limits. The Board seeks comment on the 
appropriateness of either of these alternatives.
    Fifth, the Board asks whether banks should be required to 
collateralize their net derivatives credit exposure to affiliates in 
accordance with the collateral requirements of section 23A.
    Finally, in the event that the Board were to impose a quantitative 
limit on bank-affiliate derivative transactions (whether by 
establishing a separate limit for derivatives or by requiring banks to 
include derivatives in their overall section 23A limits), the Board 
seeks comment on how banks should be required to determine the amount 
of their derivative transactions with affiliates. One valuation option 
would be to require banks to value a derivative transaction with an 
affiliate at the current exposure of the bank to the affiliate on the 
transaction. Under this option, the amount of a bank's section 23A 
exposure to an affiliate on a derivative transaction would be based on 
the mark-to-market value of the transaction for the bank. If the mark-
to-market value of the transaction were positive, then the current 
exposure would be that mark-to-market value. If the mark-to-market 
value were zero or negative, the current exposure would be zero. The 
Board specifically asks for comment on whether these mark-to-market 
values should be adjusted to reflect counterparty credit quality.

[[Page 24197]]

    Another valuation option would require banks to value a derivative 
transaction with an affiliate at the current exposure of the bank to 
the affiliate on the transaction plus an estimate of the bank's 
potential future exposure (``PFE'') to the affiliate on the 
transaction. This is the approach to measuring derivatives exposure 
that most banks take with third parties and that the Federal banking 
agencies have taken in the Capital Guidelines.\45\ The Board seeks 
comment on whether banks should be required to include an estimate of 
PFE when determining the amount of their credit exposure on bank-
affiliate derivative transactions and, if so, how banks should be 
required to calculate PFE.
---------------------------------------------------------------------------

    \45\ See, e.g., 12 CFR part 225, appendix A.III.E.2.
---------------------------------------------------------------------------

    PFE could be measured in a wide variety of ways. The Capital 
Guidelines provide one possible methodology. Under the Capital 
Guidelines, a bank calculates its PFE by multiplying the notional 
principal amount of the derivative transaction times a conversion 
factor specified in the Guidelines that varies depending upon the 
remaining maturity of the derivative transaction and the nature of the 
asset underlying the derivative transaction. This methodology has the 
benefits of being easy to calculate and of being a method that is 
already employed by banks for regulatory capital purposes and, 
consequently, eliminates the burden that would attend a requirement for 
a different calculation method. The methodology has the drawback of 
being rather insensitive to gradations of risk and rather conservative 
in its estimates of PFE. Another possible PFE computation methodology 
would be to permit banks with sophisticated internal models to use 
those models to calculate their PFE on bank-affiliate derivative 
transactions. The Board also seeks comment on whether the appropriate 
time horizon for estimating PFE on a derivative transaction is the 
remaining maturity of the transaction or some shorter ``close-out'' 
period.
    The Board also invites comment on whether and how banks should be 
allowed to take into account credit risk mitigators such as collateral 
in determining the amount of their derivative transactions with 
affiliates. Under section 23A, transactions fully secured by cash on 
deposit or U.S. government or agency securities are generally exempt 
from the requirements of the statute. Outside of this exemption, the 
statute does not allow banks to reduce the amount of a covered 
transaction by securing the transaction with collateral or obtaining a 
third-party guarantee of the transaction. Transactions secured by 
municipal securities, corporate debt or equity securities, or real 
estate, for example, are treated the same as unsecured transactions for 
purposes of the quantitative limits of the statute.
    The Board solicits comment on whether Regulation W should provide 
banks with partial credit for partially securing derivative 
transactions with affiliates. The Board also solicits comment on what 
types of collateral the regulation should recognize for the purpose of 
reducing the section 23A credit exposure of a bank to its affiliates on 
derivative transactions. As noted, the only types of collateral that 
have an impact on a bank's quantitative limits under the terms of 
section 23A are cash on deposit and U.S. government and agency 
securities. The Board could use this same limited list of collateral 
with respect to bank-affiliate derivative transactions. The Board seeks 
comment on whether it should expand the list of collateral acceptable 
for reducing the section 23A amount of these transactions and, if so, 
what kinds of other collateral should be acceptable as credit risk 
mitigators for the transactions, and what haircuts should apply to any 
added collateral types.
    The Board also solicits the public's view on how, if the general 10 
and 20 percent quantitative limits of section 23A are applied to bank-
affiliate derivative transactions, increased credit exposure of the 
bank to an affiliate on a pre-existing derivative transaction should be 
treated. For example, a bank could be required promptly to unwind 
existing derivatives or other covered transactions or otherwise 
promptly reduce the amount of its exposure to affiliates in order to 
restore itself to compliance with the quantitative limits of section 
23A in the event that the credit exposure on a derivative transaction 
causes the bank to exceed the limits. Alternatively, a bank could be 
allowed to retain existing derivative transactions and only be required 
to cease engaging in new covered transactions until the bank's 
aggregate amount of covered transactions falls below the statute's 
quantitative limits.
    If the Board were to determine that bank-affiliate derivative 
transactions are subject to some sort of quantitative limit under 
section 23A, the Board would have to address the question of whether 
and how to recognize netting agreements. The Board solicits comment on 
whether it should recognize bilateral netting agreements when computing 
the amount of a bank's derivatives credit exposure to an affiliate and, 
if so, whether the principles set forth in the Capital Guidelines are 
appropriate minimum requirements for determining what is a qualifying 
netting agreement.\46\
---------------------------------------------------------------------------

    \46\ See, e.g., 12 CFR part 225, appendix A.III.E.3.
---------------------------------------------------------------------------

    In addition, the Board solicits comment on how often a bank should 
mark to market its derivative transactions with affiliates. The Board 
requests information on how often banks mark to market their derivative 
transactions with third parties and on the potential burden and 
benefits of requiring banks to mark to market their derivative 
transactions with affiliates on a daily basis.
    As a more general matter, the Board invites comment on whether it 
is necessary or appropriate to grandfather existing derivative 
transactions between banks and their affiliates. The Board understands 
that, depending on the approach ultimately taken on bank-affiliate 
derivatives, bringing existing derivative transactions into compliance 
with Regulation W may require expensive and time-consuming adjustments 
to positions or renegotiation of agreements and, if existing exposures 
are above any quantitative limits established by Regulation W, may 
prevent banks from engaging in future derivative transactions with 
affiliates.
    The Board will analyze comments on this proposal and the 
concurrently issued interim final rule on derivative transactions. If, 
based on that analysis, the Board believes additional measures are 
needed in this area, the Board will issue a detailed proposed rule for 
public comment.

VI. Exemptions--Subpart E

    Section 23A specifies several types of transaction that are exempt 
from the statute's quantitative and collateral requirements and other 
types of transaction that are exempt from the statute's quantitative, 
collateral, and low-quality asset requirements.\47\ The proposed 
regulation sets forth the statutory exemptions, clarifies certain of 
these exemptions, and exempts several additional types of transactions. 
The clarifications and additional exemptions are discussed below.
---------------------------------------------------------------------------

    \47\ 12 U.S.C. 371c(d).
---------------------------------------------------------------------------

A. Sister-Bank Exemption--223.15(a) and (b)
    Section 23A(d)(1) exempts any transaction between a member bank and 
a ``bank'' if the member bank controls 80 percent or more of the voting 
securities of the bank, the bank controls 80 percent or more of the 
voting securities of the member bank, or a company controls 80 percent 
or more of the

[[Page 24198]]

voting securities of both the member bank and the bank.\48\ Section 23A 
states that the term ``bank'' includes ``any State bank, national bank, 
banking association, and trust company,'' and other federal law 
provides that an insured savings association should be treated as a 
``bank'' for purposes of the sister-bank exemption.\49\ Section 23A 
also provides the Board with authority to issue definitions consistent 
with the section as may be necessary to carry out the purposes of the 
section and to prevent evasions thereof.\50\
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    \48\ The sister-bank exemption in section 23A does not allow a 
bank to avoid any restrictions on sister-bank transactions that may 
apply to the bank under the prompt corrective action framework set 
forth in section 38 of the Federal Deposit Insurance Act (12 U.S.C. 
1831o) and regulations adopted thereunder by the bank's appropriate 
Federal bankings agency.
    \49\ 12 U.S.C. 371c(b)(5), 1468(a)(2).
    \50\ 12 U.S.C. 371c(f)(1).
---------------------------------------------------------------------------

    Regulation W proposes to clarify that the sister-bank exemption 
generally applies only to transactions between a bank (as defined in 
the regulation to mean a member bank or an insured nonmember bank), on 
the one hand, and an insured depository institution, on the other hand. 
Such an interpretation is consistent with the legislative intent behind 
the sister-bank exemption, which was to permit the flow of funds from 
one insured depository institution to another insured depository 
institution. In this regard, the Board notes that, under the cross-
guarantee provisions of the Federal Deposit Insurance Act, an insured 
depository institution is generally liable for any loss incurred by the 
FDIC in connection with the default of a commonly controlled insured 
depository institution.\51\ Without such an interpretation of the 
sister-bank exemption, a bank would be able to engage in unlimited 
covered transactions with certain uninsured depository affiliates. 
Permitting a bank to provide an unlimited amount of funding to an 
uninsured depository affiliate would contravene one of the principal 
purposes of the statute-protecting the deposit insurance funds from 
loss.\52\
---------------------------------------------------------------------------

    \51\ See 12 U.S.C. 1815(e).
    \52\ As noted above, a bank and its operations subsidiaries are 
considered a single unit for purposes of section 23A. Accordingly, 
under the statute and the proposed regulation, transactions between 
a bank (or its operations subsidiary) and the operations subsidiary 
of a sister insured depository institution generally are exempt 
under the sister-bank exemption.
---------------------------------------------------------------------------

B. Purchases of Loans on a Nonrecourse Basis--223.15(c)
    Under section 23A(d)(6), a bank may purchase loans on a nonrecourse 
basis from an affiliated ``bank'' exempt from section 23A, even if the 
transaction does not qualify for the sister-bank exemption under 
section 23A(d)(1). The proposed rule clarifies that the scope of this 
exemption parallels that of the sister-bank exemption by stating that 
this exemption applies to a bank's purchase of a loan on a nonrecourse 
basis from an affiliated insured depository institution.
    Section 23A(d)(6) also exempts the purchase from an affiliate of 
assets that have a readily identifiable market quotation. This 
exemption is set forth separately in the regulation for purposes of 
clarity and is discussed in detail below.
C. Correspondent Banking--223.16(a)
    Section 23A exempts from its quantitative limits and collateral 
requirements any deposit by a bank in an affiliated bank or affiliated 
foreign bank that is made in the ordinary course of correspondent 
business, subject to any restrictions that the Board may impose.\53\ 
The proposed rule provides that such deposits must represent ongoing, 
working balances maintained by the bank in the ordinary course of 
conducting the correspondent business. An occasional deposit in an 
affiliated institution would not be in the ordinary course of 
correspondent business. The proposed rule also indicates that 
correspondent deposits in an affiliated insured savings association are 
exempt if they otherwise meet the requirements of the exemption.
---------------------------------------------------------------------------

    \53\ 12 U.S.C. 371c(d)(2).
---------------------------------------------------------------------------

D. Fully Secured Credit Transactions--223.16(c)
    Section 23A exempts any credit transaction by a bank with an 
affiliate that is fully secured by obligations issued or guaranteed by 
the United States or its agencies or by a ``segregated, earmarked'' 
deposit account.\54\ The proposed rule clarifies that a deposit account 
meets the ``segregated, earmarked'' requirement only if the account 
exists for the sole purpose of securing the extension of credit and is 
so identified. This requirement would parallel the provision in section 
223.5(b)(1)(iv) of the rule relating to which deposits count toward the 
collateral requirements of section 23A. Thus, if an earmarked deposit 
is sufficient to fully secure the transaction, then the transaction is 
exempt under this section; if the deposit represents less than full 
security, then the amount of the deposit counts toward the required 
collateral under section 223.5(b).
---------------------------------------------------------------------------

    \54\ 12 U.S.C. 371c(d)(4).
---------------------------------------------------------------------------

E. Purchases of Assets with Readily Identifiable Market Quotes--
223.16(e)(1)
    Section 23A(d)(6) exempts the purchase of assets from an affiliate 
if the assets have a ``readily identifiable and publicly available 
market quotation'' and are purchased at their current market 
quotation.\55\ The Board generally has limited the availability of this 
exemption (the ``(d)(6) exemption'') to purchases of U.S. Treasury 
securities, securities issued by a U.S. government agency, and assets 
with market prices that are recorded in widely disseminated 
publications such as newspapers with a national circulation. Because 
only exchange-traded assets are recorded in such publications, the test 
ensures that the qualifying assets are traded actively enough to have a 
true ``market quotation'' and that examiners can verify that the assets 
are purchased at their current market quotation. Regulation W codifies 
this Board interpretation of the (d)(6) exemption and clarifies that 
the exemption applies to a bank's purchase of assets having a readily 
identifiable and publicly available market quotation if the assets are 
purchased at or below the asset's current market quotation.
---------------------------------------------------------------------------

    \55\ 12 U.S.C. 371c(d)(6).
---------------------------------------------------------------------------

F. Purchases of Securities with a Ready Market From a Securities 
Affiliate--223.16(e)(2)
    The Board proposed in its 1998 Proposal to exempt from section 23A 
the purchase by a bank of certain types of securities from a securities 
affiliate.\56\ The Board has determined to adopt a somewhat revised 
form of this expanded (d)(6) exemption in a separate final rule being 
issued concurrently with Regulation W. Regulation W also contains this 
exemption, and the Board seeks further comment on the scope and 
conditions of the exemption. In particular, the Board solicits the 
views of the public on (i) whether the exemption should be limited to 
purchases from registered U.S. securities broker-dealers; (ii) whether 
it would be appropriate to use independent dealer quotations to 
establish a market price for a security under the exemption; and (iii) 
whether it would be appropriate to allow a bank to use the exemption to 
purchase asset-backed securities issued by an affiliate of the bank or 
to purchase securities

[[Page 24199]]

issued by a mutual fund advised by the bank or an affiliate of the 
bank.
---------------------------------------------------------------------------

    \56\ 63 FR 32768, June 11, 1998.
---------------------------------------------------------------------------

G. Purchasing Municipal Securities--223.16(f)
    The Board also proposes to exempt a bank's purchase of municipal 
securities from an affiliate, if the purchase meets a revised and 
somewhat shorter version of the requirements applicable to the expanded 
(d)(6) exemption contained in section 223.16(e)(2) of the proposed 
rule.\57\ First, as in the expanded (d)(6) exemption, the bank must 
purchase the municipal securities from a broker-dealer affiliate that 
is registered with the SEC. Second, also as in the expanded (d)(6) 
exemption, the municipal securities must be eligible for purchase by a 
State member bank and the bank must report the transaction as a 
securities purchase in its Call Report. Third, the municipal securities 
must either be rated by a nationally recognized statistical rating 
organization or must be part of an issue of securities that does not 
exceed $25 million in size. Finally, the price for the securities 
purchased must be (i) quoted routinely on an unaffiliated electronic 
service that provides indicative data from real-time financial 
networks, (ii) verified by reference to two or more actual independent 
dealer quotes on the securities to be purchased or securities that are 
comparable to the securities to be purchased, or (iii) in the case of 
securities purchased during the underwriting period, verified by 
reference to the price indicated in the syndicate manager's written 
summary of the underwriting.\58\ Under any of the three pricing 
options, the bank must purchase the municipal securities at or below 
the quoted or verified price.
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    \57\ The regulation defines municipal securities by reference to 
section 3(a)(29) of the Securities Exchange Act, which defines 
municipal securities as direct obligations of, or obligations 
guaranteed as to principal or interest by, a State or agency, 
instrumentality, or political subdivision thereof, and certain tax-
exempt industrial development bonds. 17 U.S.C. 78c(a)(29).
    \58\ Under the Municipal Securities Rulemaking Board's Rule G-
11, the syndicate manager for a municipal bond underwriting is 
required to send a written summary to all members of the syndicate. 
The summary discloses the aggregate par values and prices of bonds 
sold from the syndicate account.
---------------------------------------------------------------------------

    The Board believes that this streamlined set of requirements for 
purchases of municipal securities is appropriate because municipal 
obligations generally have a lower default risk than the other 
instruments whose quotations would be difficult to obtain, such as 
emerging market and high yield debt. In addition, these relaxed 
requirements are consistent with the expressed desire of Congress to 
support local communities' use of municipal securities to help meet 
their financing needs.
H. Purchases of Assets by De Novo Banks--223.16(h)
    The proposed rule would exempt a purchase of assets by a newly 
chartered bank from an affiliate if the appropriate Federal banking 
agency for the bank approved the transfer. This exemption would allow 
companies to charter a de novo bank and to transfer assets to the bank 
from its affiliates outside the restrictions of section 23A.\59\ 
Currently, if a company (usually a bank holding company) establishes a 
credit card bank or a trust company, the newly chartered institution 
cannot acquire a critical mass of assets from an affiliate because of 
the quantitative limits and other requirements of section 23A. The 
Board has received many comments that these restrictions are burdensome 
and unnecessary because the chartering authority for the new bank 
reviews the transaction (and, in the case of a bank holding company, 
the Board also reviews the transaction) to ensure that the transfer 
does not result in any safety or soundness problems. For this reason, 
the Board has proposed the exemption.
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    \59\ The Board also would not consider such transfers to be 
subject to the requirements of section 23B.
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I. Transactions Approved Under the Bank Merger Act--223.16(i)
    The Board previously has exempted from section 23A any merger or 
consolidation transaction between affiliated insured depository 
institutions if the transaction has been approved by the appropriate 
Federal banking agency pursuant to the Bank Merger Act.\60\ The 
proposed rule includes this exemption.
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    \60\ 12 CFR 241.
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J. Purchases of Extensions of Credit--223.16(j)
    Section 23A includes as a covered transaction a purchase of assets 
from an affiliate, except such purchases of real and personal property 
as may be specifically exempted by the Board by order or 
regulation.\61\ In 1979, the Board issued a formal interpretation that 
exempted a bank's purchase of a mortgage note or participation therein 
from a mortgage banking affiliate, provided that the bank's commitment 
to purchase is (i) obtained by the affiliate within the context of each 
proposed loan, (ii) obtained prior to the affiliate's commitment to 
make each loan, and (iii) based upon the bank's independent evaluation 
of the creditworthiness of each mortgagor (the ``250.250 
exemption'').\62\ Although this interpretation did not impose a strict 
dollar limit on the amount of an affiliate's mortgage loans that a bank 
could purchase under the exemption, the interpretation cautioned that 
the purpose of the exemption was to allow a bank to take advantage of 
an investment opportunity and not to provide all the working capital 
needed by an affiliate.
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    \61\ 12 U.S.C. 371c(b)(7)(C).
    \62\ 12 CFR 250.250.
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    By 1995, some bank holding companies were using the 250.250 
exemption extensively to fund their lending affiliates. In these cases, 
banks were providing all or nearly all of their affiliates' funding 
needs. In response, staff indicated in an interpretive letter that the 
250.250 exemption was not available if the dollar amount of the bank's 
purchases from the affiliate represented more than 50 percent of the 
total dollar amount of loans originated by the affiliate.\63\ Staff 
reasoned that, in these circumstances, the asset purchases look less 
like the bank taking advantage of an investment opportunity brought to 
it by the affiliate and more like the bank providing an ongoing funding 
mechanism for the affiliate. Staff intended that this restriction would 
require the affiliate to have alternative funding sources and reduce 
the pressure on the bank to purchase the affiliate's extensions of 
credit.
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    \63\ See Letter dated April 24, 1995, from J. Virgil Mattingly, 
General Counsel of the Board, to William F. Kroener, III; see also 
Letter dated January 21, 1987, from Michael Bradfield, General 
Counsel of the Board, to Jeffrey C. Gerrish.
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    The proposed rule incorporates the 250.250 exemption and formally 
expands the exemption to cover the purchase of any type of loan or 
extension of credit from an affiliate. Regulation W also includes 
staff's 50 percent test and another test designed to ensure that the 
bank is not a principal ongoing funding source for the affiliate. In 
particular, the rule provides that the 250.250 exemption is unavailable 
if (i) the amount of the bank's total purchases from the affiliate, 
when aggregated with all other assets purchased from the affiliate by 
affiliated banks and insured savings associations, represents more than 
50 percent of the credit portfolio of the affiliate; or (ii) the bank 
and its affiliated banks and insured savings associations provide 
substantial, ongoing funding to the affiliate. The Board recognizes 
that the ``substantial, ongoing funding'' condition may create some 
uncertainty for banks, but believes that the condition would provide 
examiners with additional flexibility to stop arrangements in which a 
bank provides a significant amount of

[[Page 24200]]

funding to an affiliated lending company but does not provide a 
majority of the affiliate's working capital. The Board seeks comment on 
whether the regulation should contain staff's 50 percent test or the 
``substantial, ongoing funding'' test.
    The Board also seeks comment on whether the rule should limit the 
amount of assets that a bank may purchase from an affiliate pursuant to 
the 250.250 exemption to some percentage of the bank's total assets. 
The Board recently reviewed a case where a nonbanking company proposed 
to charter a bank for the sole purpose of purchasing loans or leases 
from the nonbanking company. In these circumstances, a bank's credit 
underwriting process may be compromised as a result of the complete 
dependence of the bank on the affiliate for asset growth. Prohibiting a 
bank from using the 250.250 exemption to accumulate a substantial 
percentage of its assets may help prevent such compromises.
    The Board notes that the 250.250 exemption only applies to the 
initial purchase of assets by the bank and not any covered transaction 
that may result from the bank's ongoing holding of the asset purchased. 
For example, if a bank purchases from the selling affiliate a loan 
originated by the selling affiliate to a second affiliate, the 
exemption may exempt the bank's purchase of the loan, but it would not 
exempt the ongoing extension of credit by the bank to the second 
affiliate that results from the purchase.
    To qualify for this exemption, a bank must independently review the 
creditworthiness of each obligor prior to committing to purchase each 
loan. The Board does not believe that a bank can satisfy this 
requirement by simply having its affiliates use the bank's underwriting 
standards or the underwriting standards of the Federal National 
Mortgage Association or any other government agency or government-
sponsored enterprise. The bank must itself review and approve each loan 
prior to giving a purchase commitment to its affiliate. Consistent with 
the Board's published interpretation on this exemption, the bank also 
must not make a legally enforceable blanket advance commitment to 
purchase a stipulated amount of loans from the affiliate.
K. Intraday Extensions of Credit--223.16(k)
    As noted above, the GLB Act requires the Board to ``address as 
covered transactions credit exposure arising out of * * * intraday 
extensions of credit'' by banks to their affiliates. Banks regularly 
provide transaction accounts to their affiliates in conjunction with 
providing payment and securities clearing services. As in the case of 
unaffiliated commercial customers, these accounts are subject to 
overdrafts during the day that are repaid in the ordinary course of 
business. The Board has not to date ruled on whether these or other 
types of intraday credit extensions are covered transactions under 
section 23A or are subject to the market terms requirement of section 
23B. Industry practice does not treat an intraday credit extension as 
subject to sections 23A or 23B unless the extension remains outstanding 
at the end of the day.\64\
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    \64\ The text of section 23A in no way suggests that a 
transaction must extend overnight to qualify as an extension of 
credit.
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    Existing business practices indicate that the potential risk 
reduction benefits afforded by full application of the requirements of 
section 23A to intraday credit exposures may not justify the costs to 
banking organizations of implementing these requirements at this time. 
Intraday overdrafts and other forms of intraday credit extensions are 
generally not used as a means of funding or otherwise providing 
financial support for an affiliate. Rather, these credit extensions 
typically facilitate the settlement of transactions between an 
affiliate and its customers when there are mismatches between the 
timing of funds sent and received during the business day. Although 
some risk exists that such intraday credit extensions could turn into 
overnight funding of an affiliate, this risk may be sufficiently remote 
that the strict collateral and other requirements of section 23A would 
not be warranted for the intraday credit exposure. Moreover, mandating 
that banks collateralize intraday exposures could require banks to 
measure exposures across multiple accounts, offices, and systems on a 
global basis and to adjust collateral holdings in real time throughout 
the day. The Board seeks comment on whether banks currently have these 
capabilities and, if not, whether they would be costly to implement.
    Regulation W would provide that an intraday extension of credit is 
not subject to the quantitative limits or collateral requirements of 
section 23A if the credit extension arises in connection with the 
performance by a bank, in the ordinary course of business, of 
securities clearing and settlement transactions or payment transactions 
(for example, wire transfers, check clearing, and ACH transactions) on 
behalf of an affiliate, and the bank (i) has no reason to believe that 
the affiliate will have difficulty repaying the extension of credit in 
the ordinary course of business; (ii) establishes limits on the net 
amount of intraday credit that the bank may extend to affiliates; and 
(iii) establishes and maintains policies and procedures for assessing 
affiliate credit quality, monitoring each affiliate's compliance with 
the established limits, reviewing intraday credit extensions to an 
affiliate in the event of the affiliate's violation of the limits, and 
ensuring that intraday credit received by each affiliate complies with 
section 23B. The bank also must maintain records and supporting 
information that are sufficient to enable the appropriate Federal 
banking agency for the bank to review the position limits and required 
policies and procedures.
    Intraday extensions of credit by a bank to an affiliate that do not 
meet the conditions set forth above would be subject to the 
quantitative, collateral, and other requirements of section 23A. All 
intraday extensions of credit by a bank to an affiliate, including 
those that meet the conditions set forth above, would be subject to the 
market terms requirement of section 23B.
    Under Regulation W, all intraday credit extensions (on a worldwide 
basis) that exist at the end of the bank's business day in the United 
States would become subject to section 23A at that time. The Board 
requests comment on whether the regulation should adopt a different 
rule for determining when an ``intraday'' exposure become an 
``overnight'' exposure. In particular, the regulation could provide 
that an ``intraday'' exposure becomes an ``overnight'' exposure at the 
end of the bank's business day in the local jurisdiction in which the 
credit was extended.\65\
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    \65\ If the Board were to take this approach, the regulation may 
also have to require that a bank not transfer any intraday credit 
extensions to other jurisdictions. Such a requirement may be 
necessary to prevent a bank from cycling its ``intraday'' 
transactions around the world to prevent them from ever becoming 
``overnight'' exposures.
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    The Board may adopt a different approach to intraday credit under 
section 23A if it finds that banks are not implementing satisfactory 
controls to measure, monitor, and limit intraday credit extensions to 
affiliates. The Board requests comment on prudent risk management 
measures for intraday credit exposures.
    The Board also requests comment on whether the Board should find 
that other types of intraday credit, not related to payment 
transactions or securities clearing and settlement

[[Page 24201]]

transactions effected through an affiliate's transaction accounts at 
the bank, should be exempt from the quantitative limits and collateral 
requirements of section 23A. In particular, the Board understands that 
some credit card banks issue special purpose credit cards that 
customers may use only at affiliates of the bank. These banks extend 
credit on an intraday basis to their credit card customers to enable 
the customers to purchase goods or services from the banks' affiliates. 
At the end of the day, however, many of these banks sell their credit 
card receivables to a third party or to another affiliate to prevent 
the extensions of credit from becoming overnight credits subject to 
section 23A.\66\ These intraday credit extensions would be covered 
transactions subject to all the requirements of section 23A under 
Regulation W.\67\
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    \66\ Other credit card banks avoid section 23A by securing their 
receivables with a segregated, earmarked deposit account.
    \67\ Under section 23A and the proposed rule, an extension of 
credit by a bank to a third party where the proceeds of the 
transaction are used for the benefit of, or transferred to, an 
affiliate of the bank is a covered transaction between the bank and 
the affiliate. 12 U.S.C. 371c(a)(2).
---------------------------------------------------------------------------

    Finally, the Board requests comment on how long a transition period 
banks need to put the necessary policies and procedures in place in 
order to take advantage of the exemption for intraday credit 
extensions.

VII. General Provisions of Section 23B-Subpart F

    Subpart F of the proposed regulation sets forth the principal 
restrictions of section 23B. These include (i) the requirement that 
certain transactions between a bank and its affiliates be on terms and 
circumstances that are substantially the same as those prevailing at 
the time for comparable transactions with nonaffiliates; (ii) the 
restriction on a bank's purchase as fiduciary of assets from an 
affiliate; (iii) the restriction on a bank's purchase, during the 
existence of an underwriting syndicate, of any security if a principal 
underwriter of the security is an affiliate; and (iv) the prohibition 
on a bank's or its affiliate's publishing an advertisement or entering 
into an agreement stating that the bank will be responsible for the 
obligation of its affiliates. For the most part, subpart F restates the 
operative provisions of section 23B, and these provisions are not 
discussed below. The remainder of this section highlights four areas in 
which Regulation W provides additional guidance on section 23B.
A. Transactions Exempt from Section 23B-223.19(a)(1)
    The market terms requirement of section 23B applies to, among other 
transactions, any ``covered transaction'' between a bank and an 
affiliate.\68\ Section 23B(d)(3) makes clear that the term ``covered 
transaction'' in section 23B has the same meaning as the term ``covered 
transaction'' in section 23A, but does not include any transaction that 
is exempt under section 23A(d)-for example, transactions between sister 
banks, transactions fully secured by a deposit account or U.S. 
government securities, and purchases of assets from an affiliate at a 
readily identifiable and publicly available market quotation. The 
regulation also excludes from section 23B any covered transaction that 
is exempt from section 23A under section 223.17(h) or (i) of Regulation 
W (that is, asset purchases by a de novo bank and transactions approved 
as part of a bank merger). The Board is proposing to exclude from 
section 23B this additional set of transactions because, in each case, 
the appropriate Federal banking agency for the bank involved in the 
transaction would be expected to ensure that the terms of the 
transaction are not unfavorable to the bank.
---------------------------------------------------------------------------

    \68\ 12 U.S.C. 371c-1(a)(2)(A).
---------------------------------------------------------------------------

B. Purchases of Securities for Which an Affiliate is the Principal 
Underwriter-223.20(b)
    The GLB Act amended section 23B in one respect. Since its passage 
in 1987, section 23B(b)(1)(B) has prohibited a bank, whether acting as 
principal or fiduciary, from purchasing securities during the existence 
of an underwriting or selling syndicate if a principal underwriter of 
the securities is an affiliate of the bank.\69\ Prior to the GLB Act, a 
bank could escape this prohibition only if a majority of the outside 
directors of the bank approved the securities purchase before the 
securities were initially offered to the public.\70\ The GLB Act 
permits a bank to purchase securities during an underwriting conducted 
by an affiliate if the following two conditions are met. First, a 
majority of the directors of the bank (with no distinction drawn 
between inside and outside directors) must approve the securities 
purchase before the securities were initially offered to the public. 
Second, such approval must be based on a determination that the 
purchase would be a sound investment for the bank irrespective of the 
fact that an affiliate of the bank is a principal underwriter of the 
securities.\71\ The proposed regulation incorporates this new standard 
and clarifies that if a bank proposes to make such a securities 
purchase in a fiduciary capacity, then the directors of the bank must 
base their approval on a determination that the purchase is a sound 
investment for the person on whose behalf the bank is acting as 
fiduciary.
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    \69\ 12 U.S.C. 371c-1(b)(1)(B).
    \70\ Many smaller banking organizations had difficulty meeting 
this standard because most or all of their banks' directors were 
officers or employees of the banks or affiliates of the banks.
    \71\ GLB Act section 738 (codified at 12 U.S.C. 371c-1(b)(2)).
---------------------------------------------------------------------------

    Obviously, a bank may satisfy this director approval requirement by 
obtaining specific prior director approval of each securities 
acquisition otherwise prohibited by section 23B(b)(1)(B). The 
regulation clarifies, however, that a bank also may satisfy this 
director approval requirement if a majority of the directors of the 
bank approve appropriate standards for the bank's acquisition of 
securities otherwise prohibited by section 23B(b)(1)(B) and each such 
acquisition meets the standards adopted by the directors. In addition, 
a majority of the bank's directors must periodically review such 
acquisitions to ensure that they meet the standards and must 
periodically review the standards to ensure they meet the ``sound 
investment'' criterion of section 23B. The appropriate period of time 
between reviews would vary depending on the scope and nature of the 
bank's program, but such reviews should be conducted by the directors 
at least annually. Prior to the passage of the GLB Act, Board staff 
informally allowed banks, based on the legislative history of section 
23B, to meet the director approval requirement in this fashion, and 
there is no indication that Congress in the GLB Act intended to alter 
the procedures that a bank could use to obtain the requisite director 
approval.\72\
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    \72\ The Conference Report accompanying the Competitive Equality 
Banking Act of 1987 stated that the prior approval requirement of 
section 23B(b)(2) could be met ``by the establishment in advance of 
specific standards by the outside directors for such acquisitions. 
If the outside directors establish such standards, they must 
regularly review acquisitions to assure that the standards have been 
followed, and they must periodically review the standards to assure 
that they continue to be appropriate in light of market and other 
conditions.'' H.R. Conf. Rep. No. 100-261, at 133 (1987).
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    For these reasons, the proposed regulation would codify staff's 
preexisting approach to the director approval requirement. The Board 
seeks comment on whether this approach remains appropriate in light of 
the amendment made to section 23B by the GLB Act.

[[Page 24202]]

C. The Definition of Affiliate Under Section 23B-223.24(c)
    Section 23B(d)(1) states that the term ``affiliate'' under section 
23B has the meaning given to such term in section 23A except that the 
term ``affiliate'' under section 23B does not include a ``bank,'' as 
defined in section 23A.\73\ Other federal law provides that an insured 
savings association should be treated as a ``bank'' for purposes of 
section 23B.\74\ As in the case of the sister-bank exemption, 
Regulation W proposes to clarify that the only companies that qualify 
for the ``bank'' exception to section 23B's definition of affiliate are 
insured banks and insured savings associations. Without such an 
interpretation, a bank would be able to engage in transactions with 
certain uninsured depository affiliates on terms and conditions that 
were highly unfavorable to the bank. Entering into these kinds of 
transactions would not be consistent with bank safety and soundness and 
would contravene one of the goals of section 23B--protecting the 
deposit insurance funds.
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    \73\ 12 U.S.C. 371c-1(d)(1).
    \74\ 12 U.S.C. 1468(a)(2)(B).
---------------------------------------------------------------------------

D. The Advertising Restriction-223.21
    Section 23B(c), the ``advertising restriction,'' prohibits a bank 
from publishing any advertisement or entering into any agreement 
stating or suggesting that the bank shall in any way be responsible for 
the obligations of its affiliates.\75\ Read literally, this provision 
appears to prohibit a bank from issuing a guarantee or letter of credit 
on behalf of an affiliate. Because section 23A includes as a covered 
transaction the issuance by a bank of a guarantee or letter of credit 
on behalf of its affiliates, Board staff traditionally has read the 
advertising restriction of section 23B in light of section 23A. That 
is, the Board does not believe that section 23B(c) prohibits a bank 
from issuing a guarantee, acceptance, or letter of credit on behalf of 
an affiliate to the extent permitted under section 23A.\76\ The 
regulation contains this clarification.
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    \75\ 12 U.S.C. 371c-1(c).
    \76\ The Board also believes that if a bank and its affiliate 
enter into a joint undertaking with a third party, the contract 
among the parties should make clear that the bank is only 
responsible for its obligations under the contract.
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VIII. Application of Sections 23A and 23B to U.S. Branches and Agencies 
of Foreign Banks-Subpart G

    Subpart G discusses the application of sections 23A and 23B to U.S. 
branches and agencies of foreign banks. As noted above, sections 23A 
and 23B apply by their terms only to member banks of the Federal 
Reserve System, and other federal banking laws have made insured 
nonmember banks and insured savings associations subject to the 
sections. Federal banking law generally does not subject the U.S. 
branches and agencies of foreign banks to sections 23A and 23B.
    Section 114(b)(4) of the GLB Act grants the Board authority to 
impose restrictions or requirements on relationships or transactions 
between a branch, agency, or commercial lending company of a foreign 
bank in the United States and any affiliate in the United States of 
such foreign bank. The Board may impose such prudential limits if the 
Board finds that the limits are appropriate to prevent an evasion of 
certain Federal banking laws, avoid a significant risk to the safety 
and soundness of depository institutions or any Federal deposit 
insurance fund, or avoid other adverse effects, such as undue 
concentration of resources, decreased or unfair competition, conflicts 
of interest, or unsound banking practices.
    The Board has for years imposed certain of the requirements of 
sections 23A and 23B on transactions between a U.S. branch or agency of 
a foreign bank and its U.S. affiliates engaged in underwriting and 
dealing in bank-ineligible securities (``section 20 affiliates'').\77\ 
The Board also recently applied sections 23A and 23B to transactions 
between a U.S. branch or agency of a foreign bank and affiliates 
conducting merchant banking activities under the GLB Act and portfolio 
companies held under that authority.\78\
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    \77\ The Board's Operating Standards for section 20 affiliates 
require (i) any intraday extensions of credit by a U.S. branch or 
agency of a foreign bank to its section 20 affiliates to comply with 
the market terms requirement of section 23B; (ii) any extensions of 
credit by a U.S. branch or agency of a foreign bank to its section 
20 affiliates and any purchase by such branch or agency of 
securities for which a section 20 affiliate is the principal 
underwriter to comply with sections 23A and 23B; and (iii) a U.S. 
branch or agency of a foreign bank to refrain from advertising or 
suggesting that it is responsible for the obligations of a section 
20 affiliate, consistent with section 23B(c). See 12 CFR 225.200; 62 
FR 45295, Aug. 27, 1997.
    \78\ See 12 CFR 225.176(b)(6); 66 FR 8466, Jan. 21, 2001.
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    The proposed regulation would fully apply sections 23A and 23B to 
covered transactions between a U.S. branch or agency of a foreign bank 
and any affiliate of such foreign bank directly engaged in the United 
States in the following financial activities newly authorized under the 
GLB Act: (i) insurance underwriting pursuant to section 4(k)(4)(B) of 
the BHC Act; (ii) securities underwriting and dealing pursuant to 
section 4(k)(4)(E) of the BHC Act; (iii) merchant banking investment 
activities pursuant to section 4(k)(4)(H) of the BHC Act; or (iv) 
insurance company investment activities pursuant to section 4(k)(4)(I) 
of the BHC Act.\79\
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    \79\ See 12 U.S.C. 1843(k)(4)(B), (E), (H), and (I).
---------------------------------------------------------------------------

    The regulation also would apply these restrictions to transactions 
between a U.S. branch or agency of a foreign bank and any subsidiary of 
an affiliate directly engaged in the four activities set forth above 
(regardless of whether the subsidiary itself engages in any of the four 
activities).\80\ In addition, the regulation would apply sections 23A 
and 23B to transactions between a U.S. branch or agency of a foreign 
bank and any portfolio company controlled by the foreign bank under the 
GLB Act's merchant banking or insurance company investment authorities. 
The regulation would not apply sections 23A or 23B to transactions 
between a U.S. branch or agency and any other type of affiliate (e.g., 
foreign affiliates or U.S. affiliates engaged in nonbanking activities 
under section 4(c)(8) of the BHC Act), or to transactions between the 
foreign bank's non-U.S. offices and its U.S. affiliates.
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    \80\ The regulation covers subsidiaries of affiliates directly 
engaged in the four activities in order to prevent evasion. If these 
subsidiaries were not covered, the U.S. branch of a foreign bank 
could fund the foreign bank's U.S. insurance underwriter outside the 
scope of sections 23A and 23B by, for example, lending money to a 
subsidiary of the underwriter and having the subsidiary dividend or 
on-lend the loan proceeds to the underwriter.
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    Applying the restrictions of sections 23A and 23B to transactions 
between the U.S. branches and agencies of foreign banks and the 
indicated U.S. affiliates may help to ensure maintenance of a 
competitive playing field between U.S. banks and foreign banks 
operating in the United States. The issue of competitive equity arises 
most strongly in connection with those activities that a U.S. bank 
cannot engage in directly or through an operations subsidiary. A U.S. 
bank may affiliate itself with a company engaged in the newly 
authorized financial activities listed above only if the company is a 
holding company affiliate of the bank or, in some cases, a financial 
subsidiary of the bank.\81\ In either case, covered transactions 
between the U.S. bank and the company would be subject to sections 23A 
and 23B. Without Regulation W's extension of the scope of these 
statutory provisions, a foreign

[[Page 24203]]

bank's U.S. branch or agency could fund and engage in transactions with 
these types of affiliates more freely than could a U.S. bank. To the 
extent that a foreign bank's U.S. branches and agencies are able to 
fund these types of U.S. affiliates outside of the restrictions of 
sections 23A and 23B, the affiliates are able to compete for business 
in the United States with a potential advantage not available to the 
affiliates of U.S. banks.
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    \81\ Regulation W, consistent with the merchant banking rule, 
would impose sections 23A and 23B on a covered transaction between a 
U.S. branch or agency of a foreign bank and its U.S. merchant 
banking affiliate only to the extent the proceeds of the covered 
transaction are used for the purpose of funding the affiliate's 
merchant banking activities.
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    The Board does not believe that it is appropriate or necessary at 
this time to impose the requirements of sections 23A and 23B on 
transactions between a foreign bank's U.S. branch or agency and its 
U.S. affiliates that are engaged only in activities that were 
permissible for bank holding companies before the passage of the GLB 
Act (other than section 20 affiliates). The Board recognizes the 
hardship this might impose on foreign banks conducting such activities 
in the United States under previous law. Moreover, most of these 
activities may be conducted by a U.S. bank directly (or in an 
operations subsidiary) and, hence, may be funded by a U.S. bank in a 
manner that is not subject to sections 23A and 23B.
    The potential scope, nature, and risk of transactions and 
relationships between U.S. branches and agencies of foreign banks and 
their affiliates engaged in the United States in insurance 
underwriting, full-scope securities underwriting and dealing, merchant 
banking, and insurance company investment is unclear at this time. At 
least until the Board acquires more information and supervisory 
experience regarding these transactions and relationships, applying 
sections 23A and 23B may help ensure competitive equity between foreign 
banks and U.S. banking organizations in the funding of certain of their 
U.S. nonbank operations.
    The regulation also provides that the Board may add to the list of 
affiliates of a foreign bank that are subject to the restrictions of 
sections 23A and 23B. The Board intends generally to use this reserved 
authority to ensure competitive equity between foreign banks and U.S. 
banks with respect to affiliates engaged in the United States in new 
activities that the Board may authorize for financial holding 
companies.
    The Board also has considered the issue of how to calculate the 
capital stock and surplus of a foreign bank's U.S. branch or agency for 
purposes of section 23A. In light of the fact that foreign banks do not 
separately capitalize their U.S. branches or agencies, the regulation 
defines the capital stock and surplus of such branches and agencies by 
reference to the capital of the foreign bank as calculated under its 
home country capital standards. This definition is consistent with the 
approach recently adopted by the Board in its merchant banking 
rule,\82\ and represents a relaxation from the Board's current position 
with respect to foreign banks that operate section 20 companies in the 
United States.\83\
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    \82\ See 66 FR 8466, 8482, Jan. 31, 2001.
    \83\ The Board's position on section 20 companies requires U.S. 
branches and agencies of foreign banks whose home country supervisor 
has not adopted capital standards consistent with the Basle Accord 
to calculate their section 23A capital stock and surplus by 
reference to the capital of the foreign bank parent as calculated 
under standards applicable to U.S. banking organizations. See 62 FR 
45304, Aug. 27, 1997.
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IX. Definitions--Subpart H

    Subpart H of Regulation W sets forth definitions of the terms used 
in sections 23A and 23B and in the proposed rule. Terms that are 
defined in the regulation as they are defined in the statute generally 
are not discussed below. Terms that the Board proposes to define or 
clarify for purposes of the regulation are discussed below.
A. Definition of Affiliate--223.24
    1. Investment funds advised by the bank or a bank affiliate--
223.24(a)(6). Section 23A includes as an affiliate any company that is 
sponsored and advised by the bank or any of its affiliates.\84\ Section 
23A also includes as an affiliate any investment company for which the 
bank or its affiliate serves as an investment advisor, as defined in 
the Investment Company Act of 1940 (``1940 Act'').\85\ The proposed 
regulation sets forth these definitions and also includes as an 
affiliate any investment fund--even if not an investment company for 
purposes of the 1940 Act--for which the bank or an affiliate of the 
bank serves as an investment advisor, if the bank or an affiliate of 
the bank owns or controls more than 5 percent of any class of voting 
securities of the fund.
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    \84\ 12 U.S.C. 371c(b)(1)(D)(i).
    \85\ 12 U.S.C. 371c(b)(1)(D)(ii).
---------------------------------------------------------------------------

    Most investment funds that are advised by a bank (or an affiliate 
of a bank) are affiliates of the bank under section 23A because the 
funds either are investment companies under the 1940 Act or are 
sponsored by the bank (or an affiliate of the bank).\86\ In other 
instances, however, the bank or its affiliate may advise but not 
sponsor an investment fund that is not an investment company under the 
1940 Act. Although such a fund would not fit within the statutory 
definition of affiliate, section 23A also authorizes the Board to 
determine, by regulation or order, that any company is an affiliate of 
a bank if the company has ``a relationship with the member bank or any 
subsidiary or affiliate of the member bank, such that covered 
transactions by the member bank or its subsidiary with that company may 
be affected by the relationship to the detriment of the member bank or 
its subsidiary.'' \87\
---------------------------------------------------------------------------

    \86\ Such a fund often is required to register under the 
Commodity Exchange Act, and a bank affiliate often registers as the 
fund's commodity pool operator (thereby sponsoring the fund) and 
commodity trading advisor (thereby advising the fund). See 7 U.S.C. 
1a(4) (defining commodity pool operator); 7 U.S.C. 1a(5)(B)(i) 
(defining commodity trading advisor). Banks and trust companies are 
excluded from the definition of commodity trading advisor under the 
Commodity Exchange Act and, in certain circumstances, may be 
excluded from the definition of commodity pool operator. See 7 CFR 
4.5.
    \87\ 12 U.S.C. 371c(b)(1)(E).
---------------------------------------------------------------------------

    The Board believes that the advisory relationship of a bank or 
affiliate with an investment fund presents the same potential for 
conflicts of interest regardless of whether the fund is or is not 
treated as an investment company for purposes of the 1940 Act.\88\ An 
investment fund typically escapes from the definition of investment 
company under the 1940 Act because it (i) sells interests only to a 
limited number of investors or only to sophisticated investors; or (ii) 
invests primarily in financial instruments that are not securities.\89\ 
The Board does not believe that the private nature or investment 
strategy of a fund should have a substantial effect on the fund's 
affiliate status under section 23A because these factors do not alter 
the conflicts of interest presented in the advisory relationship 
between the bank or its affiliate and the fund.\90\
---------------------------------------------------------------------------

    \88\ In fact, a bank may face greater risk from the conflicts of 
interest arising from its relationships with an investment fund that 
is not registered as an investment company under the 1940 Act than 
with a registered investment company because the 1940 Act restricts 
transactions between a registered investment company and entities 
affiliated with the company's investment adviser.
    \89\ The term ``investment company'' in the 1940 Act does not 
include a company that is owned by qualified persons or by no more 
than 100 persons, provided that the company does not engage in a 
public offering of its securities. See 15 U.S.C. 80a-3(c)(1), (7). 
The term also generally does not include investment funds that are 
engaged primarily in investing in financial instruments other than 
securities. See 15 U.S.C. 80a-3(a)(1).
    \90\ The Board also believes that investment funds organized 
outside the United States for which a bank or affiliate serves as 
investment advisor are affiliates of the bank for purposes of 
section 23A. See Letter dated July 24, 1990, from J. Virgil 
Mattingly, General Counsel of the Board, to Anne B. McMillen. The 
term ``investment company'' in the 1940 Act does include investment 
funds organized under the laws of a non-U.S. jurisdiction.
---------------------------------------------------------------------------

    The Board seeks comment on the appropriateness of treating 
investment funds as affiliates of a bank under

[[Page 24204]]

section 23A if the bank or its affiliate serves as investment advisor 
to the fund and owns more than 5 percent of any class of voting 
securities of the fund. The Board particularly seeks comment on whether 
such investment funds should be treated as affiliates only if the 
advising bank or affiliate owns more than 5 percent of a class of 
voting securities of the fund.
    The Board is considering adding to the definition of ``affiliate'' 
any company controlled by an investment fund that is an affiliate of 
the bank. The conflicts of interest that exist between a bank and any 
investment fund that it or its affiliate advises also would appear to 
exist between the bank and a portfolio company controlled by such a 
fund. The Board invites public comment on this issue.
    2. Financial subsidiaries--223.24(a)(8); 223.26. Section 23A 
defines an affiliate of a bank to include any company that controls the 
bank and any company that is under common control with the bank. Since 
1982, however, section 23A has excluded from the definition of 
affiliate any subsidiary of the bank (other than a bank subsidiary) 
unless the Board determines by regulation or order that the subsidiary 
should be considered an affiliate.\91\ In 1997, the Board issued for 
comment a proposal to extend section 23A to covered transactions 
between a bank and a subsidiary of the bank engaged in activities not 
permissible for the bank to engage in directly.\92\
---------------------------------------------------------------------------

    \91\ See 12 U.S.C. 371c(b)(2)(A).
    \92\ 62 FR 37744, July 15, 1997.
---------------------------------------------------------------------------

    Consistent with this proposal, the GLB Act recently amended section 
23A to cover transactions between a bank and its ``financial 
subsidiaries.'' The GLB Act defines a financial subsidiary as any 
subsidiary of a bank that would be a financial subsidiary of a national 
bank under section 5136A of the Revised Statutes of the United States. 
Section 5136A of the Revised Statutes, in turn, defines a financial 
subsidiary of a national bank as any company that is controlled by one 
or more insured depository institutions, other than a subsidiary that 
(i) engages solely in activities that national banks are permitted to 
engage in directly (and subject to the same terms and conditions as 
apply to national banks) or (ii) a national bank is specifically 
authorized by the express terms of a federal statute (other than 
section 5136A), and not by implication or interpretation, to 
control.\93\ The GLB Act provides that a financial subsidiary of a bank 
is considered an affiliate of the bank for purposes of section 23A.
---------------------------------------------------------------------------

    \93\ 12 U.S.C. 24a(g)(3).
---------------------------------------------------------------------------

    Regulation W specifically provides, consistent with the GLB Act, 
that a financial subsidiary of a bank is an affiliate of the bank. The 
proposed regulation includes a definition of financial subsidiary that 
is identical to the definition of financial subsidiary set forth in 
section 23A, as amended by the GLB Act. The Board notes that many state 
banks have authority to engage directly in activities that would not be 
permissible for a national bank and seeks comment on how the definition 
of financial subsidiary should be applied to subsidiaries of state 
banks, including general insurance agency subsidiaries and real estate 
investment and development subsidiaries.
    The definition of financial subsidiary in section 23A and 
Regulation W would cover some subsidiaries of banks that are engaged 
only in agency activities. The Board invites public comment on the 
appropriateness of exempting such subsidiaries from the definition of 
financial subsidiary in the regulation.
    Regulation W also provides that any subsidiary of a bank's 
financial subsidiary will be considered a financial subsidiary of the 
bank, even if the subsidiary would not otherwise qualify as a financial 
subsidiary. The Board believes that treating such companies as 
financial subsidiaries is consistent with the anti-evasion provisions 
that the GLB Act added to section 23A and will help prevent banks from 
avoiding the special restrictions that the GLB Act placed on a bank's 
transactions with its financial subsidiaries.
    3. Companies held under merchant banking or insurance company 
investment authority--223.24(a)(9). The GLB Act amended the BHC Act to 
permit bank holding companies and foreign banks that qualify as 
financial holding companies to engage in merchant banking and insurance 
company investment activities.\94\ If a financial holding company owns 
or controls more than 25 percent of a class of voting shares of a 
company under the merchant banking or insurance company investment 
authority, the company is an affiliate of any bank controlled by the 
financial holding company by operation of the statutory definitions 
contained in section 23A. The GLB Act also added paragraph (b)(11) to 
section 23A, which creates a rebuttable presumption that a company is 
an affiliate of a bank for purposes of section 23A if the bank is 
affiliated with a financial holding company and the financial holding 
company owns or controls 15 percent or more of the equity capital of 
the company pursuant to the financial holding company's merchant 
banking or insurance company investment authority.\95\ The proposed 
regulation includes within the definition of ``affiliate'' any company 
subject to this rebuttable presumption. The regulation also provides a 
definition of equity capital, identifies three situations or ``safe 
harbors'' where the statute's presumption of control would be deemed to 
be rebutted, and clarifies the application of the presumption to 
private equity funds.
---------------------------------------------------------------------------

    \94\ GLB Act section 103(a); 12 U.S.C. 1843(k)(4)(H) and (I).
    \95\ GLB Act section 121(b)(2). As noted above, this rebuttable 
presumption applies only if the affiliated financial holding company 
owns or controls 15 percent or more of the company's equity capital 
under the new merchant banking or insurance company investment 
authorities. The Board notes, however, that under existing Board 
precedents a bank holding company may not own any shares of a 
company in reliance on sections 4(c)(6) or 4(c)(7) of the BHC Act 
where the holding company owns or controls, in the aggregate under a 
combination of authorities, more than 5 percent of any class of 
voting securities of the company.
---------------------------------------------------------------------------

    The statute does not provide a definition of equity capital. The 
regulation defines equity capital roughly in accordance with the GAAP 
definition of stockholders' equity. Equity capital includes a company's 
perpetual preferred stock, common stock, capital surplus, retained 
earnings, and accumulated other comprehensive income, less treasury 
stock. The definition of equity capital also makes clear that any other 
account of the company that constitutes equity should be included in 
the company's equity capital. Accordingly, the Board retains its 
authority on a case-by-case basis to require a holding company to treat 
a subordinated debt investment in a company as equity capital of the 
company for purposes of applying the presumption of control. The Board 
asks for comment on whether the proposed definition of equity capital 
is appropriate.
    The regulation also provides three specific regulatory safe harbors 
from the statute's presumption of affiliate status. These safe harbors 
apply in situations where the holding company owns or controls more 
than 15 percent of the total equity of the company under the merchant 
banking or insurance company investment authority (thereby triggering 
the statutory presumption) and less than 25 percent of any class of 
voting securities of the company (thereby not meeting the statutory 
definition of control). The three situations are substantially 
identical to

[[Page 24205]]

those listed in the Board's merchant banking regulation.\96\
---------------------------------------------------------------------------

    \96\ See 12 CFR 225.176(b)(2) and (3).
---------------------------------------------------------------------------

    The first exemption applies where no director, officer, or employee 
of the holding company serves as a director of the company. The second 
exemption applies where an independent third party controls a greater 
percentage of the equity capital of the company than is controlled by 
the holding company, and no more than one officer or employee of the 
holding company serves as a director of the company. The third 
exemption applies where an independent third party controls more than 
50 percent of the voting shares of the company, and officers and 
employees of the holding company do not constitute a majority of the 
directors of the company.
    For purposes of these safe harbors, the rule provides that the term 
``holding company'' includes any subsidiary of the holding company, 
including any subsidiary depository institution of the holding company. 
Accordingly, if a director of a subsidiary bank or nonbank subsidiary 
of a financial holding company also serves as a director of a portfolio 
company, the first safe harbor, for example, would be unavailable.
    These safe harbors do not require Board review or approval. 
Moreover, the safe harbors are not intended to be a complete list of 
circumstances in which the presumption may be rebutted. The regulation 
also provides, consistent with the GLB Act, that a bank or company may 
rebut the presumption of affiliation with respect to a company by 
presenting information to the Board that demonstrates, to the Board's 
satisfaction, that the holding company does not control the portfolio 
company.
    A financial holding company generally is considered to own or 
control only those shares or other ownership interests that are owned 
or controlled by itself or by a subsidiary of the holding company. The 
rule clarifies that, for purposes of applying the presumption of 
affiliation described above, a financial holding company that has an 
investment in a private equity fund (as defined in the Board's merchant 
banking rule) will not be considered indirectly to own the equity 
capital of a company in which the fund has invested unless the 
financial holding company controls the private equity fund (as 
described in the Board's merchant banking rule).\97\
---------------------------------------------------------------------------

    \97\ See 12 CFR 225.176(b)(5).
---------------------------------------------------------------------------

    4. Certain joint venture companies--223.24(b)(1)(iii). As noted 
above, under the terms of section 23A, subsidiaries of a bank generally 
are not treated as affiliates of the bank, even if they would otherwise 
qualify as affiliates.\98\ The statute contains two specific exceptions 
to this general rule: financial subsidiaries of a bank and bank 
subsidiaries of a bank are treated as affiliates of the parent bank. 
The statute also provides that the Board may determine that other 
subsidiaries of a bank should be treated as affiliates if covered 
transactions between the bank and the subsidiary may be affected by the 
relationship between the companies to the detriment of the bank.\99\
---------------------------------------------------------------------------

    \98\ See 12 U.S.C. 371c(b)(1)(A) and (b)(2)(A). Section 23A 
defines a subsidiary of a specified company as a company that is 
controlled by the specified company. Under the statute, a company 
controls another company if the first company owns or controls 25 
percent or more of a class of voting securities of the other 
company, controls the election of a majority of the directors of the 
other company, or exercises a controlling influence over the 
policies of the other company. 12 U.S.C. 371c(b)(3) and (4).
    \99\ 12 U.S.C. 371c(b)(2)(A).
---------------------------------------------------------------------------

    Pursuant to this authority, the Board proposes to determine that 
two additional classes of subsidiaries of a bank should be treated as 
affiliates. First, the proposed regulation provides that any subsidiary 
of a bank in which an affiliate of the bank directly owns or controls 
25 percent or more of any class of voting securities would be 
considered an affiliate of the bank. For example, a joint venture 
company that is 50 percent owned by a bank holding company and 50 
percent owned by one of its subsidiary banks, would be treated as an 
affiliate of the bank. In such circumstances, although the joint 
venture company qualifies as a subsidiary of the bank under section 23A 
because the bank owns more than 25 percent of the company's voting 
stock, the holding company's substantial direct interest in the company 
creates the potential for conflicts of interest that may endanger the 
bank.
    This proposed treatment of certain bank-affiliate joint ventures as 
affiliates does not apply to joint ventures between a bank and 
affiliated banks or insured savings associations. For example, if two 
affiliated banks each own 50 percent of the stock of a company, the 
company would continue to qualify as a subsidiary and not an affiliate 
of each bank (despite the fact that an affiliate of each bank owned 
more than 25 percent of a class of voting securities of the company). 
Such a special rule for joint ventures between a bank and affiliated 
banks or insured savings associations is consistent with the purpose 
behind the sister-bank and affiliated-bank exemptions contained in 
section 23A. The Board does not believe that transactions between a 
bank and a company that is wholly owned by the bank and its affiliated 
banks and insured savings associations generally pose material risks to 
the safety and soundness of the shareholding institutions or to the 
Federal deposit insurance funds. The Board would retain authority to 
treat such joint ventures as affiliates under section 23A on a case-by-
case basis.
    5. Employee benefit plans--223.24(b)(1)(iv). The second proposed 
regulatory exception to the general rule that subsidiaries of a bank 
are not treated as affiliates of the bank relates to employee benefit 
plans. Board staff traditionally has taken the position that most 
employee stock option plans, trusts, or similar entities that exist to 
benefit shareholders, members, officers, directors, or employees of a 
bank or its affiliates (``ESOPs'') should be treated as affiliates of 
the bank for purposes of sections 23A and 23B. In most cases, the 
ESOP's share ownership or the interlocking management between the ESOP 
and its associated bank or bank holding company exceeds the statutory 
thresholds for determining that a company is an affiliate. Some 
institutions have argued, however, that ESOPs should be considered 
subsidiaries of the bank and therefore exempt from coverage.
    The Board believes that the relationship between a bank and its or 
its affiliates' ESOP warrants coverage by sections 23A and 23B. In the 
past, banks have made unsecured loans to such ESOPs or have guaranteed 
loans to such ESOPs that were made by a third party. These ESOPs, 
however, generally have no means to repay the loans other than with 
funds provided by the bank. In addition, the issuance of holding 
company shares to an ESOP that is funded by a bank loan could be used 
as a vehicle by the bank to provide funds to its parent holding company 
when the bank is unable to pay dividends or is otherwise restricted in 
providing funds to its holding company. Accordingly, the proposed rule 
provides that a bank or bank affiliate's ESOP cannot avoid 
classification as an affiliate of the bank by also qualifying as a 
subsidiary of the bank.
    The Board asks for comment on whether other subsidiaries of a bank 
should be treated as affiliates of the bank under section 23A.
    The Board notes that Regulation W also defines as an affiliate of a 
bank any partnership for which the bank or any affiliate of the bank 
serves as a general partner or for which the bank or any affiliate of 
the bank causes an officer or

[[Page 24206]]

employee of the bank or affiliate to serve as a general partner.
B. Definition of Covered Transaction--223.25
    The restrictions of section 23A do not apply to every transaction 
between a bank and its affiliates. The section only applies to 
``covered transactions'' between a bank and its affiliates. The statute 
defines a covered transaction as (i) an extension of credit to an 
affiliate; (ii) a purchase of or investment in securities issued by an 
affiliate; (iii) a purchase of assets from an affiliate; (iv) the 
acceptance of securities issued by an affiliate as collateral for an 
extension of credit to any person; and (v) the issuance of a guarantee, 
acceptance, or letter of credit on behalf of an affiliate.\100\ Among 
the transactions that generally are not subject to section 23A are 
dividends paid by a bank to its holding company, sales of assets by a 
bank to an affiliate, an affiliate's purchase of securities issued by a 
bank, and many service contracts between a bank and an affiliate. This 
section discusses several interpretive issues that have arisen in 
determining whether transactions between a bank and an affiliate are 
covered transactions for purposes of section 23A.
---------------------------------------------------------------------------

    \100\ 12 U.S.C. 371c(b)(7).
---------------------------------------------------------------------------

    1. Confirmation of a letter of credit issued by an affiliate. 
Section 23A(b)(7)(E) includes as a covered transaction the issuance of 
a letter of credit by a bank on behalf of an affiliate. The proposed 
regulation clarifies that the confirmation of a letter of credit issued 
by an affiliate is a covered transaction. When a bank confirms a letter 
of credit, it assumes the risk of the underlying transaction to the 
same extent as if it had issued the letter of credit.
    2. Credit enhancements supporting a securities underwriting. The 
Board has confirmed previously that section 23A's definition of 
guarantee would not include a bank's issuance of a guarantee in support 
of securities issued by a third party and underwritten by a securities 
affiliate of the bank.\101\ Such a credit enhancement would not be 
issued ``on behalf of'' the affiliate. In addition, although the 
guarantee does provide some benefit to the affiliate (by facilitating 
the underwriting), this benefit is indirect. Accordingly, the proceeds 
of the guarantee would not be transferred to the affiliate for purposes 
of the attribution rule of section 23A.\102\ Of course, section 23B 
would apply to the transaction and, where an affiliate was issuer as 
well as underwriter, the transaction would be covered by section 23A 
because the credit enhancement would be on behalf of the affiliate.
---------------------------------------------------------------------------

    \101\ 62 FR 45295 Aug. 27, 1997.
    \102\ See 12 U.S.C. 371c(a)(2).
---------------------------------------------------------------------------

    3. Cross-guarantee agreements and cross-affiliate netting 
arrangements. In addition, Board staff has confirmed previously that a 
cross-guarantee agreement among a bank, an affiliate, and a 
nonaffiliate in which the nonaffiliate may use the bank's assets to 
satisfy the obligations of a defaulting affiliate is a guarantee for 
purposes of section 23A.\103\ The Board believes that such cross-
guarantee arrangements among banks and their affiliates should be 
subject to the quantitative limits and collateral requirements of 
section 23A.
---------------------------------------------------------------------------

    \103\ See Letter dated Aug. 6, 1993, from J. Virgil Mattingly, 
General Counsel fo the Board, to Richard Lasner.
---------------------------------------------------------------------------

    Similarly, the Board understands that some banks have entered into 
or are contemplating entering into cross-affiliate netting 
arrangements. These are arrangements among a bank, one or more 
affiliates of the bank, and one or more nonaffiliates of the bank, 
where a nonaffiliate is permitted to net obligations of an affiliate of 
the bank to the nonaffiliate when settling the nonaffiliate's 
obligations to the bank. These arrangements also would include 
agreements where a bank is required to add the obligations of an 
affiliate of the bank to a nonaffiliate when determining the bank's 
obligations to the nonaffiliate.
    Cross-affiliate netting arrangements expose a bank to the credit 
risk of its affiliates. Under these agreements, a bank may become 
obligated effectively to make good on the obligations of its 
affiliates. The exposure of a bank to its affiliates in such an 
arrangement resembles closely the exposure of a bank when it issues a 
guarantee on behalf of an affiliate or extends credit to an affiliate. 
Accordingly, the Board believes that cross-affiliate netting 
arrangements are credit transactions under section 23A. Accordingly, 
the quantitative limits of section 23A would prohibit a bank from 
entering into a cross-affiliate netting arrangement to the extent that 
the netting arrangement does not cap the potential exposure of the bank 
to the participating affiliate(s).
    The Board asks for comment on whether alternative treatments of 
cross-guarantees or cross-affiliate netting arrangements under section 
23A would be appropriate.
    4. Keepwell agreements. Banks have asked for guidance on the 
question of whether a ``keepwell'' agreement should be considered a 
guarantee for purposes of section 23A. In a keepwell agreement between 
a bank and an affiliate, the bank typically commits to maintain the 
capital levels or solvency of the affiliate. The credit risk incurred 
by the bank in entering into such a keepwell agreement is similar to 
the credit risk incurred by a bank in connection with issuing a 
guarantee on behalf of an affiliate. Accordingly, keepwell agreements 
generally should be treated as guarantees for purposes of section 23A 
and, if unlimited in amount, would be prohibited by the quantitative 
limits of section 23A.
    5. Securitization vehicles. The Board seeks comment on whether 
additional clarification is necessary in the area of securitizations. 
In the securitization process, a bank segregates certain of its or its 
customer's assets into a relatively homogenous pool and then transfers 
the pool to a bankruptcy-remote special purpose entity (``SPE''). The 
SPE, all of whose voting securities are generally held by a party other 
than the bank or the bank's customer, then issues securities to 
investors. The asset-backed securities issued by the SPE often receive 
some form of credit enhancement from the bank, the bank's customer, or 
a third-party guarantor. The Board requests comment on the question of 
whether such SPEs should in any circumstances be deemed to be 
affiliates of the bank involved in the securitization and, if so, what 
transactions between the bank and the SPE should be considered covered 
transactions under section 23A.
    6. Loans and extensions of credit. Although section 23A includes a 
``loan or extension of credit'' as a covered transaction, the statute 
does not define these terms. The proposed regulation defines 
``extension of credit'' to mean an extension or renewal of a loan, a 
grant of a line of credit, or an extension of credit in any manner 
whatsoever, including on an intraday basis. The regulation also 
provides a nonexhaustive list of transactions that the Board deems to 
be extensions of credit, including an advance by means of an overdraft, 
cash item, or otherwise; a lease that is the functional equivalent of 
an extension of credit; a purchase of a note or other obligation, 
including commercial paper or other debt securities; and any increase 
in the amount of, extension of the maturity of, or adjustment in the 
interest rate term or other material term of an extension of 
credit.\104\ A floating-rate loan does not

[[Page 24207]]

become a new covered transaction whenever there is a change in the 
relevant index (for example, LIBOR or the bank's prime rate) from which 
the loan's interest rate is calculated. If the bank and the borrower, 
however, amend the loan agreement to change the interest rate term from 
``LIBOR plus 100 basis points'' to ``LIBOR plus 150 basis points,'' the 
parties have engaged in a new covered transaction.
---------------------------------------------------------------------------

    \104\ A floating-rate loan does not become a new covered 
transaction whenever there is a change in the relevant index (for 
example, LIBOR or the bank's prime rate) from which the loan's 
interest rate is calculated. If the bank and the borrower, however, 
amend the loan agreement to change the interest rate term from 
``LIBOR plus 100 basis points'' to ``LIBOR plus 150 basis points,'' 
the parties have engaged in a new covered transaction.
---------------------------------------------------------------------------

    As noted, the regulation proposes to clarify that a bank's purchase 
of a note or debt security, including commercial paper, issued by an 
affiliate is a loan or extension of credit by the bank to the affiliate 
for purposes of section 23A.\105\ The Board is aware that some banks 
have purchased or have proposed to purchase the commercial paper of 
their holding companies, and have done so or proposed to do so without 
collateralizing the purchase. These banks have argued that a purchase 
of commercial paper is a ``purchase of or investment in securities 
issued by an affiliate'' for purposes of section 23A, and that such a 
purchase cannot also then be an ``extension of credit'' for purposes of 
section 23A and its collateral requirements.
---------------------------------------------------------------------------

    \105\ This position is consistent with the Board's long-standing 
view that a purchase of an affiliate's note represents an extension 
of credit to the affiliate under section 23A. See 37 Federal Reserve 
Bulletin 960 (1951).
---------------------------------------------------------------------------

    Although the Board is aware that section 23A's definition of 
covered transaction separately includes a bank's purchase of securities 
issued by an affiliate and a bank's extension of credit to an 
affiliate, the fact that a holder of debt securities expects repayment 
of principal upon maturity makes debt securities closely resemble loans 
for purposes of section 23A and the statute's objective of protecting 
the bank. Therefore, Regulation W provides that a bank that buys debt 
securities issued by an affiliate has made an extension of credit to an 
affiliate under section 23A and must collateralize the transaction in 
accordance with the section 23A collateral requirements applicable to 
extensions of credit.\106\
---------------------------------------------------------------------------

    \106\ As discussed above, however, the regulation requires a 
bank to value purchases of the debt securities of an affiliate, for 
purposes of computing compliance with the quantitative limits and 
collateral requirements of section 23A, in accordance with the 
valuation principles for purchases of debt securities and not those 
for extensions of credit.
---------------------------------------------------------------------------

    The Board seeks comment on whether the rule should permit banks in 
certain circumstances to purchase debt securities issued by an 
affiliate without satisfying the collateral requirements of section 
23A. In particular, the Board seeks comment on whether it should 
require section 23A collateralization in circumstances where a bank 
purchases an affiliate's debt securities (i) from a third party in a 
bona fide secondary market transaction; or (ii) pursuant to a 
registered public offering document or a private placement memorandum 
in an offering in which the affiliate receives significant 
participation from third parties. In these circumstances, the risk that 
a bank's purchase of an affiliate's debt securities is designed to 
shore up an ailing affiliate may be reduced. Moreover, in both of these 
situations, the purchase of affiliate debt securities would be subject 
to the quantitative limits of section 23A and the market terms 
requirement of section 23B.
    The Board asks for comment on whether other aspects of the 
definition of extension of credit are in need of clarification.
C. Other Definitions--223.26
    1. Bank--223.26(c). Regulation W applies to all ``banks.'' As 
discussed above, sections 23A and 23B apply by their terms to member 
banks of the Federal Reserve System, and the Federal Deposit Insurance 
Act subjects insured nonmember banks to the restrictions of sections 
23A and 23B as if they were member banks. Accordingly, the proposed 
rule defines the term ``bank'' to include any ``member bank,'' as 
defined in section 1 of the Federal Reserve Act, and any ``insured 
bank'' other than an ``insured branch,'' as such terms are defined in 
section 3 of the Federal Deposit Insurance Act.\107\
---------------------------------------------------------------------------

    \107\ The carve-out for insured branches is explicitly required 
by the Federal Deposit Insurance Act, which provides that a foreign 
bank should not be treated as a member bank under section 23A solely 
because the foreign bank has an insured branch. 12 U.S.C. 
1828(j)(3)(A).
---------------------------------------------------------------------------

    The definition of bank in the regulation also states that most 
subsidiaries of a bank are to be treated as the bank itself for 
purposes of sections 23A and 23B. The only subsidiaries of a bank that 
are excluded from this treatment are financial subsidiaries, depository 
institution subsidiaries, certain joint venture subsidiaries, and 
ESOPs--companies that are deemed affiliates of the bank under the 
regulation. This treatment of subsidiaries reflects the fact that the 
statute typically does not distinguish between a member bank and its 
subsidiaries, and all of the significant restrictions of the statute 
apply to actions taken by a member bank ``and its subsidiaries.'' The 
Board believes that defining the term ``bank'' as described above and 
using the term ``bank'' wherever the statute says ``member bank and its 
subsidiaries'' makes the regulation shorter and easier to understand 
while also reminding banks that certain subsidiaries of a bank should 
not be treated as part of the bank for purposes of the statute.
    2. Capital stock and surplus--223.26(d). Under section 23A, the 
quantitative limits on covered transactions are based on the ``capital 
stock and surplus'' of the bank.\108\ The proposed regulation includes 
a definition of capital stock and surplus that the Board previously 
adopted as an interpretation of section 23A.\109\ Capital stock and 
surplus is defined as the sum of the bank's tier 1 capital and tier 2 
capital and the balance of the bank's allowance for loan and lease 
losses not included in its tier 2 capital. This definition employs 
familiar concepts contained in the Federal banking agencies' capital 
adequacy guidelines,\110\ and is consistent with the loans-to-one-
borrower limits applicable to national banks \111\ and the Board's 
Regulation O, which limits lending to a bank's insiders. \112\ Use of a 
common definition across these rules should reduce compliance burden. 
The Board requests comment, however, on whether the balance of a bank's 
allowance for loan and lease losses not included in its tier 2 capital 
should be included in section 23A's ``capital stock and surplus.''
---------------------------------------------------------------------------

    \108\ 12 U.S.C. 371c(a)(1).
    \109\ 12 CFR 250.242.
    \110\ See, e.g., 12 CFR part 225, appendix A.
    \111\ 12 CFR 32.2(b).
    \112\ 12 CFR 215.2(i); see also 61 FR 19805, May 3, 1996.
---------------------------------------------------------------------------

    The National Bank Act requires a national bank, ``in determining 
compliance with applicable capital standards,'' to deduct from its 
capital the aggregate amount of any outstanding equity investments, 
including retained earnings, of the bank in all its financial 
subsidiaries.\113\ The Federal Deposit Insurance Act imposes the same 
capital deduction requirement on insured state banks that establish 
financial subsidiaries.\114\ In determining compliance with the 
quantitative limits of section 23A, a bank is required by statute to 
include in its covered transactions any equity investments (excluding 
retained earnings) of the bank in its financial subsidiaries. It would 
be unfair to compel a bank to include such investments in its covered 
transaction amount (the numerator of the fraction in section 23A's 
quantitative limits) but to exclude such investments from capital (the

[[Page 24208]]

denominator of the fraction). Accordingly, a bank with a financial 
subsidiary may add back to its section 23A ``capital stock and 
surplus'' the amount of any investment in a financial subsidiary that 
counts as a covered transaction and is required to be deducted from the 
bank's capital for regulatory capital purposes.
---------------------------------------------------------------------------

    \113\ 12 U.S.C. 24a(c)(1).
    \114\ 12 U.S.C. 1831w(a)(2).
---------------------------------------------------------------------------

    3. Control--223.26(f). Section 23A provides that a company or 
shareholder shall be deemed to have control over another company if, 
among other things, such company or shareholder controls in any manner 
the election of a majority of the ``directors or trustees'' of the 
other company.\115\ Regulation W expands this prong of the control 
definition to conform it to the control definition contained in the 
Board's Regulation Y by adding that control also exists when a company 
or shareholder controls the election of a majority of the ``general 
partners (or individuals exercising similar functions)'' of another 
company. This expansion of the control definition is intended to ensure 
that banks understand that a company or shareholder would be deemed to 
control another company (including a partnership, limited liability 
company, or other similar organization) if the company or shareholder 
controlled the election of a majority of the principal policymakers of 
such other company.
---------------------------------------------------------------------------

    \115\ 12 U.S.C. 371c(b)(3)(A)(ii).
---------------------------------------------------------------------------

    In addition, the regulation includes two additional presumptions of 
control that are similar to presumptions contained in Regulation Y. 
First, a company will be deemed to control securities, assets, or other 
ownership interests controlled by any subsidiary of the company.\116\ 
Second, a company that controls securities (including options and 
warrants) that are convertible, at the option of the holder or owner, 
into other securities, will be deemed to control the other 
securities.\117\
---------------------------------------------------------------------------

    \116\ See 12 CFR 225.2(e)(2)(i).
    \117\ See 12 CFR 225.31(d)(1)(i).
---------------------------------------------------------------------------

    4. Low-quality asset--223.26(q). Two provisions of section 23A 
restrict a bank's ability to engage in transactions with affiliates 
that involve low-quality assets. First, the statute prohibits a bank 
from purchasing a low-quality asset from an affiliate unless the bank 
performed an independent credit evaluation and committed itself to 
purchase the asset prior to the asset's acquisition by the 
affiliate.\118\ Second, the statute prohibits a bank from counting a 
low-quality asset toward section 23A's collateral requirements for a 
credit transaction with an affiliate.\119\
---------------------------------------------------------------------------

    \118\ 12 U.S.C. 371c(a)(3).
    \119\ 12 U.S.C. 371c(c)(3).
---------------------------------------------------------------------------

    For purposes of these provisions, section 23A defines a low-quality 
asset to include (i) an asset classified as ``substandard,'' 
``doubtful,'' or ``loss'' or treated as ``other loans especially 
mentioned'' in the most recent report of examination or inspection by a 
Federal or State supervisory agency (a ``classified asset''); (ii) an 
asset in nonaccrual status; (iii) an asset on which payments are more 
than thirty days past due; or (iv) an asset whose terms have been 
renegotiated or compromised due to the deteriorating financial 
condition of the obligor.\120\ The Board notes that any asset meeting 
one of the above four criteria, including securities and real property, 
is a low-quality asset.\121\
---------------------------------------------------------------------------

    \120\ 12 U.S.C. 371c(b)(10).
    \121\ The Federal banking agencies generally consider non-
investment grade securities to be classified assets. See, e.g., 
``Uniform Agreement on the Classification of Assets and Appraisal of 
Securities Held by Banks'' (May 7, 1979); Federal Reserve Commercial 
Bank Examination Manual Sec. 2020.1. The Board also notes that 
assets identified by examiners through the Shared National Credit 
and International Country Exposure Review Committee processes should 
be considered classified assets for purposes of section 23A.
---------------------------------------------------------------------------

    The regulation broadens the definition of low-quality asset in 
three ways. First, the regulation provides that an asset identified by 
examiners as an ``other transfer risk problem'' (``OTRP'') is a low-
quality asset. Such assets represent credits to countries that are not 
complying with their external debt-service obligations, but are taking 
positive steps to restore debt service through economic adjustment 
measures, generally as part of an International Monetary Fund program. 
Although OTRP assets are not considered classified assets, examiners 
are instructed to consider such assets in their assessment of a bank's 
asset quality and capital adequacy.\122\ The Board asks for comment on 
the appropriateness of treating OTRP assets as low-quality assets under 
section 23A.
---------------------------------------------------------------------------

    \122\ See Federal Reserve Commercial Bank Examination Manual 
Sec. 7040.1.
---------------------------------------------------------------------------

    Second, the regulation reflects the increasing use by financial 
institutions of their own internal asset classification systems. A 
recent Board study of the 50 largest U.S. banks demonstrated that all 
use internal loan classifications, and a substantial proportion of such 
institutions have relatively advanced internal rating systems.\123\ 
Although there is considerable variance in how large banks rate 
performing assets, the banks generally use the same categories employed 
by the Federal banking agencies for rating classified assets.
---------------------------------------------------------------------------

    \123\ William F. Treacy & Mark S. Carey, Credit Risk Rating at 
Large U.S. Banks, 84 Federal Reserve Bulletin 897 (1998).
---------------------------------------------------------------------------

    Because examinations may be twelve months apart--eighteen months 
for smaller banks--these internal classification systems may cause a 
bank to regrade an asset long before its next examination. Accordingly, 
the Board is proposing to include within the definition of low-quality 
asset not only assets classified during the last examination but also 
assets classified by the affiliate's internal classification system (or 
assets that received an internal rating that is substantially 
equivalent to classified in such an internal system). These assets 
generally have been renegotiated or compromised because the borrower is 
in financial distress and, thus, typically would meet the fourth prong 
of the statutory definition of low-quality asset. Moreover, the 
purchase of such assets by a bank raises safety and soundness concerns.
    The Board has some concern that this interpretation may induce 
companies to avoid or defer reclassification of an asset in order to 
allow its sale to an affiliated bank, but believes that such evasions 
can be addressed through the examination process. The Board expects 
companies with internal rating systems to use the systems consistently 
over time and over similar classes of assets and will view as an 
evasion of section 23A any company's deferral or alteration of an 
asset's rating to facilitate sale of the asset to an affiliated bank.
    Finally, the proposed rule defines low-quality asset to include 
foreclosed property designated ``other real estate owned,'' until it is 
reviewed by an examiner and receives a favorable classification. In the 
Board's experience, such property is often of such poor quality that 
its ownership poses the same risk to the bank as a low-quality loan 
that was purchased or taken as collateral.
    5. Securities--223.26(w). Section 23A defines ``securities'' to 
mean ``stocks, bonds, debentures, notes, or other similar 
obligations.''\124\ In light of the ambiguous nature of this 
definition, the Board generally has looked to the securities laws for 
guidance in determining which financial instruments should be 
considered securities for purposes of section 23A. In light of the 
similarities between commercial paper and debentures and notes and the 
countervailing fact that the Securities Exchange Act of 1934 excludes 
some forms of commercial

[[Page 24209]]

paper from its definition of security,\125\ the proposed regulation 
clarifies that commercial paper is a security for purposes of section 
23A. Accordingly, as discussed in more detail above, when a bank 
purchases commercial paper issued by an affiliate, the bank makes an 
extension of credit to the affiliate (which must be secured in 
accordance with section 23A's collateral requirements) and purchases 
securities issued by the affiliate for purposes of section 23A.
---------------------------------------------------------------------------

    \124\ 12 U.S.C. 371c(b)(9).
    \125\ See 15 U.S.C. 78c(a)(10).
---------------------------------------------------------------------------

    6. Voting securities--223.26(aa). Section 23A uses both the terms 
``voting shares'' and ``voting securities.'' To remove any ambiguity 
and to provide additional guidance to banks, the proposed regulation 
replaces all statutory uses of the term ``voting shares'' with the term 
``voting securities'' and defines ``voting securities'' to have the 
same meaning as ``voting securities'' in Regulation Y.\126\
---------------------------------------------------------------------------

    \126\ See 12 CFR 225.2(q).
---------------------------------------------------------------------------

Regulatory Flexibility Act

    In accordance with section 3(a) of the Regulatory Flexibility Act 
(5 U.S.C. 603(a)), the Board must publish an initial regulatory 
flexibility analysis with this rulemaking. Sections 23A and 23B of the 
Federal Reserve Act limit transactions between a bank and its 
affiliates and authorize the Board to issue regulations as may be 
necessary to administer and carry out the purposes of the sections. The 
proposed rule would comprehensively implement these sections of the 
Federal Reserve Act. The rule would simplify for banks the task of 
complying with the sections and would help ensure that the sections are 
consistently interpreted and applied by the Federal banking agencies 
and the banking industry. A description of the reasons why action by 
the Board is being considered and a statement of the objectives of, and 
legal basis for, the proposed rule are contained in the supplementary 
material provided above.
    The proposed rule would apply to all banks regardless of their 
size. Although the rule potentially affects all banks, the regulation 
mainly codifies existing practice. The Board specifically seeks comment 
on the likely burden that the proposed rule would impose on banks.

Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3501 et seq.), the Board has reviewed the proposed rule under the 
authority delegated to the Board by the Office of Management and 
Budget. No collections of information pursuant to the Paperwork 
Reduction Act are contained in the proposed rule.

Solicitation of Comments Regarding Use of ``Plain Language''

    Section 722 of the GLB Act requires the Board to use ``plain 
language'' in all proposed and final rules published after January 1, 
2000. The Board invites comments about how to make the proposed rule 
easier to understand, including answers to the following questions:
    (1) Has the Board organized the material in an effective manner? If 
not, how could the material be better organized?
    (2) Are the terms of the rule clearly stated? If not, how could the 
terms be more clearly stated?
    (3) Does the rule contain technical language or jargon that is 
unclear? If so, which language requires clarification?
    (4) Would a different format (with respect to grouping and order of 
sections and use of headings) make the rule easier to understand? If 
so, what changes to the format would make the rule easier to 
understand?
    (5) Would increasing the number of sections (and making each 
section shorter) clarify the rule? If so, which portions of the rule 
should be changed in this respect?
    (6) What additional changes would make the rule easier to 
understand?

List of Subjects in 12 CFR Part 223

    Banks, Banking, Federal Reserve System.

    For the reasons set out in the preamble, title 12, chapter II of 
the Code of Federal Regulations is proposed to be amended by adding a 
new part 223 to read as follows:

PART 223--TRANSACTIONS BETWEEN BANKS AND THEIR AFFILIATES 
(REGULATION W)

Subpart A  Introduction
Sec.
223.1  Authority, purpose, and scope.
Subpart B--General Provisions of Section 23A
223.2  What is the maximum amount of covered transactions that a 
bank may enter into with any single affiliate?
223.3   What is the maximum amount of covered transactions that a 
bank may enter into with all affiliates?
223.4   What safety and soundness requirement applies to covered 
transactions?
223.5   What are the collateral requirements for a credit 
transaction with an affiliate?
223.6   May a bank purchase a low-quality asset from an affiliate?
223.7   What transactions by a bank with any person are treated as 
transactions with an affiliate?
Subpart C--Valuation and Timing Principles Under Section 23A
223.8  What valuation and timing principles apply to credit 
transactions?
223.9   What valuation and timing principles apply to asset 
purchases?
223.10   What valuation and timing principles apply to purchases of 
and investments in securities issued by an affiliate?
223.11   What valuation principles apply to extensions of credit 
secured by affiliate securities?
Subpart D--Other Considerations Under Section 23A
223.12  How does section 23A apply to a bank's acquisition of an 
affiliate that becomes a subsidiary of the bank after the 
acquisition?
223.13   What rules apply to financial subsidiaries of a bank?
223.14   What rules apply to derivative contracts? [Reserved]
Subpart E--Exemptions From the Provisions of Section 23A
223.15  What covered transactions between a bank and an insured 
depository institution are exempt from the quantitative limits and 
collateral requirements?
223.16   What covered transactions are exempt from the quantitative 
limits, collateral requirements, and low-quality asset prohibition?
223.17   What are the standards under which the Board may grant 
additional exemptions from the requirements of section 23A?
Subpart F--General Provisions of Section 23B
223.18   What is the market terms requirement of section 23B?
223.19   What transactions with affiliates or others must comply 
with section 23B's market terms requirement?
223.20   What asset purchases are prohibited by section 23B?
223.21   What advertisements and statements are prohibited by 
section 23B?
223.22   What are the standards under which the Board may grant 
exemptions from the requirements of section 23B?
Subpart G--Application of Sections 23A and 23B to U.S. Branches and 
Agencies of Foreign Banks
223.23  How do sections 23A and 23B apply to U.S. branches and 
agencies of foreign banks?
Subpart H--Definitions of Terms
223.24  What is an ``affiliate'' for purposes of sections 23A and 
23B?
223.25   What transactions with affiliates are covered by section 
23A?
223.26   What are the meanings of the other terms used in sections 
23A and 23B?

    Authority: 12 U.S.C. 371c(b)(1) (E) and (f), 371c-1(e), 1828(j), 
1468.

[[Page 24210]]

Subpart A--Introduction


Sec. 223.1  Authority, purpose, and scope.

    (a) Authority. The Board of Governors of the Federal Reserve System 
(Board) has issued this part (Regulation W) under the authority of 
sections 23A(f)(1) and 23B(e) of the Federal Reserve Act (12 U.S.C. 
371c(f)(1), 371c-1(e)).
    (b) Purpose. Sections 23A and 23B of the Federal Reserve Act (12 
U.S.C. 371c, 371c-1) establish certain quantitative limits and other 
prudential requirements for loans, purchases of assets, and certain 
other transactions between a bank and its affiliates. This Regulation W 
implements sections 23A and 23B by defining terms used in those 
sections, explaining the requirements of the sections, and exempting 
certain transactions from certain of the requirements.
    (c) Scope. Sections 23A and 23B apply by their terms to ``member 
banks''--that is, national banks, State banks, trust companies, and 
other institutions that are members of the Federal Reserve System. The 
Federal Deposit Insurance Act (12 U.S.C. 1828(j)) subjects insured 
nonmember banks to sections 23A and 23B as if they were member banks. 
Accordingly, this Regulation W applies to member banks and insured 
nonmember banks, and uses the term ``banks'' to describe the companies 
that are subject to its provisions. This regulation implements sections 
23A and 23B of the Federal Reserve Act (12 U.S.C. 371c, 371c-1); it 
does not contain every statutory or regulatory restriction on 
transactions between banks and their affiliates, including those that 
may apply to banks subject to prompt corrective action under section 38 
of the Federal Deposit Insurance Act (12 U.S.C. 1831o).

Subpart B--General Provisions of Section 23A


Sec. 223.2  What is the maximum amount of covered transactions that a 
bank may enter into with any single affiliate?

    A bank may not engage in a covered transaction with an affiliate if 
the aggregate amount of the bank's covered transactions with any 
affiliate would exceed 10 percent of the capital stock and surplus of 
the bank.


Sec. 223.3  What is the maximum amount of covered transactions that a 
bank may enter into with all affiliates?

    A bank may not engage in a covered transaction with any affiliate 
if the aggregate amount of the bank's covered transactions with all 
affiliates would exceed 20 percent of the capital stock and surplus of 
the bank.


Sec. 223.4  What safety and soundness requirement applies to covered 
transactions?

    A bank may not engage in any covered transaction, including any 
covered transaction exempt under this regulation, unless the 
transaction is on terms and conditions that are consistent with safe 
and sound banking practices.


Sec. 223.5  What are the collateral requirements for a credit 
transaction with an affiliate?

    (a) Collateral required for extensions of credit and certain other 
covered transactions. A bank must ensure that each of its credit 
transactions with an affiliate is secured by the amount of collateral 
required by paragraph (b) of this section at the time of the 
transaction.
    (b) Amount of collateral required. A credit transaction described 
in paragraph (a) of this section must be secured by collateral having a 
market value equal to at least:
    (1) 100 percent of the amount of the transaction, if the collateral 
is:
    (i) Obligations of the United States or its agencies;
    (ii) Obligations fully guaranteed by the United States or its 
agencies as to principal and interest;
    (iii) Notes, drafts, bills of exchange, or bankers' acceptances 
that are eligible for rediscount or purchase by a Federal Reserve Bank; 
or
    (iv) A segregated, earmarked deposit account with the bank that is 
for the sole purpose of securing the transaction and is so identified;
    (2) 110 percent of the amount of the transaction, if the collateral 
is obligations of any State or political subdivision of any State;
    (3) 120 percent of the amount of the transaction, if the collateral 
is other debt instruments, including loans and other receivables; or
    (4) 130 percent of the amount of the transaction, if the collateral 
is stock, leases, or other real or personal property.
    (c) Ineligible collateral. The following items are not eligible 
collateral for purposes of this section:
    (1) Low-quality assets;
    (2) Securities issued by any affiliate or the bank;
    (3) Intangible assets, including servicing assets; and
    (4) Guarantees and letters of credit.
    (d) Perfection and priority requirements for collateral. (1) A bank 
must maintain a security interest in collateral required by this 
section that is perfected and enforceable under applicable law, 
including in the event of default resulting from insolvency, 
liquidation, or similar circumstances.
    (2) A bank either must obtain a first priority security interest in 
collateral required by this section or must deduct from the value of 
collateral obtained by the bank the lesser of:
    (i) The amount of any security interest in the collateral that is 
senior to that of the bank; or
    (ii) The amount of any credit secured by the collateral that is 
senior to that of the bank.
    (e) Replacement requirement for retired or amortized collateral. A 
bank must replace any required collateral that subsequently is retired 
or amortized with additional eligible collateral as needed to keep the 
percentage of the collateral value relative to the amount of the 
outstanding credit transaction equal to the minimum percentage required 
at the inception of the transaction.
    (f) Inapplicability of the collateral requirements to certain 
acceptances. The collateral requirements of this section do not apply 
to an acceptance that already is fully secured either by attached 
documents or by other property that is involved in the transaction and 
has an ascertainable market value.
    (g) Inapplicability of the collateral requirements to the undrawn 
portion of certain extensions of credit. The collateral requirements of 
this section do not apply to the undrawn portion of an extension of 
credit to an affiliate so long as the bank does not have any legal 
obligation to advance additional funds under the extension of credit 
until the affiliate posts the amount of collateral required by 
paragraph (b) of this section with respect to the entire drawn portion 
of the extension of credit.


Sec. 223.6  May a bank purchase a low-quality asset from an affiliate?

    (a) In general. A bank may not purchase a low-quality asset from an 
affiliate unless the bank, pursuant to an independent credit 
evaluation, committed itself to purchase the asset prior to the time 
the asset was acquired by the affiliate.
    (b) Exemption for renewals of loan participations involving problem 
loans. The prohibition contained in paragraph (a) of this section does 
not apply to the renewal of, or extension of additional credit with 
respect to, a bank's participation in a loan to a nonaffiliate that was 
originated by an affiliated depository institution if:
    (1) The loan was not a low-quality asset at the time the bank 
purchased its participation;
    (2) The renewal or extension of additional credit is approved by 
the board of directors of the participating bank as necessary to 
protect the bank's

[[Page 24211]]

investment by enhancing the ultimate collection of the original 
indebtedness;
    (3) The participating bank's share of the renewal or additional 
extension of credit does not exceed its proportional share of the 
original transaction; and
    (4) The participating bank provides its appropriate Federal banking 
agency with 20 days' prior notice of the proposed renewal or additional 
extension of credit.


Sec. 223.7  What transactions by a bank with any person are treated as 
transactions with an affiliate?

    (a) In general. A bank must treat any of its transactions with any 
person as a transaction with an affiliate to the extent that the 
proceeds of the transaction are used for the benefit of, or transferred 
to, an affiliate.
    (b) Exemptions. Notwithstanding paragraph (a) of this section, the 
following transactions are not subject to the quantitative limits of 
Secs. 223.2 and 223.3 or the collateral requirements of Sec. 223.5. The 
transactions are, however, subject to the safety and soundness 
requirement of Sec. 223.4, the prohibition on the purchase of a low-
quality asset of Sec. 223.6, and the market terms requirement and other 
provisions of subpart F of this part.
    (1) Certain riskless principal transactions. An extension of credit 
by a bank to a nonaffiliate, if:
    (i) The proceeds of the extension of credit are used to purchase a 
security through a securities affiliate of the bank, and the securities 
affiliate is acting exclusively as a riskless principal for the 
nonaffiliate in the transaction;
    (ii) The security purchased by the nonaffiliate is not issued or 
underwritten by, or sold out of the inventory of, any affiliate of the 
bank; and
    (iii) Any riskless principal mark-up or other compensation received 
by the affiliate from the proceeds of the extension of credit meets the 
market terms standard set forth in paragraph (b)(2) of this section.
    (2) Brokerage commissions, agency fees, and riskless principal 
mark-ups. An affiliate's retention of a portion of the proceeds of an 
extension of credit described in paragraph (b)(1) of this section or in 
12 CFR 250.243 as a brokerage commission, agency fee, or riskless 
principal mark-up, if that commission, fee, or mark-up is substantially 
the same as, or lower than, those prevailing at the same time for 
comparable transactions with or involving other nonaffiliates, in 
accordance with the market terms requirement of Sec. 223.18.
    (3) Preexisting lines of credit. An extension of credit by a bank 
to a nonaffiliate, if:
    (i) The proceeds of the extension of credit are used to purchase a 
security from or through a securities affiliate of the bank; and
    (ii) The extension of credit is made pursuant to, and consistent 
with any conditions imposed in, a preexisting line of credit that was 
not established in contemplation of the purchase of securities from or 
through an affiliate of the bank.
    (4) General purpose credit card transactions. An extension of 
credit by a bank to a nonaffiliate, if:
    (i) The proceeds of the extension of credit are used by the 
nonaffiliate to purchase a product or service from an affiliate of the 
bank; and
    (ii) The extension of credit is made pursuant to, and consistent 
with any conditions imposed in, a general purpose credit card issued by 
the bank to the nonaffiliate.

Subpart C--Valuation and Timing Principles under Section 23A


Sec. 223.8  What valuation and timing principles apply to credit 
transactions?

    (a) Valuation. (1) Initial valuation of direct credit transactions. 
Except as provided in paragraph (a)(2) or (3) of this section, a credit 
transaction with an affiliate initially must be valued at the sum of:
    (i) The amount provided to, or on behalf of, the affiliate in the 
transaction; and
    (ii) Any additional amount that the bank could be required to 
provide to, or on behalf of, the affiliate under the terms of the 
transaction.
    (2) Initial valuation of indirect credit transactions. If a bank 
acquires a credit transaction with an affiliate, the covered 
transaction initially must be valued at the sum of:
    (i) The total amount of consideration given (including liabilities 
assumed) by the bank in exchange for the credit transaction; and
    (ii) Any additional amount that the bank could be required to 
provide to, or on behalf of, the affiliate under the terms of the 
transaction.
    (3) Debt securities. The valuation principles of paragraphs (a)(1) 
and (2) of this section do not apply to a bank's purchase of or 
investment in a debt security issued by an affiliate, which is governed 
by Sec. 223.10.
    (b) Timing. (1) In general. A bank engages in a credit transaction 
with an affiliate:
    (i) At the time during the day that the bank becomes legally 
obligated to make an extension of credit to, issue a guarantee, 
acceptance, or letter of credit on behalf of, or confirm a letter of 
credit issued by, an affiliate; and
    (ii) At the time during the day that the bank acquires an extension 
of credit to, or guarantee, acceptance, or letter of credit issued on 
behalf of, an affiliate.
    (2) Credit transactions by a bank with a nonaffiliate that becomes 
an affiliate of the bank. (i) In general. A credit transaction with a 
nonaffiliate becomes a covered transaction at the time that the 
nonaffiliate becomes an affiliate of the bank. The bank must ensure 
that any such credit transaction complies with the collateral 
requirements of Sec. 223.5 promptly after the nonaffiliate becomes an 
affiliate. The bank also must treat the amount of any such credit 
transaction as part of the aggregate amount of the bank's covered 
transactions for purposes of determining compliance with the 
quantitative limits of Secs. 223.2 and 223.3 in connection with any 
future covered transactions. Except as described in paragraph 
(b)(2)(ii) of this section, the bank is not required to reduce the 
amount of its covered transactions with any affiliate because the 
nonaffiliate has become an affiliate.
    (ii) Credit transactions by a bank with a nonaffiliate in 
contemplation of the nonaffiliate becoming an affiliate of the bank. In 
addition to the provisions of paragraph (b)(2)(i) of this section, if a 
bank engages in a credit transaction with a nonaffiliate in 
contemplation of the nonaffiliate becoming an affiliate of the bank, 
the bank must ensure that the aggregate amount of the bank's covered 
transactions (including any such transaction with the nonaffiliate) 
would not exceed the quantitative limits of Secs. 223.2 or 223.3 at the 
time the nonaffiliate becomes an affiliate.
    (iii) Example. A bank with capital stock and surplus of $1,000 and 
no outstanding covered transactions makes a $120 unsecured loan to a 
nonaffiliate. Several years later, the bank's holding company purchases 
all the stock of the nonaffiliate, thereby making the nonaffiliate an 
affiliate of the bank. Promptly after the time of the stock 
acquisition, the bank must ensure that the loan is in compliance with 
the collateral requirements of section 23A of the Federal Reserve Act 
(12 U.S.C. 371c). The bank will not be in violation of the quantitative 
limits of section 23A at the time of the stock acquisition (unless the 
loan was made by the bank in contemplation of the nonaffiliate becoming 
an affiliate). The bank will, however, be prohibited from engaging in 
any additional covered transactions until such time as the value of the 
loan

[[Page 24212]]

transaction falls below 10 percent of the bank's capital stock and 
surplus.


Sec. 223.9  What valuation and timing principles apply to asset 
purchases?

    (a) Valuation. (1) In general. Unless the transaction is described 
in Sec. 223.12, a purchase of an asset (other than a security issued by 
an affiliate or a note or obligation of an affiliate) by a bank from an 
affiliate must be valued initially at the total amount of consideration 
given (including liabilities assumed) by the bank in exchange for the 
asset. The value of the covered transaction after the purchase may be 
reduced to reflect amortization or depreciation of the asset, to the 
extent that such reductions are consistent with GAAP.
    (2) Examples of the valuation of asset purchases. The following are 
examples of how to value a bank's purchase of an asset from an 
affiliate.
    (i) Cash purchase of assets. A bank purchases a pool of loans from 
an affiliate for $10 million. The bank initially must value the covered 
transaction at $10 million. Going forward, if the borrowers on the 
loans pay down $6 million of the principal amount of the loans, the 
bank may value the covered transaction at $4 million.
    (ii) Purchase of assets through an assumption of liabilities. An 
affiliate of a bank contributes real property with a fair market value 
of $200,000 to the bank. The bank pays the affiliate no cash for the 
property, but assumes a $50,000 mortgage on the property. The bank has 
engaged in a covered transaction with the affiliate and initially must 
value the transaction at $50,000. Going forward, if the bank retains 
the real property but pays off the mortgage, the bank must continue to 
value the covered transaction at $50,000.
    (b) Timing. (1) In general. A purchase of an asset remains a 
covered transaction for a bank for as long as the bank holds the asset.
    (2) Asset purchases by a bank from a nonaffiliate in contemplation 
of the nonaffiliate becoming an affiliate of the bank. If a bank 
purchases assets from a nonaffiliate in contemplation of the 
nonaffiliate becoming an affiliate of the bank, the asset purchase 
becomes a covered transaction at the time that the nonaffiliate becomes 
an affiliate of the bank. In addition, the bank must ensure that the 
aggregate amount of the bank's covered transactions (including any such 
transaction with the nonaffiliate) would not exceed the quantitative 
limits of Secs. 223.2 or 223.3 at the time the nonaffiliate becomes an 
affiliate.


Sec. 223.10  What valuation and timing principles apply to purchases of 
and investments in securities issued by an affiliate?

    (a) Valuation. (1) In general. Except as provided in paragraph (b) 
of Sec. 223.13 with respect to securities issued by a financial 
subsidiary, a bank's purchase of or investment in a security issued by 
an affiliate must be valued at the greater of:
    (i) The total amount of consideration given (including liabilities 
assumed) by the bank in exchange for the security, reduced to reflect 
amortization of the security to the extent consistent with GAAP; or
    (ii) The carrying value of the security on the financial statements 
of the bank, determined in accordance with GAAP.
    (2) Examples of the valuation of purchases of and investments in 
the securities of an affiliate (other than a financial subsidiary). The 
following are examples of how to value a bank's purchase of or 
investment in securities issued by an affiliate (other than a financial 
subsidiary). Examples of how to value a bank's purchase of or 
investment in securities issued by a financial subsidiary are provided 
in paragraph (b)(3) of Sec. 223.13.
    (i) Purchase of the debt securities of an affiliate that is not a 
financial subsidiary. The parent holding company of a bank owns 100 
percent of the shares of a mortgage company. The bank purchases debt 
securities issued by the mortgage company for $600. The initial 
carrying value of the securities on the bank's GAAP financial 
statements is $600. The bank initially must value the investment at 
$600.
    (ii) Purchase of the shares of an affiliate that is not a financial 
subsidiary. The parent holding company of a bank owns 51 percent of the 
shares of a mortgage company. The bank purchases an additional 30 
percent of the shares of the mortgage company from a third party for 
$100. The initial carrying value of the shares on the bank's GAAP 
financial statements is $100. The bank initially must value the 
investment at $100. Going forward, if the bank's carrying value of the 
shares declines to $40, the bank must continue to value the investment 
at $100.
    (iii) Contribution of the shares of an affiliate that is not a 
financial subsidiary. The parent holding company of a bank owns 100 
percent of the shares of a mortgage company and contributes 30 percent 
of the shares to the bank. The bank gives no consideration in exchange 
for the shares. If the initial carrying value of the shares on the 
bank's GAAP financial statements is $300, then the bank initially must 
value the investment at $300. Going forward, if the bank's carrying 
value of the shares increases to $500, the bank must value the 
investment at $500.
    (b) Timing. A purchase of or investment in a security issued by an 
affiliate remains a covered transaction for a bank for as long as the 
bank holds the security.


Sec. 223.11  What valuation principles apply to extensions of credit 
secured by affiliate securities?

    (a) Valuation of extensions of credit secured exclusively by 
affiliate securities. An extension of credit by a bank to a 
nonaffiliate secured exclusively by securities issued by an affiliate 
of the bank must be valued at the lesser of:
    (1) The total value of the extension of credit; or
    (2) The fair market value of the affiliate's securities that are 
pledged as collateral, if such securities meet the market quotation 
standard contained in paragraph (e)(1) of Sec. 223.16 or the standards 
set forth in paragraphs (e)(2)(i) and (v) of Sec. 223.16.
    (b) Valuation of extensions of credit secured by affiliate 
securities and other collateral. An extension of credit by a bank to a 
nonaffiliate secured in part by securities issued by an affiliate of 
the bank and in part by other collateral must be valued at the lesser 
of:
    (1) The total value of the extension of credit less the fair market 
value of the nonaffiliate collateral; or
    (2) The fair market value of the affiliate's securities that are 
pledged as collateral, if such securities meet the market quotation 
standard contained in paragraph (e)(1) of Sec. 223.16 or the standards 
set forth in paragraphs (e)(2)(i) and (v) of Sec. 223.16.

Subpart D--Other Considerations Under Section 23A


Sec. 223.12  How does section 23A apply to a bank's acquisition of an 
affiliate that becomes a subsidiary of the bank after the acquisition?

    (a) Certain acquisitions by a bank of securities issued by an 
affiliate are treated as a purchase of assets from an affiliate. A 
bank's acquisition of a security issued by a company that was an 
affiliate of the bank before the acquisition is treated as a purchase 
of the assets of an affiliate, if:
    (1) As a result of the transaction, the company becomes a 
subsidiary of the bank and ceases to be an affiliate of the bank; and
    (2) The company has liabilities, or the bank gives cash or any 
other consideration in exchange for the security.

[[Page 24213]]

    (b) Valuation. A transaction described in paragraph (a) of this 
section but not exempt under paragraph (d) of this section must be 
valued initially at the sum of:
    (1) The total amount of consideration given by the bank in exchange 
for the security; and
    (2) The total liabilities of the company whose securities have been 
acquired by the bank, as of the time of the acquisition.
    (c) Valuation example. The parent holding company of a bank 
contributes between 25 and 100 percent of the voting shares of a 
mortgage company to the bank. The bank gives no consideration in 
exchange for the shares. The mortgage company has total assets of 
$300,000 and total liabilities of $100,000. As a result of the 
transaction, the mortgage company becomes a subsidiary of the bank and 
ceases to be an affiliate of the bank. The transaction is treated as a 
purchase of the assets of the mortgage company by the bank from an 
affiliate under paragraph (a) of this section. The bank initially must 
value the transaction at $100,000, the total amount of the liabilities 
of the mortgage company.
    (d) Exemption for step transactions. A transaction described in 
paragraph (a) of this section is not subject to the provisions of 
subpart B of this part (other than the safety and soundness requirement 
of Sec. 223.4) if:
    (1) The bank acquires the securities issued by the company 
immediately after the company becomes an affiliate of the bank;
    (2) The bank acquires all the securities of the company that were 
transferred in connection with the transaction that made the company an 
affiliate of the bank; and
    (3) The acquisition complies with the market terms requirement of 
Sec. 223.18.


Sec. 223.13  What rules apply to financial subsidiaries of a bank?

    (a) Exemption from the 10 percent limit for covered transactions 
between a bank and a single financial subsidiary. The 10 percent 
quantitative limit contained in Sec. 223.2 does not apply with respect 
to covered transactions between a bank and a financial subsidiary of 
the bank. The 20 percent quantitative limit contained in Sec. 223.3 
does apply to such transactions.
    (b) Valuation of purchases of or investments in the securities of a 
financial subsidiary. (1) General rule. A bank's purchase of or 
investment in a security issued by a financial subsidiary must be 
valued at the greater of:
    (i) The total amount of consideration given (including liabilities 
assumed) by the bank in exchange for the security, reduced to reflect 
amortization of the security to the extent consistent with GAAP; and
    (ii) The carrying value of the security on the financial statements 
of the bank, determined in accordance with GAAP but without reflecting 
the bank's pro rata portion of any earnings retained or losses incurred 
by the financial subsidiary after the bank's acquisition of the 
security.
    (2) Carrying value of an investment in a consolidated financial 
subsidiary. If a financial subsidiary is consolidated with its parent 
bank under GAAP, the carrying value of the bank's investment in 
securities issued by the financial subsidiary shall be equal to the 
carrying value of the securities on parent-only financial statements of 
the bank, determined in accordance with GAAP but without reflecting the 
bank's pro rata portion of any earnings retained or losses incurred by 
the financial subsidiary after the bank's acquisition of the 
securities.
    (3) Examples of the valuation of purchases of and investments in 
the securities of a financial subsidiary. The following are examples of 
how a bank must value its purchase of or investment in the securities 
of a financial subsidiary. Each example involves a securities 
underwriter that becomes a financial subsidiary of the bank after the 
transactions described below.
    (i) Initial valuation. (A) Direct acquisition by a bank. A bank 
pays $500 to acquire 100 percent of the shares of a securities 
underwriter. The initial carrying value of the shares on the bank's 
parent-only GAAP financial statements is $500. The bank initially must 
value the investment at $500.
    (B) Contribution of a financial subsidiary to a bank. The parent 
holding company of a bank acquires 100 percent of the shares of a 
securities underwriter in a transaction valued at $500, and immediately 
contributes the shares to the bank. The bank gives no consideration in 
exchange for the shares. The bank initially must value the investment 
at the carrying value of the shares on the bank's parent-only GAAP 
financial statements. If the parent holding company's acquisition of 
the securities underwriter was accounted for as a purchase, the bank's 
initial carrying value of the shares would be $500. Alternatively, if 
the parent holding company's acquisition of the securities underwriter 
was accounted for as a pooling-of-interests, the bank's initial 
carrying value of the shares would equal the book value of the 
underwriter prior to the acquisition, which may be less than $500.
    (ii) Carrying value not adjusted for earnings and losses of the 
financial subsidiary. A bank and its parent holding company engage in 
the transaction described in paragraph (b)(3)(i)(B) of this section, 
and the bank initially values the investment at $500. In the following 
year, the securities underwriter earns $25 in profit, which is added to 
its retained earnings. The bank's carrying value of the shares of the 
underwriter is not adjusted for purposes of this part, and the bank 
must continue to value the investment at $500. If, however, the bank 
contributes $100 of additional capital to the securities underwriter, 
the bank must value the investment at $600.
    (c) Treatment of an affiliate's investments in, and extensions of 
credit to, a financial subsidiary of a bank. (1) Investments. Any 
purchase of, or investment in, the securities of a financial subsidiary 
of a bank by an affiliate of the bank (other than an affiliate that is 
itself a bank or an insured savings association) will be treated as a 
purchase of or investment in such securities by the bank.
    (2) Extensions of credit. Any extension of credit to a financial 
subsidiary of a bank by an affiliate of the bank (other than an 
affiliate that is itself a bank or an insured savings association) will 
be treated as an extension of credit by the bank to the financial 
subsidiary, if the Board determines, by regulation or order, that such 
treatment is necessary or appropriate to prevent evasions of the 
Federal Reserve Act or the Gramm-Leach-Bliley Act.
    (3) An extension of credit that is treated as regulatory capital of 
the financial subsidiary. The Board has determined, under the authority 
of paragraph (c)(2) of this section, that any extension of credit to a 
financial subsidiary of a bank by an affiliate of the bank (other than 
an affiliate that is itself a bank or an insured savings association) 
will be treated as an extension of credit by the bank to the financial 
subsidiary if the extension of credit is treated as capital of the 
financial subsidiary under any Federal or State law, regulation, or 
interpretation applicable to the subsidiary.

[[Page 24214]]

Sec. 223.14  What rules apply to derivative contracts? [Reserved]

Subpart E--Exemptions From the Provisions of Section 23A


Sec. 223.15  What covered transactions between a bank and an insured 
depository institution are exempt from the quantitative limits and 
collateral requirements?

    The following transactions are not subject to the quantitative 
limits of Secs. 223.2 and 223.3 or the collateral requirements of 
Sec. 223.5. The transactions are, however, subject to the safety and 
soundness requirement of Sec. 223.4 and the prohibition on the purchase 
of a low-quality asset of Sec. 223.6.
    (a) Parent institution/subsidiary institution transactions. 
Transactions with an insured depository institution if the bank 
controls 80 percent or more of the voting securities of the insured 
depository institution or the insured depository institution controls 
80 percent or more of the voting securities of the bank;
    (b) Transactions between a bank and an insured depository 
institution owned by the same holding company. Transactions with an 
insured depository institution if the same company controls 80 percent 
or more of the voting securities of the bank and the insured depository 
institution; and
    (c) Certain loan purchases from an affiliated insured depository 
institution. Purchasing a loan on a nonrecourse basis from an 
affiliated insured depository institution.


Sec. 223.16  What covered transactions are exempt from the quantitative 
limits, collateral requirements, and low-quality asset prohibition?

    The following transactions are not subject to the quantitative 
limits of Secs. 223.2 and 223.3, the collateral requirements of 
Sec. 223.5, or the prohibition on the purchase of a low-quality asset 
of Sec. 223.6. The transactions are, however, subject to the safety and 
soundness requirement of Sec. 223.4.
    (a) Making correspondent banking deposits. Making a deposit in an 
affiliated depository institution or affiliated foreign bank that 
represents an ongoing, working balance maintained in the ordinary 
course of correspondent business;
    (b) Giving credit for uncollected items. Giving immediate credit to 
an affiliate for uncollected items received in the ordinary course of 
business;
    (c) Transactions secured by cash or U.S. government securities. 
Engaging in a credit transaction with an affiliate that is fully 
secured by:
    (1) Obligations of the United States or its agencies;
    (2) Obligations fully guaranteed by the United States or its 
agencies as to principal and interest; or
    (3) A segregated, earmarked deposit account with the bank that is 
for the sole purpose of securing the credit transaction and is 
identified as such;
    (d) Purchasing securities of a servicing affiliate. Purchasing a 
security issued by any company engaged solely in providing services 
described in section 4(c)(1) of the Bank Holding Company Act of 1956 
(12 U.S.C. 1843(c)(1));
    (e) Purchasing certain liquid assets. (1) Purchasing an asset 
(other than a security issued by an affiliate) having a readily 
identifiable and publicly available market quotation and purchased at 
or below the asset's current market quotation. An asset has a readily 
identifiable and publicly available market quotation if:
    (i) The asset's price is quoted routinely in a widely disseminated 
news source; or
    (ii) The asset is an obligation of the United States or its 
agencies or an obligation fully guaranteed by the United States or its 
agencies as to principal and interest; or
    (2) Purchasing a security from a securities affiliate, if:
    (i) The security has a ``ready market,'' as defined in 17 CFR 
240.15c3-1(c)(11)(i);
    (ii) The security is eligible for a State member bank to purchase 
directly, subject to the same terms and conditions that govern the 
investment activities of a State member bank, and the bank records the 
transaction as a purchase of a security for purposes of the bank Call 
Report, consistent with the requirements for a State member bank;
    (iii) The security is not a low-quality asset;
    (iv) The bank does not purchase the security during an 
underwriting, or within 30 days of an underwriting, if an affiliate is 
an underwriter of the security, unless the security is purchased as 
part of an issue of obligations of, or obligations fully guaranteed as 
to principal and interest by, the United States or its agencies;
    (v) The security's price is quoted routinely on an unaffiliated 
electronic service that provides indicative data from real-time 
financial networks, provided that:
    (A) The price paid by the bank is at or below the current market 
quotation for the security; and
    (B) The size of the transaction executed by the bank does not cast 
material doubt on the appropriateness of relying on the current market 
quotation for the security; and
    (vi) The security is not issued by an affiliate, unless the 
security is an obligation fully guaranteed by the United States or its 
agencies as to principal and interest.
    (f) Purchasing municipal securities. Purchasing a municipal 
security from a securities affiliate if:
    (1) The security is rated by a nationally recognized statistical 
rating agency or is part of an issue of securities that does not exceed 
$25 million;
    (2) The security is eligible for purchase by a State member bank, 
subject to the same terms and conditions that govern the investment 
activities of a State member bank, and the bank records the transaction 
as a purchase of a security for purposes of the bank Call Report, 
consistent with the requirements for a State member bank; and
    (3)(i) The security's price is quoted routinely on an unaffiliated 
electronic service that provides indicative data from real-time 
financial networks, provided that:
    (A) The price paid by the bank is at or below the current market 
quotation for the security; and
    (B) The size of the transaction executed by the bank does not cast 
material doubt on the appropriateness of relying on the current market 
quotation for the security; or
    (ii) The price paid for the security can be verified by reference 
to two or more actual, current price quotes from unaffiliated broker-
dealers on the exact security to be purchased or a security comparable 
to the security to be purchased, where:
    (A) The price quotes obtained from the unaffiliated broker-dealers 
are based on a transaction similar in size to the transaction that is 
actually executed; and
    (B) The price paid is no higher than the average of the price 
quotes; or
    (iii) The price paid for the security can be verified by reference 
to the written summary provided by the syndicate manager to syndicate 
members that discloses the aggregate par values and prices of all bonds 
sold from the syndicate account, if the bank:
    (A) Purchases the municipal security during the underwriting 
period;
    (B) Obtains a copy of the summary from its securities affiliate and 
retains the summary for three years; and
    (C) Purchases the municipal security at a price that is at or below 
that indicated in the summary;
    (g) Purchasing an extension of credit subject to a repurchase 
agreement.

[[Page 24215]]

Purchasing from an affiliate an extension of credit that was originated 
by the bank and sold to the affiliate subject to a repurchase agreement 
or with recourse;
    (h) Asset purchases by a de novo bank. The purchase of an asset 
from an affiliate by a de novo bank, if the appropriate Federal banking 
agency for the bank has approved the asset purchase in writing in 
connection with its review of the formation of the bank;
    (i) Transactions approved under the Bank Merger Act. Any merger or 
consolidation between a bank and an affiliated insured depository 
institution, or any acquisition of assets or assumption of deposit 
liabilities by a bank from an affiliated insured depository 
institution, if the transaction has been approved by the responsible 
Federal banking agency pursuant to the Bank Merger Act (12 U.S.C. 
1828(c));
    (j) Purchasing an extension of credit from an affiliate. Purchasing 
an extension of credit from an affiliate, if:
    (1) The bank makes an independent evaluation of the 
creditworthiness of the borrower prior to the affiliate making or 
committing to make the extension of credit;
    (2) The bank commits to purchase the extension of credit prior to 
the affiliate making or committing to make the extension of credit;
    (3) The bank does not make a blanket advance commitment to purchase 
extensions of credit from the affiliate;
    (4) The dollar amount of the bank's total accumulated purchases 
from the affiliate, when aggregated with all other assets purchased 
from the affiliate by banks and insured savings associations that are 
affiliates of the bank, does not represent more than 50 percent of the 
dollar amount of extensions of credit originated by the affiliate; and
    (5) The bank and its affiliated banks and insured savings 
associations do not provide substantial, ongoing funding to the 
affiliate through this exemption.
    (k) Certain intraday extensions of credit. (1) In general. An 
intraday extension of credit that arises in connection with the 
performance by a bank, in the ordinary course of business, of 
securities clearing and settlement transactions or payment transactions 
on behalf of an affiliate and effected through one or more accounts 
that the affiliate holds with the bank, if the bank:
    (i) Has no reason to believe that the affiliate will have 
difficulty repaying the extension of credit in the ordinary course of 
business;
    (ii) Establishes and maintains prudent limits on the net amount of 
intraday credit that the bank may extend to each affiliate, and all 
affiliates in the aggregate, and integrates these limits into the 
bank's overall credit risk exposure limits and systems;
    (iii) Establishes and maintains policies, procedures, and systems 
reasonably designed to:
    (A) Assess the credit quality of each affiliate that obtains an 
intraday extension of credit from the bank and determine each such 
affiliate's ability to repay such credit extensions;
    (B) Periodically monitor each such affiliate's compliance with the 
established limits during the business day;
    (C) Review an affiliate's intraday extensions of credit in the 
event of the affiliate's violation of the established limits; and
    (D) Ensure that any intraday extension of credit received by an 
affiliate complies with the market terms requirement of Sec. 223.18;
    (iv) Maintains records and supporting information that are 
sufficient to enable the appropriate Federal banking agency to review 
the position limits and the policies, procedures, and systems described 
in paragraph (k)(1)(iii) of this section; and
    (v) Treats any such extension of credit (regardless of 
jurisdiction) that exists at the end of the bank's business day in the 
United States, as a nonexempt covered transaction as of the end of the 
bank's business day in the United States (assuming no other exemption 
applies to the transaction at such time).
    (2) Definition of ``payment transactions''. For purposes of this 
paragraph (k), ``payment transactions'' means transactions undertaken 
for the purpose of transferring funds to another account of the 
affiliate or to a third party and includes funds transfers, ACH 
transactions, check transactions, and other similar transactions.


Sec. 223.17  What are the standards under which the Board may grant 
additional exemptions from the requirements of section 23A?

    (a) The standards. The Board may, at its discretion, by regulation 
or order, exempt transactions or relationships from the requirements of 
section 23A of the Federal Reserve Act (12 U.S.C. 371c) and subpart B 
of this Regulation W if it finds such exemptions to be in the public 
interest and consistent with the purposes of section 23A.
    (b) Procedure. A bank may request an exemption from the 
requirements of section 23A and subpart B of this Regulation W by 
submitting a written request to the General Counsel of the Board.

Subpart F--General Provisions of Section 23B


Sec. 223.18  What is the market terms requirement of section 23B?

    A bank may not engage in a transaction described in Sec. 223.19 
unless the transaction is:
    (a) On terms and under circumstances, including credit standards, 
that are substantially the same, or at least as favorable to the bank, 
as those prevailing at the time for comparable transactions with or 
involving nonaffiliates; or
    (b) In the absence of comparable transactions, on terms and under 
circumstances, including credit standards, that in good faith would be 
offered to, or would apply to, nonaffiliates.


Sec. 223.19  What transactions with affiliates or others must comply 
with section 23B's market terms requirement?

    (a) The market terms requirement of Sec. 223.18 applies to the 
following transactions:
    (1) Any covered transaction with an affiliate, unless the 
transaction is:
    (i) Exempt under Sec. 223.15 or paragraphs (a) through (e)(1) or 
(g) through (i) of Sec. 223.16; and
    (ii) Consistent with the safety and soundness requirement of 
Sec. 223.4;
    (2) The sale of a security or other asset to an affiliate, 
including an asset subject to an agreement to repurchase;
    (3) The payment of money or the furnishing of a service to an 
affiliate under contract, lease, or otherwise;
    (4) Any transaction in which an affiliate acts as an agent or 
broker or receives a fee for its services to the bank or to any other 
person; and
    (5) Any transaction or series of transactions with a nonaffiliate, 
if an affiliate:
    (i) Has a financial interest in the nonaffiliate; or
    (ii) Is a participant in the transaction or series of transactions.
    (b) For the purpose of this section, any transaction by a bank with 
any person will be deemed to be a transaction with an affiliate of the 
bank if any of the proceeds of the transaction are used for the benefit 
of, or transferred to, the affiliate.


Sec. 223.20  What asset purchases are prohibited by section 23B?

    (a) Fiduciary purchases of assets from an affiliate. A bank may not 
purchase as fiduciary any security or other asset from any affiliate 
unless the purchase is permitted:
    (1) Under the instrument creating the fiduciary relationship;
    (2) By court order; or

[[Page 24216]]

    (3) By law of the jurisdiction governing the fiduciary 
relationship.
    (b) Purchase of a security underwritten by an affiliate. (1) A 
bank, whether acting as principal or fiduciary, may not knowingly 
purchase or otherwise acquire, during the existence of any underwriting 
or selling syndicate, any security if a principal underwriter of that 
security is an affiliate of the bank.
    (2) Paragraph (b)(1) of this section does not apply if the purchase 
or acquisition of the security has been approved, before the security 
is initially offered for sale to the public, by a majority of the 
directors of the bank based on a determination that the purchase is a 
sound investment for the bank, or for the person on whose behalf the 
bank is acting as fiduciary, as the case may be, irrespective of the 
fact that an affiliate of the bank is a principal underwriter of the 
security.
    (3) The approval requirement of paragraph (b)(2) of this section 
may be met if:
    (i) A majority of the directors of the bank approves standards for 
the bank's acquisitions of securities described in paragraph (b)(1) of 
this section, based on the determination set forth in paragraph (b)(2) 
of this section;
    (ii) Each acquisition described in paragraph (b)(1) of this section 
meets the standards; and
    (iii) A majority of the directors of the bank periodically reviews 
acquisitions described in paragraph (b)(1) of this section to ensure 
that they meet the standards and periodically reviews the standards to 
ensure that they continue to meet the criterion set forth in paragraph 
(b)(2) of this section.
    (c) Special definitions. For purposes of this section:
    (1) Principal underwriter means any underwriter who, in connection 
with a primary distribution of securities:
    (i) Is in privity of contract with the issuer or an affiliated 
person of the issuer;
    (ii) Acting alone or in concert with one or more other persons, 
initiates or directs the formation of an underwriting syndicate; or
    (iii) Is allowed a rate of gross commission, spread, or other 
profit greater than the rate allowed another underwriter participating 
in the distribution.
    (2) Security has the same meaning as in section 3(a)(10) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(10)).


Sec. 223.21  What advertisements and statements are prohibited by 
section 23B?

    (a) In general. A bank and its affiliates may not publish any 
advertisement or enter into any agreement stating or suggesting that 
the bank will in any way be responsible for the obligations of its 
affiliates.
    (b) Guarantees, acceptances, and letters of credit subject to 
section 23A. Paragraph (a) of this section does not prohibit a bank 
from issuing a guarantee, acceptance, or letter of credit on behalf of 
an affiliate to the extent otherwise permitted under this Regulation W.


Sec. 223.22  What are the standards under which the Board may grant 
exemptions from the requirements of section 23B?

    The Board may prescribe regulations to exempt transactions or 
relationships from the requirements of section 23B of the Federal 
Reserve Act (12 U.S.C. 371c-1) and subpart F of this Regulation W if it 
finds such exemptions to be in the public interest and consistent with 
the purposes of section 23B.

Subpart G--Application of Sections 23A and 23B to U.S. Branches and 
Agencies of Foreign Banks


Sec. 223.23  How do sections 23A and 23B apply to U.S. branches and 
agencies of foreign banks?

    (a) Applicability of sections 23A and 23B to foreign banks engaged 
in underwriting insurance, underwriting or dealing in securities, 
merchant banking, or insurance company investment in the United States. 
Sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c and 
371c-1) and the provisions of this Regulation W apply to transactions 
between each U.S. branch, agency, or commercial lending company of a 
foreign bank and:
    (1) Any affiliate of the foreign bank directly engaged in the 
United States in any of the following activities:
    (i) Insurance underwriting pursuant to section 4(k)(4)(B) of the 
Bank Holding Company Act (12 U.S.C. 1843(k)(4)(B));
    (ii) Securities underwriting, dealing, or market making pursuant to 
section 4(k)(4)(E) of the Bank Holding Company Act (12 U.S.C. 
1843(k)(4)(E));
    (iii) Merchant banking activities pursuant to section 4(k)(4)(H) of 
the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H)) (but only to the 
extent that the proceeds of the transaction are used for the purpose of 
funding the affiliate's merchant banking activities);
    (iv) Insurance company investment activities pursuant to section 
4(k)(4)(I) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(I)); 
or
    (v) Any other activity designated by the Board;
    (2) Any subsidiary of an affiliate described in paragraph (a)(1) of 
this section; and
    (3) Any portfolio company (as defined in 12 CFR 225.177(c)) that 
the foreign bank or affiliate controls (for purposes of 12 CFR 
225.173(d)(4)) and any company that would be an affiliate of the 
branch, agency, or commercial lending company of the foreign bank under 
paragraph (a)(9) of Sec. 223.24 if the branch, agency, or commercial 
lending company were a bank.
    (b) Method of applying sections 23A and 23B to foreign banks. (1) 
In general. Sections 23A and 23B of the Federal Reserve Act and the 
provisions of this Regulation W will apply to transactions described in 
paragraph (a) of this section in the same manner and to the same extent 
as if the branch, agency, or commercial lending company of the foreign 
bank were a bank and the companies described in paragraphs (a)(1) 
through (3) of this section were affiliates of the branch, agency, or 
commercial lending company.
    (2) Attribution rule. Sections 23A and 23B of the Federal Reserve 
Act and the provisions of this Regulation W will apply to transactions 
between each U.S. branch, agency, or commercial lending company of a 
foreign bank and any person to the extent that the proceeds of the 
transaction are used for the benefit of, or transferred to, a company 
described in paragraphs (a)(1) through (3) of this section.
    (3) Capital stock and surplus. For purposes of Secs. 223.2 and 
223.3, the ``capital stock and surplus'' of a U.S. branch, agency, or 
commercial lending company of a foreign bank will be determined by 
reference to the capital of the foreign bank as calculated under its 
home country capital standards.

Subpart H--Definitions of Terms


Sec. 223.24  What is an ``affiliate'' for purposes of sections 23A and 
23B?

    (a) For purposes of this part and except as provided in paragraphs 
(b) and (c) of this section, ``affiliate'' with respect to a bank 
means:
    (1) Parent companies. Any company that controls the bank;
    (2) Companies under common ownership by a parent company. Any 
company, including any subsidiary of the bank, that is controlled by a 
company that controls the bank;
    (3) Companies under other common ownership. Any company, including 
any subsidiary of the bank, that is controlled, directly or indirectly, 
by trust or otherwise, by or for the benefit of shareholders who 
beneficially or otherwise control, directly or indirectly, by trust or 
otherwise, the bank or any company that controls the bank;

[[Page 24217]]

    (4) Companies with interlocking directorates. Any company in which 
a majority of its directors or trustees (or individuals exercising 
similar functions) constitute a majority of the persons holding any 
such office with the bank or any company that controls the bank;
    (5) Sponsored and advised companies. Any company, including a real 
estate investment trust, that is sponsored and advised on a contractual 
basis by the bank or an affiliate of the bank;
    (6) Investment companies. (i) Any investment company for which the 
bank or any affiliate of the bank serves as an investment adviser, as 
defined in section 2(a)(20) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(20)); and
    (ii) Any other investment fund for which the bank or any affiliate 
of the bank serves as an investment advisor, if the bank or any 
affiliate of the bank owns or controls more than 5 percent of any class 
of voting shares or similar interests in the fund;
    (7) Depository institution subsidiaries. A depository institution 
that is a subsidiary of the bank;
    (8) Financial subsidiaries. A financial subsidiary of the bank;
    (9) Companies held under merchant banking or insurance company 
investment authority. (i) In general. Any company in which a holding 
company that controls the bank (or a holding company that is controlled 
by shareholders that control the bank) owns or controls, directly or 
indirectly, or acting through one or more other persons, 15 percent or 
more of the equity capital pursuant to section 4(k)(4)(H) or (I) of the 
Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H) or (I)).
    (ii) General exemption. A company may avoid affiliate status under 
paragraph (a)(9)(i) of this section if the holding company presents 
information to the Board that demonstrates, to the Board's 
satisfaction, that the holding company does not control the company.
    (iii) Specific exemptions. A company also may avoid affiliate 
status under paragraph (a)(9)(i) of this section if:
    (A) No director, officer, or employee of the holding company serves 
as a director, trustee, or general partner (or individual exercising 
similar functions) of the company;
    (B) A person that is not affiliated or associated with the holding 
company owns or controls a greater percentage of the equity capital of 
the company than is owned or controlled by the holding company, and no 
more than one officer or employee of the holding company serves as a 
director or trustee (or individual exercising similar functions) of the 
company; or
    (C) A person that is not affiliated or associated with the holding 
company owns or controls more than 50 percent of the voting shares of 
the company, and officers and employees of the holding company do not 
constitute a majority of the directors or trustees (or individuals 
exercising similar functions) of the company.
    (iv) Application of rule to private equity funds. A holding company 
will not be deemed to own or control the equity capital of a company 
for purposes of paragraph (a)(9)(i) of this section solely by virtue of 
an investment made by the holding company in a private equity fund (as 
defined in 12 CFR 225.173(a)) that owns or controls the equity capital 
of the company unless the holding company controls the private equity 
fund (as described in 12 CFR 225.173(d)(4)).
    (v) Definition of ``holding company''. For purposes of this 
paragraph (a)(9), ``holding company'' means the holding company and all 
of its subsidiaries (including any subsidiary depository institution of 
the holding company);
    (10) Partnerships for which the bank or an affiliate serves as 
general partner. Any partnership for which the bank or any affiliate of 
the bank serves as a general partner or for which the bank or any 
affiliate of the bank causes any officer or employee of the bank or 
affiliate to serve as a general partner; and
    (11) Other companies. Any company that the Board determines by 
regulation or order to have a relationship with the bank, or any 
affiliate of the bank, such that covered transactions by the bank with 
that company may be affected by the relationship to the detriment of 
the bank.
    (b) ``Affiliate'' with respect to a bank does not include:
    (1) Subsidiaries. Any company that is a subsidiary of the bank, 
other than:
    (i) A depository institution;
    (ii) A financial subsidiary;
    (iii) A subsidiary in which any affiliate or affiliates of the bank 
(other than a bank or insured savings association) directly owns or 
controls 25 percent or more of any class of voting securities;
    (iv) An employee stock option plan, trust, or similar organization 
that exists for the benefit of the shareholders, partners, members, or 
employees of the bank or any of its affiliates; and
    (v) Any other company determined to be an affiliate under paragraph 
(a)(11) of this section;
    (2) Bank premises. Any company engaged solely in holding premises 
of the bank;
    (3) Safe deposit. Any company engaged solely in conducting a safe 
deposit business;
    (4) Government securities. Any company engaged solely in holding 
obligations of the United States or its agencies or obligations fully 
guaranteed by the United States or its agencies as to principal and 
interest; and
    (5) Companies held DPC. Any company where control results from the 
exercise of rights arising out of a bona fide debt previously 
contracted. This exclusion from the definition of ``affiliate'' applies 
only for the period of time specifically authorized under applicable 
State or Federal law or regulation or, in the absence of such law or 
regulation, for a period of two years from the date of the exercise of 
such rights. The Board may authorize, upon application and for good 
cause shown, extensions of time for not more than one year at a time, 
but such extensions in the aggregate will not exceed three years.
    (c) For purposes of subpart F of this part, ``affiliate'' with 
respect to a bank also does not include any insured depository 
institution.


Sec. 223.25  What transactions with affiliates are covered by section 
23A?

    For purposes of this part, a ``covered transaction'' with respect 
to an affiliate of a bank means:
    (a) An extension of credit to the affiliate;
    (b) A purchase of, or an investment in, a security issued by the 
affiliate;
    (c) A purchase of an asset from the affiliate, including an asset 
subject to recourse or an agreement to repurchase, except such 
purchases of real and personal property as may be specifically exempted 
by the Board by order or regulation;
    (d) The acceptance of a security issued by the affiliate as 
collateral for an extension of credit to any person or company; and
    (e) The issuance of a guarantee, acceptance, or letter of credit, 
including an endorsement or standby letter of credit, on behalf of the 
affiliate, and a confirmation of a letter of credit issued by the 
affiliate.


Sec. 223.26  What are the meanings of the other terms used in sections 
23A and 23B?

    For purposes of this part:
    (a) Aggregate amount of covered transactions means the amount of 
the covered transaction about to be engaged in added to the current 
amount of all outstanding covered transactions.

[[Page 24218]]

    (b) Appropriate Federal banking agency has the same meaning as in 
section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813).
    (c) Bank. (1) In general. Bank means:
    (i) Any member bank, as defined in section 1 of the Federal Reserve 
Act (12 U.S.C. 221); and
    (ii) Any insured bank that is not an insured branch, as such terms 
are defined in section 3 of the Federal Deposit Insurance Act (12 
U.S.C. 1813).
    (2) Subsidiaries of banks. For purposes of paragraph (c)(1) of this 
section, a subsidiary of a bank (other than a subsidiary described in 
paragraphs (b)(1)(i) through (v) of Sec. 223.24) is treated as the 
bank.
    (d) Capital stock and surplus means the sum of:
    (1) A bank's tier 1 and tier 2 capital under the risk-based capital 
guidelines of the appropriate Federal banking agency, based on the 
bank's most recent consolidated Report of Condition and Income filed 
under 12 U.S.C. 1817(a)(3); and
    (2) The balance of a bank's allowance for loan and lease losses not 
included in its tier 2 capital under the risk-based capital guidelines 
of the appropriate Federal banking agency, based on the bank's most 
recent consolidated Report of Condition and Income filed under 12 
U.S.C. 1817(a)(3).
    (e) Company means a corporation, partnership, limited liability 
company, business trust, association, or similar organization and, 
unless specifically excluded, includes a bank and a depository 
institution.
    (f) Control. (1) In general. Control by a company or shareholder 
over another company means that:
    (i) The company or shareholder, directly or indirectly, or acting 
through one or more other persons, owns, controls, or has power to vote 
25 percent or more of any class of voting securities of the other 
company;
    (ii) The company or shareholder controls in any manner the election 
of a majority of the directors, trustees, or general partners (or 
individuals exercising similar functions) of the other company; or
    (iii) The Board determines, after notice and opportunity for 
hearing, that the company or shareholder, directly or indirectly, 
exercises a controlling influence over the management or policies of 
the other company.
    (2) Ownership or control of shares as fiduciary. Notwithstanding 
any other provision of this Regulation W, no company will be deemed to 
control another company by virtue of its ownership or control of shares 
in a fiduciary capacity, except as provided in paragraph (a)(3) of 
Sec. 223.24 or if the company owning or controlling the shares is a 
business trust.
    (3) Ownership or control of shares by subsidiary. A company will be 
deemed to control securities, assets, or other ownership interests 
owned or controlled, directly or indirectly, by any subsidiary 
(including a bank) of the company.
    (4) Ownership or control of convertible securities. A company that 
owns or controls securities (including options and warrants) that are 
convertible, at the option of the holder or owner, into other 
securities, controls the other securities.
    (g) Credit transaction with an affiliate means:
    (1) An extension of credit to the affiliate; and
    (2) An issuance of a guarantee, acceptance, or letter of credit, 
including an endorsement or standby letter of credit, on behalf of the 
affiliate and a confirmation of a letter of credit issued by the 
affiliate.
    (h) Depository institution means a State bank, national bank, 
banking association, or trust company, or an insured savings 
association.
    (i) Equity capital means:
    (1) With respect to a corporation, perpetual preferred stock, 
common stock, capital surplus, retained earnings, and accumulated other 
comprehensive income, less treasury stock, plus any other account that 
constitutes equity of the corporation; and
    (2) With respect to a partnership, limited liability company, or 
other company, equity accounts similar to those described in paragraph 
(i)(1) of this section.
    (j) Extension of credit means an extension or renewal of a loan, a 
grant of a line of credit, or an extension of credit in any manner 
whatsoever, including on an intraday basis. An extension of credit 
includes, without limitation:
    (1) An advance by means of an overdraft, cash item, or otherwise;
    (2) A lease that is the functional equivalent of an extension of 
credit;
    (3) A purchase of a note or other obligation, including commercial 
paper or other debt securities (which is deemed an extension of credit 
to the obligor); and
    (4) Any increase in the amount of, extension of the maturity of, or 
adjustment to the interest rate term or other material term of, an 
extension of credit.
    (k) Financial subsidiary means:
    (1) Any subsidiary of a bank that would be a financial subsidiary 
of a national bank under section 5136A of the Revised Statutes of the 
United States (12 U.S.C. 24a); and
    (2) Any subsidiary of a company described in paragraph (k)(1) of 
this section.
    (l) Foreign bank and an agency, branch, or commercial lending 
company of a foreign bank have the same meanings as in section 1(b) of 
the International Banking Act of 1978 (12 U.S.C. 3101).
    (m) GAAP means U.S. generally accepted accounting principles.
    (n) General purpose credit card means a credit card issued by a 
bank if:
    (1) The card may be used to purchase products or services from 
nonaffiliates of the bank;
    (2) The card is widely accepted by merchants that are not 
affiliates of the bank for the purchase of products or services; and
    (3) Less than 25 percent of the aggregate amount of products and 
services purchased with the card by all cardholders are purchases of 
products or services from an affiliate of the bank.
    (o) Insured depository institution has the same meaning as in 
section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813), but 
(except for purposes of Sec. 223.16(i)) does not include any branch or 
agency of a foreign bank or any commercial lending company owned or 
controlled by a foreign bank.
    (p) Insured savings association means a savings association (as 
defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 
1813)) the deposits of which are insured by the Federal Deposit 
Insurance Corporation.
    (q) Low-quality asset means:
    (1) An asset (including a security) classified as ``substandard,'' 
``doubtful,'' or ``loss'' or treated as ``other assets especially 
mentioned'' or ``other transfer risk problems'' either in the most 
recent report of examination or inspection of an affiliate prepared by 
either a Federal or State supervisory agency or in any internal 
classification system used by the bank or the affiliate (including an 
asset that receives a rating that is substantially equivalent to 
classified in the internal system of the bank or affiliate);
    (2) An asset in a nonaccrual status;
    (3) An asset on which principal or interest payments are more than 
thirty days past due;
    (4) An asset whose terms have been renegotiated or compromised due 
to the deteriorating financial condition of the obligor; and
    (5) A foreclosed asset designated as ``other real estate owned'' 
that has not yet been reviewed in an examination or inspection.
    (r) Municipal securities has the same meaning as in section 
3(a)(29) of the

[[Page 24219]]

Securities Exchange Act of 1934 (17 U.S.C. 78c(a)(29)).
    (s) Nonaffiliate with respect to a bank means any person that is 
not an affiliate of the bank.
    (t) Payment transactions is defined in Sec. 223.16(k)(2).
    (u) Principal underwriter is defined in Sec. 223.20(c)(1).
    (v) Purchase of assets means the acquisition of an asset in 
exchange for cash or any other consideration, including an assumption 
of liabilities.
    (w) Securities means stocks, bonds, debentures, notes, or similar 
obligations (including commercial paper).
    (x) Securities affiliate means a broker or dealer that is an 
affiliate of the bank and is registered with the Securities and 
Exchange Commission.
    (y) State bank has the same meaning as in section 3 of the Federal 
Deposit Insurance Act (12 U.S.C. 1813).
    (z) Subsidiary with respect to a specified company means a company 
that is controlled by the specified company.
    (aa) Voting securities has the same meaning as the term ``voting 
securities'' found in 12 CFR 225.2(q).

    By order of the Board of Governors of the Federal Reserve 
System, May 3, 2001.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 01-11610 Filed 5-10-01; 8:45 am]
BILLING CODE 6210-01-P