[Federal Register Volume 68, Number 50 (Friday, March 14, 2003)]
[Proposed Rules]
[Pages 12316-12318]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-6155]



[[Page 12316]]

=======================================================================
-----------------------------------------------------------------------

FEDERAL RESERVE SYSTEM

12 CFR Part 225

[Regulation Y; Docket No. R-1146]


Bank Holding Companies and Change in Bank Control

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule with request for public comments.

-----------------------------------------------------------------------

SUMMARY: The Board of Governors of the Federal Reserve System is 
proposing an amendment to Regulation Y that would permit bank holding 
companies to take and make delivery of title to commodities underlying 
derivative contracts on an instantaneous, pass-through basis.

DATES: Comments on the proposed rule must be received not later than 
April 14, 2003.

ADDRESSES: Comments should refer to Docket No. R-1146, and should be 
mailed 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 between 8:45 a.m. and 5:15 p.m. to the Board's 
mail facility in the West Courtyard of the Eccles Building, located on 
21st Street 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. on weekdays pursuant to Sec.  261.12, except 
as provided in Sec.  261.14, of the Board's Rules Regarding 
Availability of Information, 12 CFR 261.12 and 261.14.

FOR FURTHER INFORMATION CONTACT: Scott G. Alvarez, Associate General 
Counsel (202/452-3583), Mark E. Van Der Weide, Counsel (202/452-2263), 
or Andrew S. Baer, Counsel (202/452-2246), Legal Division. For users of 
Telecommunications Device for the Deaf (TDD) only, contact 202/263-
4869.

SUPPLEMENTARY INFORMATION:

Background

    The Board's Regulation Y currently authorizes bank holding 
companies (``BHCs'') to engage as principal in forward contracts, 
options, futures, options on futures, swaps, and similar contracts, 
whether traded on exchanges or not, based on a rate, price, financial 
asset, nonfinancial asset, or group of assets (other than a bank-
ineligible security) (``Commodity Contracts''). A BHC's authority to 
enter into Commodity Contracts is subject to certain restrictions that 
are designed to limit the BHC's activity to trading and investing in 
financial instruments rather than dealing directly in commodities. In 
particular, Regulation Y provides that a BHC may enter into a Commodity 
Contract only if (i) the commodity underlying the contract is eligible 
for investment by a state member bank; or (ii) the contract requires 
cash settlement; or (iii) the contract allows for assignment, 
termination, or offset prior to delivery or expiration (the 
``Contractual Offset Requirement''), and the BHC makes every reasonable 
effort to avoid taking or making delivery of the underlying commodity 
(the ``Delivery Avoidance Requirement'').\1\
---------------------------------------------------------------------------

    \1\ 12 CFR 225.28(b)(8)(ii)(B).
---------------------------------------------------------------------------

    The effect of these restrictions is to allow a BHC to engage as 
principal in derivative contracts involving any type of commodity 
(other than bank-ineligible securities) but to limit the authority of a 
BHC to physically settle derivative contracts. Under these 
restrictions, a BHC may take or make delivery on derivative contracts 
based on commodities that a state member bank is permitted to own.\2\ 
For all other types of physically settled commodity derivatives,\3\ a 
BHC must make reasonable efforts to avoid delivery, and the contract 
must have assignment, termination, or offset provisions.
---------------------------------------------------------------------------

    \2\ State member banks may own, for example, investment grade 
corporate debt securities, U.S. government and municipal securities, 
foreign exchange, and certain precious metals.
    \3\ These would include derivative contracts based on, for 
example, energy-related commodities and agricultural commodities.
---------------------------------------------------------------------------

    The Bank Holding Company Act (``BHC Act''), as amended by the 
Gramm-Leach-Bliley Act (Pub. L. No. 106-102, 113 Stat. 1338 (1999)) 
(``GLB Act''), permits a BHC to engage in activities that the Board had 
determined were closely related to banking, by regulation or order, 
prior to November 12, 1999. A BHC must conduct these activities in 
accordance with the terms and conditions contained in such regulations 
and orders, unless modified by the Board.
    Citigroup Inc., New York, New York (``Citigroup''), and UBS AG, 
Zurich, Switzerland (``UBS''), have asked the Board to modify the 
restrictions in Regulation Y to allow BHCs to enter into derivative 
contracts that typically result in taking and making delivery of title 
to, but not physical possession of, commodities on an instantaneous, 
pass-through basis (regardless of whether the contracts contain 
specific assignment, termination, or offset provisions).\4\
---------------------------------------------------------------------------

    \4\ Citigroup and UBS also have asked the Board to allow 
financial holding companies to take and make physical delivery of a 
limited amount of commodities as an activity that is incidental or 
complementary to engaging as principal in BHC-permissible Commodity 
Contracts. The Board continues to review these broader requests.
---------------------------------------------------------------------------

    In response to these requests, the Board has determined to seek 
public comment on the proposed rule described below.

Proposed Rule

    As noted, Citigroup and UBS have urged the Board to permit BHCs to 
enter into Commodity Contracts that are settled by the BHC receiving 
and transferring title to the underlying commodity instantaneously, by 
operation of contract, and without taking physical possession of the 
commodity. Citigroup and UBS also have urged the Board to remove its 
regulatory requirement that BHCs only enter into Commodity Contracts 
that require cash settlement or specifically provide for assignment, 
termination, or offset prior to delivery.
    These requests arise in large part because, in certain over-the-
counter forward markets (U.S. energy markets, for example), the 
physically settled derivative contracts traded by market participants 
do not specifically provide for assignment, termination, or offset 
prior to delivery and, thus, do not conform to the Contractual Offset 
Requirement of Regulation Y. Moreover, participants in these markets 
generally settle the derivative contracts by temporarily taking and 
making delivery of title to the underlying commodities and, thus, do 
not comply with the Delivery Avoidance Requirement of Regulation Y.
    Financial intermediary participants in these markets generally 
enter into back-to-back derivative contracts with third parties that 
effectively offset each other. That is, financial intermediaries in 
these markets that enter into a contract to buy, for example, a certain 
number of barrels of oil from a certain counterparty in a certain 
future month generally also will enter into another contract, prior to 
the expiration of the original contract, to sell the same number of 
barrels of oil to another counterparty in the same future month on 
substantially identical delivery terms. These market practices 
typically result in the creation of a chain of contractual 
relationships that begins with a commodity producer, passes through a 
number of intermediaries who have entered into matched contracts both 
to buy and sell the same commodity at the same future time, and

[[Page 12317]]

ends with a purchaser that intends to take physical delivery of the 
commodity. On the maturity date of the derivative contracts, the 
producer will be responsible for making physical delivery and the 
ultimate buyer will be responsible for accepting physical delivery, 
while each intermediate participant in the chain will be deemed, by 
operation of contract, to have instantaneously received and transferred 
legal title to the commodity.
    The Board adopted the restrictions in Regulation Y on the types of 
Commodity Contracts that a BHC may enter into as principal to reduce 
the potential that BHCs would become involved in and bear the risks of 
physical possession, transport, storage, delivery, and sale of bank-
ineligible commodities. The restrictions ensure that the commodity 
derivatives business of a BHC is largely limited to acting as a 
financial intermediary that facilitates transactions for customers who 
use or produce commodities or are otherwise exposed to commodity price 
risk as part of their regular business.
    Citigroup and UBS contend that a BHC that takes title to a 
commodity on an instantaneous, pass-through basis takes no risk that is 
greater than or different in kind from the risk that it has as a holder 
of a commodity derivative contract that meets the current requirements 
of Regulation Y. Instantaneous receipt and transfer of title to (but 
not physical possession of) commodities does not appear to involve the 
usual activities relating to, or risks attendant on, commodity 
ownership. Instead, such transactions involve the routine operations 
functions of passing notices, documents, and payments--functions that 
BHCs regularly perform in their role as financial intermediaries in 
other markets. Moreover, although BHCs that receive and transfer title 
to commodities on an instantaneous, pass-through basis face default 
risks, they are not significantly different than the default risks 
associated with cash-settled derivative contracts or derivative 
contracts that include the assignment, termination, or offset 
provisions required by Regulation Y.
    In this light, the Board proposes to modify Regulation Y by 
changing the Delivery Avoidance Requirement to allow BHCs to take or 
make delivery of title to commodities underlying commodity derivative 
transactions on an instantaneous, pass-through basis.
    In addition, the Board proposes to modify Regulation Y by changing 
the Contractual Offset Requirement to permit BHCs to participate in 
physically settled derivative markets where the standard industry 
documentation does not allow for assignment, termination, or offset. In 
particular, the proposal would allow BHCs to enter into Commodity 
Contracts that do not require cash settlement or specifically provide 
for assignment, termination, or offset prior to delivery so long as the 
contracts involve commodities for which futures contracts have been 
approved for trading on a U.S. futures exchange by the Commodity 
Futures Trading Commission (``CFTC'') (and the BHC complies with the 
revised Delivery Avoidance Requirement). Limiting this relief from the 
Contractual Offset Requirement to derivative contracts based on 
commodities approved for exchange trading (which are more likely to 
have reasonably liquid markets) is intended to provide some assurance 
that a BHC's reasonable efforts to avoid delivery would be successful. 
This requirement would, therefore, serve the same purpose as the 
current Contractual Offset Requirement, which facilitates the financial 
settlement of Commodity Contracts by requiring BHCs to have contractual 
rights to avoid taking or making delivery of the underlying 
commodities.
    The proposed modifications of the derivatives provisions in 
Regulation Y would apply to all BHCs. Although the GLB Act prohibited 
the Board from adding to the list of activities permissible for all 
BHCs after November 11, 1999, the Act preserved the Board's authority 
to modify the terms and conditions that applied to such activities 
before that date.\5\ The Board had authorized BHCs to engage as 
principal in commodity derivative transactions prior to November 11, 
1999. The proposed rule would represent a relaxation of the current 
limitations that apply to a BHC's commodity derivative activities under 
Regulation Y and would not create a new permissible activity for BHCs.
---------------------------------------------------------------------------

    \5\ See 12 U.S.C. 1843(c)(8).
---------------------------------------------------------------------------

    The Board invites comment on all aspects of the proposed rule and 
particularly seeks comment on whether the proposed modifications to 
Regulation Y would expand the ability of BHCs to participate in 
commodity derivative markets without exposing them to significant 
additional risks.

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. In light of this requirement, the Board has sought to present the 
proposed rule in a simple and straightforward manner. The Board invites 
comment on whether the Board could take additional steps to make the 
proposed rule easier to understand.

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 proposed rule. The proposed rule, if 
adopted, would expand the scope of permissible commodity derivatives 
activities for a bank holding company. A description of the reasons for 
the Board's decision to issue the proposed rule 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 bank holding companies regardless 
of their size and should enhance the ability of all bank holding 
companies, including small ones, to compete with other providers of 
financial services in the United States and to respond to changes in 
the marketplace in which banking organizations compete. The Board 
specifically seeks comment on the likely burden the proposed rule would 
have on bank holding companies, especially small bank holding 
companies.

Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3506; 5 CFR 1320 Appendix A.1), the Board has reviewed the proposed 
rule under authority delegated to the Board by the Office of Management 
and Budget. The proposed rule contains no collections of information 
pursuant to the Paperwork Reduction Act.

List of Subjects in 12 CFR Part 225

    Administrative practice and procedures, Banks, Banking, Federal 
Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Securities.

Authority and Issuance

    For the reasons set forth in the preamble, the Board proposes to 
amend 12 CFR part 225 as follows:

PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL 
(REGULATION Y)

    1. The authority citation for part 225 continues to read as 
follows:

    Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1, 
1843(c)(8), 1843(k), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 
3907, and 3909.

    2. Section 225.28 would be amended by revising paragraph 
(b)(8)(ii)(B) to read as follows:

[[Page 12318]]

Sec.  225.28  List of permissible nonbanking activities.

* * * * *
    (b) * * *
    (8) * * *
    (ii) * * *
    (B) Forward contracts, options, futures, options on futures, swaps, 
and similar contracts, whether traded on exchanges or not, based on any 
rate, price, financial asset (including gold, silver, platinum, 
palladium, copper, or any other metal approved by the Board), 
nonfinancial asset, or group of assets, other than a bank-ineligible 
security,\6\ if:
---------------------------------------------------------------------------

    \6\ A bank-ineligible security is any security that a state 
member bank is not permitted to underwrite or deal in under 12 
U.S.C. 24 and 335.
---------------------------------------------------------------------------

    (1) A state member bank is authorized to invest in the asset 
underlying the contract;
    (2) The contract requires cash settlement;
    (3) The contract allows for assignment, termination, or offset 
prior to delivery or expiration, and the company--
    (i) makes every reasonable effort to avoid taking or making 
delivery of the asset underlying the contract; or
    (ii) engages in the instantaneous receipt and transfer of title to 
the underlying asset, by operation of contract and without taking or 
making physical delivery of the underlying asset; or
    (4) The contract is based on an asset for which futures contracts 
or options on futures contracts have been approved for trading on a 
U.S. contract market by the Commodity Futures Trading Commission, and 
the company--
    (i) makes every reasonable effort to avoid taking or making 
delivery of the asset underlying the contract; or
    (ii) engages in the instantaneous receipt and transfer of title to 
the underlying asset, by operation of contract and without taking or 
making physical delivery of the underlying asset.
* * * * *

    By order of the Board of Governors of the Federal Reserve 
System, March 10, 2003.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 03-6155 Filed 3-13-03; 8:45 am]
BILLING CODE 6210-01-P