[Federal Register Volume 68, Number 33 (Wednesday, February 19, 2003)]
[Rules and Regulations]
[Pages 7898-7899]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-3643]


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FEDERAL RESERVE SYSTEM

12 CFR Part 211


Regulation K; Docket No. R-1143; International Banking Operations

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Interpretation.

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SUMMARY: The Board of Governors of the Federal Reserve System has 
issued an interpretation concerning the underwriting by foreign banks 
of securities to be distributed in the United States. The 
interpretation clarifies that a foreign bank that wishes to engage in 
such activity must either be a financial holding company or have 
authority to engage in underwriting activity under section 4(c)(8) of 
the Bank Holding Company Act.

EFFECTIVE DATE: February 19, 2003.

FOR FURTHER INFORMATION CONTACT: Kathleen M. O'Day, Associate General 
Counsel (202/452-3786), Ann Misback, Assistant General Counsel (202/
452-3788), or Michael Waldron, Counsel (202/452-2798), Legal Division, 
Board of Governors of the Federal Reserve System, 20th Street and 
Constitution Avenue, NW., Washington, DC 20551. For users of 
Telecommunications Devices for the Deaf (TDD) only, contact 202/263-
4869.

SUPPLEMENTARY INFORMATION: A number of foreign banks that are subject 
to the Bank Holding Company Act (``BHC Act''), but do not have 
authority to engage in underwriting activity in the United States, have 
participated as co-managers in the underwriting of securities that are 
to be distributed in the United States. The foreign banks use U.S. 
offices or affiliates to engage in activities conducted in support of 
the underwriting transaction for which the U.S. offices or affiliates 
are compensated by the foreign bank. The foreign bank becomes a member 
of the underwriting syndicate but does not distribute any of the 
securities in the United States or elsewhere. The foreign banks take 
the position that they are not engaged in underwriting in the United 
States because any underwriting obligation is booked outside the United 
States.
    A foreign bank that is subject to the BHC Act may engage in 
underwriting activities in the United States only if it has been 
authorized under section 4 of that Act. Section 225.124 of the Board's 
Regulation Y states that a foreign bank will not be considered to be 
engaged in the activity of underwriting in the United States if the 
shares to be underwritten are distributed outside the United States. In 
the transactions in question, all of the securities were distributed in 
the United States.
    Regulation K defines ``engaged in business'' and ``engaged in 
activities'' to mean conducting an activity through an office or 
subsidiary in the United States. In 1985, however, the Board amended 
another provision of Regulation K to clarify that, with respect to 
securities activities, the location of the prohibited activity was not 
dependent on being conducted through an office or subsidiary in the 
United States. Section 211.23(f)(5)(ii) of Regulation K states that a 
foreign banking organization shall not:

    Directly underwrite, sell, or distribute, nor own or control 
more than 10 percent of the voting shares of a company that 
underwrites, sells, or distributes securities in the United States, 
except to the extent permitted bank holding companies;

    In adopting the provision, the Board stated in part that it was 
intended to clarify that no part of the prohibited underwriting process 
may take place in the United States. Thus, the prohibition did not 
depend on the activity being conducted through a U.S. office or 
subsidiary. The definition of ``engaged in business'' in Regulation K 
is not intended to operate as authority to allow banking organizations 
to avoid regulatory restrictions in the United States by conducting 
activities from abroad, as the 1985 revision of Sec.  211.23(f)(5)(ii) 
made clear.
    Technological and regulatory changes since the Regulation K 
definition of ``engaged in business'' was adopted in 1979 have 
eliminated some of the barriers to the delivery of cross-border 
services into the United States. Many of the services that can now be 
provided on a cross-border basis, including securities and insurance, 
were not permissible activities for banking organizations to conduct in 
the United States prior to the enactment of the Gramm-Leach-Bliley Act 
(``GLB Act'') and generally can be conducted by banking organizations 
in the United States today only in conformance with the requirements of 
that Act. To allow activities to be conducted in the United States from 
abroad would undermine the careful framework adopted in the GLB Act, 
which is available to both domestic and foreign banking organizations.
    As a result, the Board believes it would be appropriate to issue 
this interpretation in order to clarify the scope of existing 
restrictions on underwriting by foreign banks. Specifically, the Board 
wishes to clarify that the underwriting by a banking organization 
subject to the BHC Act of securities to be distributed in the United 
States is an activity that is considered to be conducted in the United 
States. Such activity may only be conducted by a banking organization 
that is a financial holding company under the GLB Act or has so-called 
section 20 authority under section 4(c)(8) of the BHC Act.

List of Subjects in 12 CFR Part 211

    Exports, Federal Reserve System, Foreign banking, Holding 
companies, Investments, Reporting and recordkeeping requirements.

Authority and Issuance

    For the reasons set forth in the preamble, the Board amends 12 CFR 
Part 211 as follows:

[[Page 7899]]

PART 211--INTERNATIONAL BANKING OPERATIONS (REGULATION K)

    1. The authority citation for part 211 continues to read as 
follows:

    Authority: 12 U.S.C. 221 et seq., 1818, 1835a, 1841 et seq., 
3101 et seq., and 3901 et seq.


    2. Part 211 is amended by adding a new Sec.  211.605 to read as 
follows:


Sec.  211.605  Permissible underwriting activities of foreign banks.

    (a) Introduction. A number of foreign banks that are subject to the 
Bank Holding Company Act (``BHC Act'') have participated as co-managers 
in the underwriting of securities to be distributed in the United 
States despite the fact that the foreign banks in question do not have 
authority to engage in underwriting activity in the United States under 
either the Gramm-Leach-Bliley Act (``GLB Act'') or section 4(c)(8) of 
the BHC Act (12 U.S.C. 1843(c)(8)). This interpretation clarifies the 
scope of existing restrictions on underwriting by such foreign banks 
with respect to securities that are distributed in the United States.
    (b) Underwriting transactions engaged in by foreign banks. (1) In 
the transactions in question, a foreign bank typically becomes a member 
of the underwriting syndicate for securities that are registered and 
intended to be distributed in the United States. The lead underwriter, 
usually a registered U.S. broker-dealer not affiliated with the foreign 
bank, agrees to be responsible for distributing the securities being 
underwritten. The underwriting obligation is assumed by a foreign 
office or affiliate of the foreign bank.
    (2) The foreign banks have used their U.S. offices or affiliates to 
act as liaison with the U.S. issuer and the lead underwriter in the 
United States, to prepare documentation and to provide other services 
in connection with the underwriting. In some cases, the U.S. offices or 
affiliates that assisted the foreign bank with the underwriting receive 
a substantial portion of the revenue generated by the foreign bank's 
participation in the underwriting. In other cases, the U.S. offices 
receive ``credit'' from the head office of the foreign bank for their 
assistance in generating profits arising from the underwriting.
    (3) By assuming the underwriting risk and booking the underwriting 
fees in their foreign offices or affiliates, the foreign banks are able 
to take advantage of an exemption under U.S. securities laws; a foreign 
underwriter is not required to register in the United States if the 
underwriter either does not distribute any of the securities in the 
United States or distributes them only through a registered broker-
dealer.
    (c) Permissible scope of underwriting activities. (1) A foreign 
bank that is subject to the BHC Act may engage in underwriting 
activities in the United States only if it has been authorized under 
section 4 of the Act. The foreign banks in question have argued that 
they are not engaged in underwriting activity in the United States 
because the underwriting activity takes place only outside the United 
States where the transaction is booked. The foreign banks refer to 
Regulation K, which defines ``engaged in business'' or ``engaged in 
activities'' to mean conducting an activity through an office or 
subsidiary in the United States. Because the underwriting is not booked 
in a U.S. office or subsidiary, the banks assert that the activity 
cannot be considered conducted in the United States.
    (2) The Board believes that the position taken by the foreign banks 
is not supported by the Board's regulations or policies. Section 
225.124 of the Board's Regulation Y (12 CFR 225.124(d)) states that a 
foreign bank will not be considered to be engaged in the activity of 
underwriting in the United States if the shares to be underwritten are 
distributed outside the United States. In the transactions in question, 
all of the securities to be underwritten by the foreign banks are 
distributed in the United States.
    (3) Regulation K (12 CFR part 211) was amended in 1985 to provide 
clarification that a foreign bank may not own or control voting shares 
of a foreign company that directly underwrites, sells or distributes 
securities in the United States (emphasis added). 12 CFR 
211.23(f)(5)(ii). In proposing this latter provision, the Board 
clarified that no part of the prohibited underwriting process may take 
place in the United States and that the prohibition on the activity 
does not depend on the activity being conducted through an office or 
subsidiary in the United States. Moreover, in the transactions in 
question, there was significant participation by U.S. offices and 
affiliates of the foreign banks in the underwriting process. In some 
transactions, the foreign office at which the transactions were booked 
did not have any documentation on the particular transactions; all 
documentation was maintained in the United States office. In all cases, 
the U.S. offices or affiliates provided virtually all technical support 
for participation in the underwriting process and benefitted from 
profits generated by the activity.
    (4) The fact that some technological and regulatory constraints on 
the delivery of cross-border services into the United States have been 
eliminated since the Regulation K definition of ``engaged in business'' 
was adopted in 1979 creates greater scope for banking organizations to 
deal with customers outside the U.S. bank regulatory framework. The 
definition in Regulation K, however, does not authorize foreign banking 
organizations to evade regulatory restrictions on securities activities 
in the United States by directly underwriting securities to be 
distributed in the United States or by using U.S. offices and 
affiliates to facilitate the prohibited activity. In the GLB Act, 
Congress established a framework within which both domestic and foreign 
banking organizations may underwrite and deal in securities in the 
United States. The GLB Act requires that banking organizations meet 
certain financial and managerial requirements in order to be able to 
engage in these activities in the United States. The Board believes the 
practices described above undermine this legislative framework and 
constitute an evasion of the requirements of the GLB Act and the 
Board's Regulation K. Foreign banking organizations that wish to 
conduct securities underwriting activity in the United States have long 
had the option of obtaining section 20 authority and now have the 
option of obtaining financial holding company status.
    (d) Conclusion. The Board finds that the underwriting of securities 
to be distributed in the United States is an activity conducted in the 
United States, regardless of the location at which the underwriting 
risk is assumed and the underwriting fees are booked. Consequently, any 
banking organization that wishes to engage in such activity must either 
be a financial holding company under the GLB Act or have authority to 
engage in underwriting activity under section 4(c)(8) of the BHC Act 
(so-called ``section 20 authority''). Revenue generated by underwriting 
bank-ineligible securities in such transactions should be attributed to 
the section 20 company for those foreign banks that operate under 
section 20 authority.

    Dated: By order of the Board of Governors, February 7, 2003.
Jennifer J. Johnson,
 Secretary of the Board.
[FR Doc. 03-3643 Filed 2-18-03; 8:45 am]
BILLING CODE 6210-02-P