4(c)(8)—Agency Transactional Services (Futures Commission ... · 4(c)(8)—Agency Transactional...

4(c)(8)—Agency Transactional Services(Futures Commission Merchants and Futures Brokerage) Section 3250.0

A futures commission merchant (FCM) is anentity referred to in the Commodity ExchangeAct to denote a registered firm that is in the busi-ness of soliciting or accepting orders, as broker,for the purchase or sale of any exchange-tradedfutures contract and options thereon. For thepurposes of this examiner guidance, the term‘‘FCM activities’’ is used in a broad context andrefers to all futures brokerage activities, opera-tions, and their associated risks that are subjectto the Federal Reserve System’s supervision. Inconnection with these activities, banking organi-zations may hold customer funds, assets, orproperty and may be members of futuresexchanges and their associated clearinghouses.They may also offer related advisory services asregistered commodity trading advisers (CTAs).The guidance addresses the expanding scope offutures activities conducted by different types ofbanking organizations worldwide and imple-ments supervisory initiatives to effect more risk-focused and burden-sensitive approaches to thesupervision of FCM activities. The guidance isdesigned to help examiners (1) assess how wella consolidated financial organization managesone or more discrete futures brokerage opera-tions and (2) make a broader assessment of theorganization’s overall risk management.

The guidance pertains to FCM subsidiaries ofbank holding companies (BHCs), but it is alsoapplicable to FCM subsidiaries of state memberbanks, Edge Act corporations, and foreign bank-ing organizations. It addresses the broader scopeof permissible futures brokerage activitiesarticulated within Regulation Y1 and, by exten-sion, inRegulationK,and focuseson theadequacyof management and the management processes

used to control the credit, market, liquidity,reputation, and operations risks entailed in theseactivities, including brokerage, clearing, fundsmanagement, and advisory services.

The guidance takes a global line-of-businesssupervisory approach to the inspection of FCMactivities rather than using the traditional full-scope inspections of individual FCM subsidi-aries, many of which are primarily supervisedby functional regulators. Reviews and reports offunctional regulators should be used to the full-est extent when planning and conducting inspec-tions of FCM activities of bank holding compa-nies and other banking organizations to avoidduplication and minimize supervisory burdens.However, in conducting an inspection of variousaspects of an FCM’s activities, a review ofvarious functions, derived from a sample of theorganization’s FCM subsidiaries, may be neces-sary and appropriate to determine the extent ofthe risks these operations pose to the bankingorganization and to determine whether manage-ment of those risks is satisfactory. The examinershould pay particular attention to activities con-ducted in FCM subsidiaries that have not beensubject to a regular inspection by their func-tional regulator and to FCM activities of foreignaffiliates in which there is uncertainty concern-ing the level of local supervision.

BHC subsidiaries, banks (generally throughoperating subsidiaries), Edge Act corporations,and foreign banking organizations (FBOs) oper-ating in the United States may operate futuresbrokerage and clearing services involving amyriad of financial and nonfinancial futurescontracts and options on futures. These activi-ties can involve futures exchanges and clearing-houses throughout the world. In general, mostorganizations conduct these activities as FCMs.

The Federal Reserve has a supervisory inter-est in ensuring that the banking organizationssubject to its oversight conduct their futuresbrokerage activities in a safe and sound mannerconsistent with Regulations Y and K (and withany terms and conditions in Board orders for aparticular organization). Accordingly, a reviewof futures brokerage activities is an importantelement for inspections of BHCs, examinationsof state member banks, and reviews of FBO

1. The Board broadened the scope of permissible FCMnonbanking activities for a bank holding company with therevision of Regulation Y, effective April 21, 1997. For exam-ple, the following activities are permissible:• Derivative contracts can be executed and cleared on a broad

range of nonfinancial commodities.• Derivative contracts can be cleared without simultaneously

providing execution services. Likewise, execution ser-vices can be provided without also providing clearingservices.

• Foreign-exchange transactional services can be provided inthe same FCM subsidiary that provides advice regardingforeign exchange.

• Bank holding companies can engage in FCM activitiesthrough a section 20 subsidiary.

• An FCM nonbanking subsidiary can trade for its ownaccount.

• An FCM nonbanking subsidiary may act on exchange-traded futures contracts and on options on futures contractsbased on a financial or nonfinancial commodity.

• A bank holding company may combine FCM activities andincidental activities. For example, FCM activities may be

combined with futures-related financing to customers, suchas financing to cover margin obligations (note: such financ-ing may be prohibited by some exchanges).

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operations. The following guidance on evaluat-ing the futures brokerage activities of bank hold-ing company subsidiaries, branches and agen-cies of foreign banks operating in the UnitedStates, or any operating subsidiaries of statemember banks provides a list of procedures thatmay be used to tailor the scope of an inspectionof these activities.

3250.0.1 SCOPE OF GUIDANCE

Examiners are to use a risk-based inspectionapproach to evaluating FCM activities—including brokerage, clearing, funds manage-ment, and advisory activities. Significantemphasis should be placed on evaluating theadequacy of management and the managementprocesses used to control the credit, market,liquidity, legal, reputation, and operations risksentailed in these operations. Both the adequacyof risk management and the quantitative level ofrisk exposures should be assessed, as appropri-ate to the scope of the FCM’s activities. Theobjectives of a particular inspection should dic-tate the FCM activities to be reviewed and setthe scope of the inspection.

Examiners are to use a functional-regulatoryapproach (consistent with section III of theGramm-Leach-Bliley Act) to minimize duplica-tive inspection and supervisory burdens. Reviewsand reports of functional regulators should beused to their fullest extent. For the examinationauthority and limitations on the examination ofa functionally regulated subsidiary, see section1040.0 and 12 U.S.C. 1844(c).

When futures brokerage occurs in more thanone domestic or foreign affiliate, examinersshould assess, using a functional-regulatoryapproach (consistent with section III of theGramm-Leach-Bliley Act), the adequacy of themanagement of the futures brokerage activitiesof the consolidated financial organization toensure that the parent organization recognizesand effectively manages the risks posed by itsvarious futures brokerage subsidiaries. Accord-ingly, in reviewing futures brokerage opera-tions, examiners should identify all bank hold-ing company, bank operating, or FBO subsidiariesthat engage in FCM activities and the scope ofthose activities. Not all subsidiaries may need tobe reviewed to assess the risk management ofthe consolidated organization. Selection of theparticular FCM subsidiaries to be reviewed should

be based on an assessment of the risks theiractivities pose to the consolidated organization.

This guidance primarily addresses the assess-ment of activities associated with futures broker-age operations. Any proprietary trading thatoccurs at an FCM should be assessed in connec-tion with the review of proprietary tradingactivities of the consolidated financial organiza-tion, using the appropriate guidance in the Fed-eral Reserve’s Trading and Capital-MarketsActivities Manual. Similarly, when a review offutures advisory activities is planned, examinersshould refer to investment, financial, and futuresadvisory inspection guidance in this manual(sections 3130.0 and 3130.4), as appropriate.

3250.0.2 EVALUATION OF FCM RISKMANAGEMENT

Consistent with existing Federal Reserve poli-cies, examiners should evaluate the risk-management practices of FCM operations andensure that this evaluation is incorporated appro-priately in the rating of risk management underthe bank CAMELS, BHC RFI/C(D), or FBOROCA rating systems. Accordingly, examinersshould place primary consideration on findingsrelated to the adequacy of (1) board and seniormanagement oversight; (2) policies, procedures,and limits used to control risks; (3) systems formeasuring, monitoring, and reporting risk; and(4) internal controls and audit programs.

3250.0.2.1 Board and SeniorManagement Oversight

The board of directors has the ultimate responsi-bility for the level of risks taken by the organiza-tion. Accordingly, the board, a designated sub-committee of the board, or a high level of seniormanagement should approve overall businessstrategies and significant policies that governrisk-taking in the organization’s FCM activities.In particular, the board or a committee thereofshould approve policies that identify authorizedactivities and managerial oversight and shouldarticulate risk tolerances and exposure limits ofFCM activities. The board should also activelymonitor the performance and risk profile of itsFCM activities. Directors and senior manage-ment should periodically review informationthat is sufficiently detailed and timely to allowthem to understand and assess the various risksinvolved in these activities. In addition, theboard or a delegated committee should periodi-

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cally reevaluate the business strategies and majorrisk-management policies and procedures,emphasizing the organization’s financial objec-tives and risk tolerances.

The FCM’s senior management is responsiblefor ensuring that policies and procedures forconducting FCM activities on both a long-rangeand day-to-day basis are adequate. Senior man-agement or a designated subcommittee of theboard should review and approve these policiesand procedures annually. The consistency ofthese policies with parent company limits orother directions pertaining to the FCM’s activi-ties should be confirmed. Management mustalso maintain (1) clear lines of authority andresponsibility for managing operations and therisks involved, (2) appropriate limits on risk-taking, (3) adequate systems and standards formeasuring and tracking risk exposures and mea-suring financial performance, (4) effective inter-nal controls, and (5) a comprehensive risk-reporting and risk-management review process.To provide adequate oversight, managementshould fully understand the risk profile of FCMactivities. Examiners should review reports givento senior management and evaluate whetherthey consist of good summary information andsufficient detail that will enable management toassess and manage the FCM’s risk. As part ofits oversight responsibilities, senior manage-ment should periodically review the organiza-tion’s risk-management procedures to ensurethat they remain appropriate and sound.

Management should also ensure that activi-ties are conducted by competent staff whosetechnical knowledge and experience are consis-tent with the nature and scope of the organiza-tion’s activities. There should be sufficient depthin staff resources to manage these activities ifkey personnel are not available. Managementshould also ensure that back-office and financial-control resources are sufficient to effectivelymanage and control risks. Functions for measur-ing, monitoring, and controlling risk shouldhave clearly defined duties. There should beadequate separation of duties in key elements ofthe risk-management process to avoid potentialconflicts of interest. The nature and scope ofthese safeguards should be in accordance withthe scope of the FCM’s activities.

3250.0.2.2 Policies, Procedures, andLimits

FCMs should maintain written policies and pro-cedures that clearly outline their approach formanaging futures brokerage and related activi-

ties. Such policies should be consistent with theorganization’s broader business strategies, capi-tal adequacy, technical expertise, and generalwillingness to take risk. Policies, procedures,and limits should address the relevant credit,market, liquidity, reputation, and operations risksin light of the scope and complexity of theFCM’s activities. Policies and procedures shouldestablish a logical framework for limiting thevarious risks involved in an FCM’s activitiesand should clearly delineate lines of responsibil-ity and authority over these activities. Theyshould also address the approval of new productlines, strategies, and other activities; conflicts ofinterest, including transactions by employees;and compliance with all applicable legalrequirements. Procedures should incorporate andimplement the parent company’s relevant poli-cies and should be consistent with applicablestatutes, Federal Reserve Board regulations,interpretations, Board orders, and supervisorypolicies and guidance.

A sound system of integrated limits and risk-taking guidelines is an essential component ofthe risk-management process. Such a systemshould set boundaries for organizational risk-taking and ensure that positions that exceedcertain predetermined levels receive prompt man-agement attention so they can be either reducedor prudently addressed.

3250.0.2.3 Risk Measurement,Monitoring, and Reporting

An FCM’s system for measuring the credit,market, liquidity, and other risks involved in itsactivities should be as comprehensive and accu-rate as practicable and should be commensuratewith the nature of its activities. Risk exposuresshould be aggregated across customers, prod-ucts, and activities to the fullest extent possible.Examiners should evaluate whether the riskmeasures and the risk-measurement process aresufficiently robust to accurately reflect the dif-ferent types of risks facing the organization.Clear standards for measuring risk exposuresand financial performance should be established.The standards should provide a common frame-work for limiting and monitoring risks andshould be understood by all relevant personnel.

An accurate, informative, and timely manage-ment information system is essential to the pru-dent operation of an FCM. Accordingly, theexaminer’s assessment of the quality of the


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management information system is an importantfactor in the overall evaluation of the risk-management process. Appropriate mechanismsshould exist for reporting risk exposures and thefinancial performance of the FCM to its boardand parent company, as well as for internalmanagement purposes. FCMs must establishmanagement-reporting policies to apprise theirboards of directors and senior management ofmaterial developments, the adequacy of riskmanagement, operating and financial perfor-mance, and material deficiencies identified dur-ing reviews by regulators and by internal orexternal audits. The FCM should also providereports to the parent company (or in the case offoreign-owned FCMs, to its U.S. parent organi-zation, if any) on financial performance; adher-ence to risk parameters and other limits andcontrols established by the parent for the FCM;and any material developments, including find-ings of material deficiencies by regulators.Examiners should determine the adequacy of anFCM’s monitoring and reporting of its riskexposure and financial performance to appropri-ate levels of senior management and to theboard of directors.

3250.0.2.4 Internal Controls

An FCM’s internal control structure is critical toits safe and sound functioning in general and toits risk-management system in particular. Estab-lishing and maintaining an effective system ofcontrols, including the enforcement of officiallines of authority and appropriate separation ofduties—such as trading, custodial, and backoffice—is one of management’s more importantresponsibilities. Appropriately segregating dutiesis a fundamental and essential element of asound risk-management and internal control sys-tem. Failure to implement and maintain anadequate separation of duties can constitute anunsafe and unsound practice, possibly leading toserious losses or otherwise compromising thefinancial integrity of the FCM.

When properly structured, a system of inter-nal controls promotes effective operations andreliable financial and regulatory reporting; safe-guards assets; and helps to ensure compliancewith relevant laws, regulations, and organiza-tional policies. Ideally, internal controls aretested by an independent internal auditor whoreports directly to either the entity’s board ofdirectors or its designated committee. Personnel

who perform these reviews should generally beindependent of the function they are assigned toreview. Given the importance of appropriateinternal controls to banking organizations of allsizes and risk profiles, the results of audits orreviews, whether conducted by an internal audi-tor or by other personnel, should be adequatelydocumented, as should management’s responsesto them. In addition, communication channelsshould exist that will allow negative or sensitivefindings to be reported directly to the board ofdirectors or the relevant board committee (forexample, a board audit committee).

3250.0.3 FUTURES EXCHANGES,CLEARINGHOUSES, AND FCMs

Futures exchanges provide auction markets forstandardized futures and options on futures con-tracts. In the United States and most other coun-tries, futures exchanges and FCMs are regulatedby a governmental agency. Futures exchangesare membership organizations and impose finan-cial and other regulatory requirements on mem-bers, particularly those that do business for cus-tomers as brokers. In the United States and mostother countries, futures exchanges also havequasi-governmental (self-regulatory) responsi-bilities to monitor trading and prevent fraud,with the authority to discipline or sanction mem-bers that violate exchange rules. FCMs may bemembers of the exchange on which they effectcustomers’ trades. When they are not members,FCMs must use other firms that are exchangemembers to execute customer trades.2

Each futures exchange has an affiliated clear-inghouse responsible for clearing and settlingtrades on the exchange and for managing associ-ated risks. When a clearinghouse accepts trans-action information from its clearing members, itgenerally guarantees the performance of thetransaction to each member and becomes thecounterparty to the trade (that is, the buyer toevery seller and the seller to every buyer). Dailycash settlements are paid or collected by clear-ing members through the clearinghouse. Thecash transfers represent the difference betweenthe original trade price and the daily officialclosing settlement price for each commodityfutures contract. The two members settle theirsides of the transaction with the clearinghouse,

2. A firm or trading company that maintains only a propri-etary business may become a member of an exchange withoutregistering as an FCM.


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usually by closing out the position before deliv-ery of the futures contract or the expiration ofthe option on the futures contract.

An exchange member that wishes to clear orsettle transactions for itself, customers, otherFCMs, or commodity professionals (locals ormarket makers) may become a member of theaffiliated clearinghouse (clearing member) if itis able to meet the clearinghouse’s financial-eligibility requirements. In general, theserequirements are more stringent than thoserequired for exchange membership. For exam-ple, a clearing member usually is required tomaintain a specified amount of net capital inexcess of the regulatory required minimum andto make a guaranty deposit as part of the finan-cial safeguards of the clearinghouse. The size ofthe deposit is related to the scale of the clearingmember’s activity. If it is not a member of theclearinghouse for the exchange on which a con-tract is executed, an FCM must arrange foranother FCM that is a clearing member to clearand settle its transactions.3

Margin requirements are an important risk-management tool for maintaining the financialintegrity of clearinghouses and their affiliatedexchanges. Clearinghouses require that theirmembers post initial margin (performance bond)on a new position to cover potential credit expo-sures borne by the clearinghouse. The clearingfirm, in turn, requires its customers to post mar-gin. At the end of each day, and on someexchanges on an intraday basis, all positions aremarked to the market. Clearing members withpositions that have declined in value pay theamount of the decline in cash to the clearing-house, which then pays the clearing membersholding positions that have increased in valueon that day. This process of transferring gainsand losses among clearing-member firms, knownas collecting variation margin, is intended toperiodically eliminate credit-risk exposure fromthe clearinghouse.4 In volatile markets, a clear-inghouse may call for additional variation mar-gin during the trading day, sometimes with only

one hour’s notice, and failure to meet a variation(or initial) margin call is treated as a default tothe clearinghouse.

Some clearinghouses also require that theirmembers be prepared to pay loss-sharing assess-ments to cover losses sustained by the clearing-house in meeting the settlement obligations of aclearing member that has defaulted on its (or itscustomers’) obligations. Such assessments arisewhen losses exceed the resources of defaultingmembers, the guaranty fund, and other surplusfunds of the clearinghouse. Each clearinghousehas its own unique loss-sharing rules.5 At leastone U.S. and one foreign exchange have unlim-ited loss-sharing requirements. Most U.S. clear-inghouses relate loss-sharing requirements tothe size of a member’s business at the clearing-house. Given the potential drain on a bankingorganization’s financial resources, the exposureto loss-sharing agreements should be a signifi-cant consideration in the decision to become aclearing member. A parent bank holding com-pany may not provide a guarantee or becomeliable to an exchange or clearing associationother than for trades conducted by the subsidi-ary for its own account or for the account of anyaffiliate. (See section 225.28(b)(6)(iv) of Regu-lation Y.)

3250.0.4 COMMODITY EXCHANGEACT, COMMODITY FUTURESTRADING COMMISSION, ANDSELF-REGULATORYORGANIZATIONS

In the United States, the primary regulator ofexchange-traded futures activities is the Com-modity Futures Trading Commission (CFTC),which was created by and derives its authorityfrom the Commodity Exchange Act (CEA). TheCFTC has adopted registration,6 financialresponsibility, antifraud, disclosure, and otherrules for FCMs and CTAs, and has generalenforcement authority over commodities firmsand professionals that buy or sell exchange-traded futures contracts.

3. The nonmember FCM opens an account, usually on anomnibus basis, with the clearing-member FCM. Separate om-nibus accounts have to be maintained for customer and non-customer or proprietary trading activity. If the FCM does notcarry customer accounts by holding customer funds and main-taining account records, the clearing member will carry thecustomer’s account on a fully disclosed basis and issue confir-mations, account statements, and margin calls directly to thecustomer on behalf of the introducing FCM. In such cases, theintroducing FCM operates as an introducing broker (IB) andcould have registered with the Commodity Futures TradingCommission as such.

4. Some foreign exchanges do not allow the withdrawal ofunrealized profits as mark-to-market variation.

5. Clearinghouses usually (1) retain the right to use assetsowned by clearing members, but under the control of theclearinghouse (for example, proprietary margin); (2) requireadditional contributions of funds or assets or require themember to purchase additional shares of the clearinghouse; or(3) perfect a claim against the member for its share of the loss.

6. Many FCMs also are SEC-registered as broker-dealersand are subject to SEC and CFTC financial-responsibilityrules.


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The futures exchanges, in addition to provid-ing a marketplace for futures contracts, aredeemed to be self-regulatory organizations(SROs) under the CEA. For example, a numberof SROs have adopted detailed uniform practicerules for FCMs, including ‘‘know your cus-tomer’’ recordkeeping rules and other formalcustomer-disclosure requirements. The NationalFutures Association (NFA) also is an SRO,although it does not sponsor a futures exchangeor other marketplace. The NFA has adoptedsales-practice rules applicable to members whodo business with customers. All FCMs that wishto accept orders and hold customer funds andassets must be members of the NFA.

The CEA and rules of the CFTC require theSROs to establish and maintain enforcementand surveillance programs for their markets andto oversee the financial responsibility of theirmembers.7 The CFTC has approved an arrange-ment under which a designated SRO (DSRO) isresponsible for performing on-site audits andreviewing periodic reports of a member FCMthat is a member of more than one futuresexchange. The NFA is the DSRO for FCMs thatare not members of any futures exchange.

Oversight of FCMs is accomplished throughannual audits by the DSRO and the filing ofperiodic financial statements and early warningreports by FCMs, in compliance with CFTC andSRO rules. In summary, this oversight encom-passes the following three elements:

1. Full-scope audits at least once every otheryear of each FCM that carries customeraccounts.Audit procedures conform to aUniform Audit Guide developed jointly bythe SROs. The full-scope audit focuses onthe firm’s net capital computations, segrega-tion of customer funds and property, finan-cial reporting, recordkeeping, and opera-tions.8 The audit also reviews sales practices(including customer records, disclosures,

advertisements, and customer complaints)and the adequacy of employee supervision.The audit’s scope should reflect the FCM’sprior compliance history as well as the exam-iner’s on-site evaluation of the firm’s internalcontrols. During the off-year, the DSROs per-form limited-scope audits of member FCMs.This audit is limited to financial matters suchas a review of the FCM’s net capital compu-tations, segregation of customer funds, andits books and records.

2. FCM quarterly financial reporting require-ments.FCMs are required to file quarterlyfinancial statements (form 1-FR-FCM) withtheir DSROs. The fourth-quarter statementmust be filed as of the close of the FCM’sfiscal year and must be certified by an inde-pendent public accountant. The filings gener-ally include statements regarding changes inownership equity, current financial condi-tion, changes in liabilities subordinated toclaims of general creditors, computation ofminimum net capital, segregation require-ments and funds segregated for customers,secured amounts and funds held in separateaccounts, and any other material informationrelevant to the firm’s financial condition. Thecertified year-end financial report also mustcontain statements of income and cash flows.

3. Early warning reports.FCMs are required tonotify the CFTC and the SROs when certainfinancial weaknesses are experienced.9 Forexample, if an FCM’s net capital falls to aspecified warning level, it must file a writtennotice within five business days and filemonthly financial reports (form 1-FR-FCM)until its net capital meets or exceeds thewarning level for a full three months. If anFCM’s net capital falls below the minimumrequired, it must cease doing business andgive telegraphic notice to the CFTC and anycommodities or securities SRO of which it isa member. Similar notices must be given bya clearing organization or carrying FCMwhen it determines that a position of an FCMmust be liquidated for failure to meet a mar-gin call or other required deposit.

3250.0.5 FEDERAL RESERVEREGULATION OF FCMs AND CTAs

Bank holding companies are permitted, underRegulationY(section225.28(b)(7)(iv)), toengage

7. CFTC Rule 1.51, contract market program for enforce-ment, requires that SROs monitor market activity and tradingpractices in their respective markets, perform on-site examina-tions (audits) of members’ books and records, review periodicfinancial reports filed by members, and bring disciplinary andcorrective actions against members for violations of the CEAand CFTC and SRO rules.

8. If an FCM is also a broker-dealer, the DSRO is notrequired to examine the FCM for compliance with net capitalrequirements if the DSRO confers with the broker-dealer’sexamining authority at least annually to determine that theFCM is in compliance with the broker-dealer’s net capitalrequirementsand receives theDSROcopiesofall examinations.

9. CFTC Rule 1.12 requires the maintenance of minimumfinancial requirements by FCMs and introducing brokers.These requirements are similar to those applicable to broker-dealers under SEC rules.



in FCM and CTA activities on both domesticand foreign futures exchanges through sepa-rately incorporated nonbank subsidiaries. As ageneral matter, the nonbank subsidiaries of bankholding companies (and some foreign banks)provide services to unaffiliated customers in theUnited States under section 4(c)(8) of the BankHolding Company Act (BHC Act) and to unaf-filiated customers outside the United States underRegulation K.10 Banks and the operating subsid-iaries of banks usually provide futures-relatedservices to unaffiliated parties in the UnitedStates under the general powers of the bank andto unaffiliated parties outside the United Statesunder Regulation K. These various subsidiariesmay provide services to affiliates under section4(c)(1)(C) of the BHC Act.

Regulation Y permits a bank holding com-pany subsidiary that acts as an FCM to engagein other activities in the subsidiary, includingfutures advisory services and trading, as well asother permissible securities and derivativeactivities as defined in sections 225.28(b)(6)(financial and investment advisory activities)and 225.28(b)(7) (agency transactional servicesfor customer investments). Section 225.28(b)(7)specifically authorizes FCMs to provide agencyservices for unaffiliated persons in execution,clearance, or execution and clearance of anyfutures contract and option on a futures contracttraded on an exchange in the United States andabroad. It also includes the authority to engagein other agency-type transactions (for example,riskless principal) involving a forward contract,an option, a future, an option on a future, andsimilar instruments. Furthermore, this sectioncodifies the long-standing prohibition against aparent bank holding company’s issuing anyguarantees or otherwise becoming liable to anexchange or clearinghouse for transactionseffected through an FCM, except for the propri-etary trades of the FCM and those of affiliates.

A well-capitalized and well-managed bankholding company, as defined in section 225.2(r)and (s) of Regulation Y, respectively, may com-mence activities as an FCM or a CTA by filing anotice prescribed under section 225.23(a) ofRegulation Y. Bank holding companies that arenot eligible to file notices or that wish to act in a

capacity other than as an FCM or CTA, such asa commodity pool operator (CPO), must followthe specific application process for these activi-ties. Examiners should ensure that all of theseactivities are conducted in accordance with theBoard’s approval order.

A bank holding company, bank, or FBO par-ent company of an FCM is expected to establishspecific risk parameters and other limits andcontrols on the brokerage operation. These lim-its and controls should be designed to managefinancial risk to the consolidated organizationand should be consistent with its business objec-tives and overall willingness to assume risk.

3250.0.6 PARTICIPATION INFOREIGN MARKETS

FCMs frequently transact business on foreignexchanges as either exchange or clearinghousemembers or through third-party brokers that aremembers of the foreign exchange. The risks ofdoing business in foreign markets generally par-allel those in U.S. markets; however, some uniqueissues of doing business on foreign futuresexchanges must be addressed by the FCM andits parent company to ensure that the activitydoes not pose undue risks to the consolidatedfinancial organization.

Before doing business on a foreign exchange,an FCM should understand the legal and opera-tional differences between the foreign exchangeand U.S. exchanges. For example, the FCMshould know about local business practices andlegal precedents that pertain to business in theforeign market. In addition, the FCM shouldknow how the foreign exchange is regulated andhow it manages risk, and should develop poli-cies and the appropriate operational infrastruc-ture of controls, procedures, and personnel tomanage these risks. Accordingly, examinersshould confirm that, in considering whether andhow to participate in a foreign market, an FCMperforms due diligence on relevant legal andregulatory issues, as well as on local businesspractices. Foreign-exchange risks should beunderstood and authorized by the FCM’s parentcompany, and any limits set by the parent com-pany or FCM management should be carefullymonitored. The FCM and its parent companyalso should assess the regulatory and financialrisks associated with exchange and clearing-house membership in a foreign market, includ-ing an understanding of the extent to which the

10. Those nonbank subsidiaries that operate in the UnitedStates may open offices outside the United States if (1) thebank holding company’s authority under Regulation Y is notlimited geographically, (2) the foreign office is not a sepa-rately incorporated entity, and (3) the activities conducted bythe foreign office are within the scope of the bank holdingcompany’s authority under Regulation Y. In addition, a bankholding company may operate a limited foreign-based busi-ness in the United States under Regulation K. (See 12 C.F.R.211.6.)



foreign clearinghouse monitors and controls day-to-day credit risk and its loss-sharingrequirements.

3250.0.7 SPECIFIC RISKS ANDTHEIR RISK-MANAGEMENTCONSIDERATIONS

In general, FCMs face five basic categories ofrisk—credit risk, market risk, liquidity risk,reputation risk, and operations risk. The follow-ing discussions highlight specific considerationsin evaluating the key elements of sound riskmanagement as they relate to these risks. Thecompliance and internal-controls functions pro-vide the foundation for managing the risks of anFCM.

3250.0.7.1 Credit Risk

FCMs encounter a number of different types ofcredit risks. The following discussions identifysome of these risks and discuss sound risk-management practices applicable to each.

3250.0.7.1.1 Customer Credit Risk

Customer credit risk is the potential that a cus-tomer will fail to meet its variation-margin callsor its payment or delivery obligations. An FCMshould establish a credit-review process for newcustomers that is independent of the marketingand sales function. It is not unusual for theFCM’s parent company (or banking affiliate) toperform the credit evaluation and provide thenecessary internal approvals for the FCM toexecute and clear futures contracts for particularcustomers. In some situations, however, theFCM may have the authority to perform thecredit review internally. Examiners should deter-mine how customers are approved and confirmthat documentation in the customer’s credit filesis adequate even when the approval is per-formed by the parent. Customer credit filesshould indicate the scope of the credit reviewand contain approval of the customer’s accountand credit limits. For example, customer creditfiles may contain recent financial statements,sources of liquidity, trading objectives, and anyother pertinent information used to support thecredit limits established for the customer. In

addition, customer credit files should be updatedperiodically.

FCM procedures should describe how cus-tomer credit exposures will be identified andcontrolled. For example, an FCM could monitora customer’s transactions, margin settlements,or open positions as a means of managing thecustomer’s credit risk. Moreover, proceduresshould be in place to handle situations in whichthe customer has exceeded credit limits. Theseprocedures should give senior managers whoare independent of the sales and marketing func-tion the authority to approve limit exceptionsand require that such exceptions be documented.

3250.0.7.1.2 Customer-Financing Risk

Several exchanges, particularly in New Yorkand overseas, allow FCMs to finance customerpositions. These exchanges allow an FCM tolend initial and variation margin to customerssubject to taking the capital charges under theCFTC’s (or SEC’s) capital rules if the chargesare not repaid within three business days. Inaddition, some exchanges allow FCMs to financecustomer deliveries, again subject to a capitalcharge.

An FCM providing customer-financing ser-vices should adopt financing policies and proce-dures that identify customer-credit standards.The financing policies should be approved bythe parent company and should be consistentwith the FCM’s risk tolerance. In addition, anFCM should establish overall lending limits foreach customer based on a credit review that isanalogous to that performed by a bank withsimilar lending services. The process should beindependent of the FCM’s marketing, sales, andfinancing functions, but it may be performed bythe FCM’s banking affiliate. Examiners shoulddetermine how customer-financing decisions aremade and confirm that documentation is adequate,even when an affiliate approves the financing. Inaddition, the FCM should review financial infor-mation on its customers periodically and adjustlending limits when appropriate.

3250.0.7.1.3 Clearing-Only Risk

FCMs often enter into agreements to clear, butnot execute, trades for customers. Under a‘‘clearing-only’’ arrangement, the customer givesits order directly to an executing FCM. Theexecuting FCM then gives the executed transac-tion to the clearing FCM, which is responsiblefor accepting and settling the transaction. Cus-



tomers often prefer this arrangement because itprovides the benefits of centralized clearing(recordkeeping and margin payments) with theflexibility of using a number of specialized bro-kers to execute transactions.

FCMs entering into clearing-only arrange-ments execute written give-up agreements, whichare triparty contracts that set forth the responsi-bilities of the clearing FCM, the executing FCM,and the customer. Most FCMs use the ‘‘uniformgive-up agreement’’ prepared by the FuturesIndustry Association, although some FCMs stilluse their own give-up contracts. The uniformgive-up agreement permits a clearing FCM,upon giving prior notice to the customer and theexecuting FCM, to place limits or conditions onthe transactions it will accept to clear or termi-nate the arrangement. If an executed transactionexceeds specified limits, the FCM may declineto clear the transaction unless it is acting as thequalifying or primary clearing FCM for the cus-tomer and has not given prior notice oftermination.

Clearing-only arrangements can present sig-nificant credit risks for an FCM. An FCM’srisk-management policies and procedures forclearing-only activities should address the quali-fications required of clearing-only customersand their volume of trading, the extent to whichcustomer-trading activities can be monitored bythe clearing-FCM at particular exchanges, andhow aggregate risk will be measured andmanaged.

The FCM should establish trading limits foreach of its clearing-only customers and haveprocedures in place to monitor their intradaytrading exposures. The FCM should take appro-priate action to limit its liability either by review-ing and approving a limit exception or by reject-ing the trade if a clearing-only customer hasexceeded acceptable trading limits. Examinersshould confirm that the FCM formally advises(usually in the give-up agreement) its customersand their executing FCMs of the trading param-eters established for the customer. Examinersshould also confirm that the FCM personnelresponsible for accepting or rejecting an executedtrade for clearance have sufficient current infor-mation to determine whether the trade is consis-tent with the customer’s trading limits. Prudentgive-up agreements (or other relevant docu-ments such as the customer account agreement)should permit the FCM to adjust the customer’stransaction limits when appropriate in light ofmarket conditions or changes in the customer’sfinancial condition.

Some FCMs act as the primary clearing firm(also referred to as the sponsoring or qualifying

firm) for customers.11 A primary clearing firmguarantees to the clearinghouse that it will acceptand clear all trades submitted by the customer orexecuting FCM, even if the trade is outside theagreed-on limits. Because an FCM is obligatedto accept and clear all trades submitted by itsprimary clearing customers, the FCM must beable to monitor its customers’ trading activitieson an intraday basis for compliance withagreed-on trading limits. Monitoring is espe-cially important during times of market stress.The FCM should be ready and able to takeimmediate steps to address any unacceptablerisks that arise, for example, by contacting thecustomer to obtain additional margin or otherassurances, approving a limit exception, takingsteps to liquidate open customer positions, orgiving appropriate notice of termination of theclearing arrangement to enable the FCM toreject future transactions.

Intraday monitoring techniques will varydepending on the technology available at theparticular exchange. A number of the larger,more automated U.S. exchanges have developedtechnologies that permit multiple intraday col-lection, matching, and reporting of trades—although the frequency of such reconciliationsvaries. On exchanges that are less automated,the primary clearing FCM must develop proce-dures for monitoring clearing-only risks. Forexample, the FCM could maintain a significantphysical presence on the trading floor to moni-tor customer trading activities and promote morefrequent collection (and tallying) of trade infor-mation from clearing-only customers. Theresources necessary for such monitoring obvi-ously will depend on the physical layout of theexchange—the size of the trading floor and thenumber of trading pits, the floor population anddaily trading volumes, and the level of familiar-ity the FCM has with the trading practices andobjectives of its primary clearing customers.The FCM should be able to increase its floorpresence in times of market stress.

3250.0.7.1.4 Carrying-Broker Risk

An FCM may enter into an agreement withanother FCM to execute and clear transactions

11. Primary clearing customers include institutions andindividuals, as well as other nonclearing futures professionals(locals or floor traders), who execute their own trades on theexchange and other nonclearing FCMs that execute trades forunaffiliated customers.



on behalf of the first FCM (typically, when thefirst FCM is not an exchange or clearing mem-ber of an exchange). In such cases, the FCMseeking another or carrying FCM to execute itstransactions should have procedures for review-ing the creditworthiness of the carrying FCM. Ifthe FCM reasonably expects that the carryingFCM will use yet another FCM to clear itstransactions (for example, if the carrying FCMenters into its own carrying-broker relationshipwith another firm for purposes of executing orclearing transactions on another exchange), thefirst FCM should try to obtain an indemnifica-tion from the carrying FCM for any lossesincurred on these transactions.12 When carryingtransactions occur on a foreign exchange, anFCM should know about the legal ramificationsof the carrying relationship under the rules ofthe exchange and the laws of the host country.Moreover, it may be appropriate for an FCM toreach an agreement with its customers thataddresses liabilities relative to transactionseffected on a non-U.S. exchange by a carryingbroker.

3250.0.7.1.5 Executing-FCM Risk

When an FCM uses an unaffiliated FCM toexecute customer transactions under a give-uparrangement, the clearing firm that sponsors theexecuting FCM guarantees its performance.Therefore, the first FCM should review the sub-contracting risk of its executing FCMs and theirsponsoring clearing firms. However, unlike theclearing risk inherent in a carrying-broker rela-tionship, the subcontracting risk for an FCMusing an executing FCM is limited to transac-tion risk (execution errors). An FCM’s manage-ment should approve each executing broker ituses, considering the broker’s reputation forobtaining timely executions and the financialcondition of its sponsoring clearing firm.

3250.0.7.1.6 Pit-Broker Risk

Usually, FCMs will subcontract the execution oftheir orders to unaffiliated pit brokers who accept

and execute transactions for numerous FCMsduring the trading day. The risk associated withusing a pit broker is similar to that of using anexecuting broker: the risk is limited to the bro-ker’s performance in completing the transac-tion. If the pit broker fails, then the primaryclearing firm is responsible for completing thetransaction. Therefore, an FCM should approveeach pit broker it uses, considering the pit bro-ker’s reputation for obtaining timely executionsand the resources of its sponsoring clearing firm.

3250.0.7.1.7 Clearinghouse Risk

Clearinghouse risk is the potential that a clear-inghouse will require a member to meet loss-sharing assessments caused by another clearingmember’s failure. Before authorizing member-ship in an exchange or clearinghouse, an FCM’sboard of directors and its parent company mustfully understand the initial and ongoing regula-tory and financial requirements for members.The FCM’s board of directors should approvemembership in a clearinghouse only after a thor-ough consideration of the financial condition,settlement and default procedures, and loss-sharing requirements of the clearinghouse.

Particularly when it is considering member-ship in a foreign exchange or clearinghouse, anFCM’s board should examine any regulatoryand legal precedents related to how the exchange,clearinghouse, or host country views loss-sharing arrangements. As in the United States,some foreign clearinghouses have unlimited loss-sharing requirements, and some have ‘‘limited’’requirements that are set at very high percent-ages. However, the loss-sharing provisions ofsome of the foreign clearinghouses have not yetbeen applied, which means that there are nolegal and regulatory precedents for applying thestated requirements. In addition, the board shouldbe apprised of any differences in how foreignaccounts are viewed, for example, whether cus-tomer funds are considered separate from thoseof the FCM, whether the relationship betweenan FCM and its customer is viewed as an agencyrather than a principal relationship, and whetherthere are material differences in the way futuresactivities are regulated.

The board also should be apprised of anymaterial changes in the financial condition ofevery clearinghouse of which the FCM is amember. Senior management should monitorthe financial condition of its clearinghouses aspart of its risk-management function.

12. The CFTC takes the position that an FCM is respon-sible to its customers for losses arising from the failure of theperformance of a carrying broker. The industry disagrees withthis position, and the issue has not been resolved by thecourts.



3250.0.7.1.8 Guarantees

FCM parent companies often are asked to pro-vide assurances to customers and clearinghousesthat warrant the FCM’s performance. Thesearrangements may take the form of formal guar-antees or less formal letters of comfort.

Under Regulation Y (section 225.28(b)(7)(iv)(B)), a bank holding company may notprovide a guarantee to a clearinghouse for theperformance of the FCM’s customer obliga-tions. A bank holding company may provide aletter of comfort or other agreement to theFCM’s customers that states the parent (or affili-ate) will reimburse the customers’ funds ondeposit with the FCM if they are lost as a resultof the FCM’s failure or default. Customers mayseek this assurance to avoid losses that couldarise from credit exposure created by anothercustomer of the FCM, since the clearinghousemay use some or all of the FCM’s customer-segregated funds in the event of a default by theFCM stemming from a failing customer’s obli-gations.13 Examiners should note any permis-sible guarantees for purposes of the consoli-dated report of the parent bank holding company,as they are relevant to calculating the consoli-dated risk-based capital of the bank holdingcompany.

3250.0.7.2 Market Risk

When an FCM acts as a broker on behalf ofcustomers, it generally is only subject to marketrisk if it executes customers’ transactions inerror. In this regard, operational problems canexpose the FCM to market fluctuations in con-tract values. However, when an FCM engages inproprietary trading, such as market making andother position-taking, it will be directly exposedto market risk. Potential market-risk exposureshould be addressed appropriately in an FCM’spolicies and procedures.

An FCM that engages in proprietary tradingshould establish market-risk and trading param-eters approved by its parent company. The FCM’ssenior management should establish an indepen-dent risk-management function to control andmonitor proprietary trading activities. Finally,the FCM should institute procedures to controlpotential conflicts of interest between its broker-age and proprietary trading activities.

3250.0.7.3 Liquidity Risk

Liquidity risk is the risk that the FCM will notbe able to meet its financial commitments (end-of-day and intraday margin calls) to its clearingFCM or clearinghouse. Clearing FCMs arerequired to establish an account at one of thesettlement banks used by the clearinghouse forits accounts and the accounts of its clearingmembers. In some foreign jurisdictions, the cen-tral bank fulfills this settlement function. AnFCM should establish and monitor daily settle-ment limits for its customers and should ensurethat there are back-up liquidity facilities to meetany unexpected shortfalls in same-day funds. Toensure the safety of its funds and assets, anFCM should also monitor the financial condi-tion of the settlement bank it has chosen andshould be prepared to transfer its funds andassets toanothersettlementbank,whennecessary.

To control other types of liquidity risks, anFCM should adopt contingency plans for liquid-ity demands that may arise from dramatic mar-ket changes. An FCM, to the extent possible,should monitor the markets it trades in to iden-tify undue concentrations by others that couldcreate an illiquid market, thereby creating a riskthat the FCM could not liquidate its positions.Most U.S. clearinghouses monitor concentra-tions and will contact an FCM that holds morethan a certain percentage of the open interest ina product. In some situations, the exchangecould sanction or discipline the FCM if it findsthat the FCM, by holding the undue concentra-tion, was attempting to manipulate the market.These prudential safeguards may not be in placeon foreign exchanges; consequently, an FCMwill have to establish procedures to monitor itsliquidity risk on those exchanges.

3250.0.7.4 Reputation Risk

FCMs should have reporting procedures in placeto ensure that any material events that harm itsreputation, and the reputations of its bank affili-ates, are brought to the attention of senior man-agement; the FCM’s board of directors; and,when appropriate, its parent company. Reportsof potentially damaging events should be sent tosenior management at the parent bank holdingcompany, who will evaluate their effect on theFCM to determine what, if any, steps should betaken to mitigate the impact of the event on thewhole organization.13. The letter of comfort would protect customers whose

funds were used to cover other customer losses by the clear-inghouse. U.S. clearinghouses also have guarantee funds thatcan be used to reimburse customers at the clearinghouse’sdiscretion.



3250.0.7.4.1 Commodity Trading Adviser

Acting as a commodity trading adviser (includ-ing providing discretionary investment advice toretail and institutional customers or commoditypools) may pose reputation and litigation risksto a CTA or an FCM, particularly when retailcustomers are involved. Accordingly, the FCM’sboard should adopt policies and proceduresaddressing compliance with CFTC and NFAsales-practice rules (including compliance withthe ‘‘know your customer’’ recordkeeping rules).

3250.0.7.5 Operations Risk, InternalControls, Internal Audits, and Compliance

3250.0.7.5.1 Operations Risk

Operations risk is the potential that deficienciesin information systems or internal controls willresult in unexpected loss. Some specific sourcesof operating risk at FCMs include inadequateprocedures, human error, system failure, or fraud.For FCMs, failure to assess or control operatingrisks accurately can be a likely source of prob-lems. Back-office or transaction-processingoperations are an important source of operations-risk exposures. In conducting reviews of back-office operations, examiners should consult theappropriate chapters of theTrading and Capital-Markets Activities Manualfor further guidance.

Operations risk also includes potential lossesfrom computer and communication systems thatare unable to handle the volume of FCM trans-actions, particularly in periods of market stress.FCMs should have procedures that address theoperations risks of these systems, including con-tingency plans to handle systems failures andback-up facilities for critical parts of risk-management, communications, and accountingsystems.

When FCMs execute or clear transactions innonfinancial commodities, they may have totake delivery of a commodity because a cus-tomer is unable or unwilling to make or takedelivery on its contract. To address this situa-tion, the FCM should have in place the proce-dures it will follow to terminate its position andavoid dealing in physical commodities.

3250.0.7.5.2 Internal Controls

Adequate internal controls are the first line ofdefense in controlling the operations risks

involved in FCM activities. Internal controlsthat ensure the separation of duties involvingaccount acceptance, order receipt, execution,confirmation, margin processing, and account-ing are particularly important. Internal controlsshould also be established to record, track, andresolve errors and discrepancies with customersand other parties.

FCMs should have approved policies thatspecify documentation requirements for transac-tions and formal procedures for saving and safe-guarding important documents, consistent withlegal requirements and internal policies. Rel-evant personnel should fully understand docu-mentation requirements. Examiners should alsoconsider the extent to which entities evaluateand control operations risks through internalaudits, contingency planning, and other manage-rial and analytical techniques.

3250.0.7.6 Internal Audits and TheirReview

An FCM should be subject to regular internalaudits to confirm that it complies with its poli-cies and procedures and is managed in a safeand sound manner. In addition, the internal auditfunction should review any significant issuesraised by compliance personnel to ensure thatthey are resolved. Other staff within the FCM(i.e., compliance personnel) should be able toreach internal audit staff to discuss any seriousconcerns they might have. Internal audit reportsshould be forwarded to the FCM’s senior man-agement. Material findings and management’splan to resolve the audit issues should be reportedto the FCM’s board of directors, the parentcompany, and any designated board committee(for example, an audit committee). Frequently,the internal audit function is located at the par-ent company, and audit reports are routinelysent to senior management at the parent com-pany and to the audit committee designated bythe board of directors.

3250.0.8 INSPECTION GUIDANCE

The review of an FCM’s functions should take afunctional-regulatory approach, using the find-ings of the FCM’s primary regulators as muchas possible. Examiners should especially focuson the significant risks that the FCM poses tothe parent company and affiliated banks. Theserisks should be assessed by reviewing the



adequacy of the FCM’s policies and procedures,internal controls, and risk-management func-tions. Compliance with policies and procedures,and with any conditions on the FCM’s activitiesimposed by regulatory authorities (including theFederalReserveBoard), shouldbe fully reviewed.

Bank holding companies, banks, and FBOsmay have more than one subsidiary that acts asan FCM in the United States or that engages infutures transactions for customers in foreignmarkets. To ensure that the FCM/CTA activitiesof a banking organization are evaluated on aconsolidated basis, a cross-section of affiliatedfutures brokerage and advisory firms should bereviewed periodically—particularly those thatpresent the greatest risk to the consolidatedfinancial organization. Relevant factors to con-sider when identifying firms for review include(1) the volume of business; (2) whether theFCM has unaffiliated customers; (3) the numberof customers; (4) whether the firm providescustomer financing; (5) the number of brokerseffecting transactions; (6) whether exchange orclearinghouse memberships are involved;(7) whether the FCM provides clearing-onlyservices; and (8) the date and scope of the lastreview conducted by the Federal Reserve, SRO,or other regulator.

The scope of any review to be conducteddepends on the size of the FCM and the scope ofits activities. The draft first-day letter shouldprovide an overview of an FCM’s authorizedactivities and conditions, as well as a descrip-tion of the actual scope of its business. Examin-ers should review the most recent summary ofmanagement points or other inspection resultsissued by the FCM’s SRO or other regulator, aswell as any correspondence between the FCMand any federal agency or SRO. If examinershave any questions about the findings of anSRO’s or a regulator’s results, they should con-tact the organization to determine whether thematter is material and relevant to the currentinspection. The status of any matters left openafter the SRO’s or regulator’s review shouldalso be inquired about.

An important factor in determining the scopeof the inspection is whether the FCM has unaf-filiated customers or conducts transactions solelyfor affiliates. Other factors include whether(1) the FCM is a clearing member of an exchange,particularly of a non-U.S. exchange; (2) it actsas a carrying broker on behalf of other FCMs;(3) it has omnibus accounts with other brokersin markets in which it is not a member (U.S. orforeign); (4) it provides advisory or portfoliomanagement services, including discretionaryaccounts, or has been authorized to act as a

commodity pool operator (CPO); (5) it providesclearing services to locals or market-makers;and (6) it provides financing services tocustomers.14

Examiners are not expected to routinely per-form a front- or back-office inspection unless(1) the FCM’s primary regulator found materialdeficiencies in either office during its most recentexamination or (2) if front- or back-office opera-tions have not been examined by the primaryregulator within the last two years. However,examiners may still choose to review a smallsample of accounts and transactions to confirmthat appropriate controls are in place. In addi-tion, net capital computations of U.S. FCMs donot need to be reviewed; they are reviewed bythe FCM’s DSRO, and the FCM is subject toreporting requirements if capital falls belowwarning levels. Examiners should perform afront- and back-office review of the FCM’soperations outside of the United States.15

Review of audit function.Examiners may relyon well-documented internal audit reports andworkpapers to verify the adequacy of risk man-agement at the FCM. Examiners should reviewthe internal audit reports and workpapers todetermine the adequacy of their scope and thor-oughness in complying with FCM policies andprocedures. If an examiner finds that an internalaudit adequately documents the FCM’s compli-ance with a policy or procedure pertaining to themanagement of the various risk assessmentsrequired by the current inspection, that factshould be documented in the workpapers, andinspection procedures should be completed inany area not adequately addressed by the inter-nal audit report. Examiners should periodicallyspot check areas covered by internal audits toensure the ongoing integrity of the audit pro-cess. Finally, examiners should ensure that inter-nal auditors have adequate training to evaluate

14. If the FCM engages in proprietary trading for its ownaccount, particularly for purposes other than hedging (marketmaking or position taking), or if the FCM acts as an interme-diary in any over-the-counter futures or other derivativeactivities, the examiner should advise the examiner in chargeof the inspection so that the firm’s proprietary trading can beevaluated in connection with similar activities of the consoli-dated financial organization.

15. The inspection procedures for reviewing front- andback-office operations may be found in sections 2050.3 and2060.3, respectively, of theTrading and Capital-MarketsActivities Manual.



the FCM’s compliance with its policies andprocedures and with applicable laws and regula-tions (both inside and, if applicable, outside theUnited States).

If an examiner has determined that it is notnecessary toperformaroutineback-office review,he or she should confirm that the FCM hasaddressed operations risks in its policies andprocedures. Examiners also should review theinternal controls of an FCM to ensure that thefirm is operated safely and soundly according toindustry standards and that it complies with anyBoard regulations or conditions placed on theFCM’s activities. Examiners should be alert toany ‘‘red flags’’ that might indicate inadequateinternal controls. An FCM must be organized sothat its sales, operations, and compliance func-tions are separate and managed independently.If an FCM engages in proprietary trading, exam-iners should confirm that the firm has proce-dures that protect against conflicts of interest inthe handling of customer orders (examples ofthese conflicts of interest include front-runningor ex-pit transactions). To make an overallassessment of the FCM’s future business, theresults of any review should be consolidatedwith the results of reviews by other FCMsinspected during this cycle.

3250.0.9 INSPECTION OBJECTIVES

1. To identify the potential and extent of vari-ous risks associated with the FCM’s activi-ties, including credit, market, liquidity, andreputation risks.

2. To evaluate the adequacy of the audit func-tionandreviewsignificantfindings, themethodof follow-up, and management’s response tocorrect any deficiencies.

3. To assess the adequacy of the risk-management function at the FCM.

4. To assess the adequacy of and compliancewith the FCM’s policies and procedures andthe adequacy of the internal control function.

5. To evaluate and determine the FCM’s levelof compliance with relevant statutes, Boardregulations, interpretations, orders, andpolicies.

6. To assess the adequacy of risk managementof affiliated FCMs on a consolidated basis.

3250.0.10 INSPECTION PROCEDURES

3250.0.10.1 Structural Organization andActivity Analysis

3250.0.10.1.1 General

1. Identify all bank holding company subsidi-aries that engage in FCM- or CTA-typeactivities in the United States or abroad oridentify U.S. FCM/CTA subsidiaries of FBOs.Determine which firms should be inspectedto provide a global view of the adequacy ofmanagement of these activities on a consoli-dated basis, based on the scope of activitiesand the degree of supervision by other regu-lators. Complete applicable procedures belowfor firms selected for inspection.

2. Review first-day-letter documents, noticesfiled under Regulation Y, Board orders andletters authorizing activities, previous inspec-tion reports and workpapers, previous auditreports by futures regulators (CFTC, DSRO,National Futures Association, foreign futuresregulator)andcorrespondenceexchangedwiththose regulatory entities, and reports byinternal or external auditors or consultants.

3. Note the scope of the FCM’s activities,including—a. execution and clearing;b. execution only for affiliates and third

parties;c. clearing-only for affiliates, third parties,

professional floor traders (locals);d. pit brokerage;e. advisory;f. discretionary portfolio management;g. commodities or commodity pool operator

(in FCM or in affiliate);h. margin financing;i proprietary trading;j. exchange market maker or specialist;k. types of instruments (for example, finan-

cial, agricultural, precious metals,petroleum);

l. contractmarketswherebusiness isdirected;m. other derivatives products (should be iden-

tified, for example, interest-rate swaps andrelated derivative contracts, foreign-exchangederivativecontracts, foreigngov-ernment securities, other);

n. other futures-related activities, includingoff-exchange transactions;

o. riskless-principal transactions; andp. registered broker-dealers.

4. Note exchange and clearinghouse member-ships here and abroad, noting any financialcommitments and any guarantees by the FCM



or its parent16 to the exchange or clearing-house with respect to proprietary, affiliate, orcustomer transactions.

5. Note any new lines of business or activitiesoccurring at the FCM or any changes toexchange and clearing memberships sincethe last inspection.

6. Note the percentage of business conductedfor—a. affiliate banks,b. nonbank affiliates,c. customers (note the breakdown between

institutional and retail customers and ifthere is any guarantee or letter of comfortto customers in which the parent companyprovides that it will reimburse customersfor loss as a result of the FCM’s failure orother default),

d. proprietary accounts (hedging, position-taking), and

e. professional floor traders (locals, marketmakers).

3250.0.10.1.2 Audit Program

Determine the quality of the internal audit pro-gram. Assess the scope, frequency, and qualityof the audit program for the FCM and relatedactivities. Consider spot checking areas coveredby internal audits.

1. Review the most recent audit report, notingany exceptions and their resolution.

2. Determine whether internal auditors haveadequate training to evaluate the FCM’s com-pliance with its policies and procedures andwith applicable laws and regulations.

3. Verify that audit findings have been commu-nicated to senior management and materialfindings have been reported to the FCM’sboard of directors and parent company.

4. Identify any areas covered by these proce-dures that are not adequately addressed bythe internal audit report.

5. Identify areas of the internal audit report thatshould be verified as part of the currentinspection.

3250.0.10.1.3 Operational Activities

Determine the scope of review that is appropri-ate to activities and allocate examiner resources,

considering the adequacy of internal auditworkpapers.

1. Complete the appropriate front- and/or back-office inspection procedures when—a. front- and back-office operations have not

been examined by the DSRO within thelast two years,

b. material deficiencies in front- or back-office operations were found by the DSROduring the most recent audit, or

c. the primary regulator for the FCM is not aU.S. entity.

2. Advise the examiner in charge of the inspec-tion of the parent company if the FCM engagesin proprietary trading or over-the-counterfutures or derivatives business as principal oragent.

3250.0.10.2 Board and SeniorManagement Oversight

1. Review the background and experience ofthe FCM’s board of directors and seniormanagement, noting prior banking and futuresbrokerage experience.

2. Determine if the board of directors of theFCM has approved written policies summa-rizing the firm’s activities listed below, andaddressing oversight by the board or a board-designated committee:a. the risk appropriate for the FCM, includ-

ing credit, market, liquidity, operation,reputation, and legal risk (see SR-95-51)

b. the monitoring of compliance with riskparameters

c. the exchange and clearinghousememberships

d. the internal audit function3. Determine if senior management of the FCM

has adopted procedures implementing theboard’s policies for—a. approval of new-product lines and other

activities;b. transactions with affiliates;c. transactions by employees;d. compliance with applicable regulations

and policies and procedures;e. management information reports;f. the separation of sales, operations, back-

office, and compliance functions; andg. reports to the FCM boards of directors on

material findings of the complaint or audit16. The parent bank holding company cannot provide aguarantee or otherwise become liable to an exchange orclearing association other than for those trades conducted bythe FCM subsidiary for its own account or for the account ofany affiliate. See Regulation Y, section 225.28(b)(7)(iv)(B).



functionsandonmaterial deficiencies iden-tified during the course of regulatory auditsor inspections.

4. Determine that policies and procedures areperiodically reviewed by the board of direc-tors or senior management, as appropriate,and ensure that they comply with existingregulatory and supervisory standards and ad-dress all of the FCM’s activities.

5. Review management information reportingsystems and determine whether the board ofdirectors of the parent company (or a desig-nated committee of the parent’s board) isapprised of—a. material developments at the FCM,b. the financial position of the firm including

significant credit exposures,c. the adequacy of risk management,d. material findings of the audit or compli-

ance functions, ande. material deficiencies identified during the

courseof regulatory reviewsor inspections.6. Review the FCM’s strategic plan.

a. Assess whether there are material incon-sistencies between the stated plans and theFCM’s stated risk tolerances.

b. Verify that the strategic plan is reviewedand periodically updated.

3250.0.10.3 Risk Management

3250.0.10.3.1 Credit Risk

1. Review credit-risk policies and procedures.a. Verify the independence of credit-review

approval from the limit-exceptionsapproval.

b. Verify that the procedures designate asenior officer with the responsibility tomonitor and approve limit-exceptionapprovals.

2. Determine whether the FCM has authorityto open customer accounts without parentcompany approval.

3. Review the customer base (affiliates, thirdparties) for credit quality in terms of affilia-tion and business activity (affiliates, corpo-rate, retail, managed funds, floor traders,etc.).

4. Evaluate the process for customer-creditreview and approval. Determine whetherthe customer-credit review identifies credit

risks associated with the volume of transac-tions executed or cleared for the customer.

5. Evaluate the adequacy of credit-risk-management policies. Determine if they—a. establish and require adequately docu-

mented credit limits for each customerthat reflect their respective financialstrengths, liquidity, trading objectives,and potential market risk associated withthe products traded;

b. require periodic updates of such creditlimits in light of changes in the financialcondition of each customer and marketconditions; and

c. do not permit the FCM to waive impor-tant broker safeguards, such as the rightto liquidate customer positions upondefault or late payment of margin.

6. Consider verifying the above informationby sampling customer-credit files.

7. Verify that up-to-date customer-credit filesare maintained on site or are available forreviewduring the inspection. If thecustomer-credit approval was performed by the par-ent company or an affiliate bank, verify thatthe FCM’s files contain information indicat-ing the scope of the credit review, theapproval, and credit limits.

8. Review notifications and approval of limitexceptions for compliance with FCMprocedures.

9. Determine whether the FCM has adoptedprocedures identifyingwhen theFCMshouldtake steps to limit its customer-credit expo-sure (for example, when to refuse a trade,grant a limit exception, transfer positions toanother FCM, or liquidate customerpositions).

10. Evaluate the adequacy of risk managementof customer-financing activities.

11. Determine that the credit-review process isindependent from the marketing, sales, andfinancing function.a. Verify that the FCM has policies that

identify customer-credit standards andthat it establishes overall lending limitsfor each customer.

b. Assess the adequacy of the credit-reviewprocess and documentation, even whencredit review is performed by an affiliate.

12. Review the instances when the FCM haslent margin to customers on an unsecuredbasis. If the FCM does not engage inmargin financing as a business line, verifythat extensions are short-term and with-in the operational threshold set for thecustomer.



3250.0.10.3.2 Clearing-Only Risk

1. Determine whether each clearing arrange-ment is in writing and that it—a. identifies the customer and executing bro-

kers, and defines and adequately docu-ments the respective rights and obliga-tions of each party;

b. establishes overall limits and tradingparameters for the customer that are basedon the customer’s creditworthiness andtrading objectives; and

c. permits transaction limits to be adjustedto accommodate market conditions orchanges in the customer’s financialcondition.

2. When the FCM has entered into a clearing-only agreement with a customer, verify thatit has reviewed the creditworthiness of eachexecuting broker or its qualifying clearingfirm identified in the agreement.

3. If the FCM acts as the primary clearing firmfor locals or other customers, confirm thatthe firm has adopted procedures for monitor-ing and controlling exposure. Note whetherthe firm monitors customer positions through-out the trading day and how this monitoringis accomplished.

3250.0.10.3.3 Carrying Brokers,Executing Brokers, and Pit Brokers

1. If the FCM uses other brokers to executeand/or clear transactions, either on an omni-bus or a fully disclosed basis, determine thatit has adequately reviewed the creditworthi-ness and approved the use of the other bro-kers. If the FCM uses nonaffiliated executingbrokers, confirm that it also has consideredthe reputation of the broker’s primary clear-ing firm. If the other broker is likely to useanother broker, determine whether the brokerhas given the FCM an indemnification againstany loss that results from the performance orfailure of the other broker.

2. If the FCM uses other brokers to execute orclear transactions in non-U.S. markets, deter-mine whether senior management under-stands the legal risks pertinent to doing busi-ness in those markets and has adopted policiesfor managing those risks.

3. When the FCM uses third-party ‘‘pit bro-kers’’ to execute transactions, verify that theFCM has reviewed and approved each bro-ker after considering the reputation of the pitbroker’s primary clearing firm.

3250.0.10.3.4 Exchange andClearinghouse Membership

1. Verify that the FCM completes a due-diligence study of each exchange and clear-inghouse before applying for membership inthe organization.a. Determine whether board minutes approv-

ing membership demonstrate a thoroughunderstanding of the loss-assessment pro-visions and other obligations of member-ship for each exchange and clearinghouse,as well as a general understanding of theregulatory scheme.

b. Determine whether, in approving mem-bership in a non-U.S. exchange or clear-inghouse, the board’s minutes indicate adiscussion of the regulatory environmentand any relevant credit, liquidity, and legalrisks associated with doing business in theparticular jurisdiction. The minutes shouldalso reflect discussion of any material dif-ferences from U.S. precedent in how for-eign accounts are viewed, for example,whether customer funds held in an omni-bus account are considered separate (seg-regated) from those of the FCM or whetherthe relationship between the FCM and itscustomers is viewed as an agency or prin-cipal relationship in the host country.

2. Verify that the FCM has apprised its parentcompany of the results of its study of theexchange or clearinghouse and that it haswritten authorization by senior managementof itsparentcompany toapply formembership.

3. Verify that the FCM monitors the financialcondition of each exchange and clearingorganization for which it is a member.

4. Review all guarantees, letters of comfort, orother forms of potential contingent liability.Verify that the parent company has not pro-vided a guarantee to the clearinghouse forthe performance of the FCM’s customer obli-gations.17 Note any guarantees against theparent losses incurred from the failure of anFCM and advise the examiner in charge ofthe parent company’s inspection, who canconfirm that guarantees are included in the

17. The parent bank holding company cannot provide aguarantee or otherwise become liable to an exchange orclearing association other than for those trades conducted bythe FCM subsidiary for its own account or for the account ofany affiliate. See Regulation Y, section 225.28(b)(7)(iv)(B).



bank holding company’s calculation of con-solidated risk-based capital.

3250.0.10.3.5 Market Risk

1. If an FCM engages in proprietary trading,determine whether policies and proceduresare in place to control potential conflicts ofinterest between its brokerage business andtrading activities.

2. When an FCM plans to enter (or has enteredinto) a foreign market, determine if the FCMperformed due-diligence reviews of relevantlegal and regulatory issues, as well as onlocal business practices.

3250.0.10.3.6 Liquidity Risk

1. Verify that the FCM has established andmonitors daily settlement limits for each cus-tomer to ensure that liquidity is sufficient tomeet clearinghouse obligations.

2. Determine whether the FCM has establishedback-up liquidity facilities to meet unex-pected shortfalls.

3. Verify that the FCM monitors by product theamount of open interest (concentrations) thatit holds at each exchange, either directly orindirectly through other brokers. If positionsare held on foreign exchanges and concentra-tions are not monitored, verify that the FCMis able to monitor its positions and manageits potential liquidity risks arising from thatmarket.

4. Review liquidity contingency plans for deal-ing with dramatic market changes.

3250.0.10.3.7 Reputation Risk

1. Review management information reportingsystems and determine whether—a. the FCM is able to assess the extent of

any material exposure to legal or reputa-tion risk arising from its activities, and

b. the parent company receives sufficientinformation from the FCM to assess theextent of any material exposure to litiga-tion or reputation risk arising from theFCM’s activities.

2. If the FCM provides investment advice tocustomers or commodity pools, determinewhether it has procedures designed to mini-

mize the risks associated with advisoryactivities. Such procedures might address thedelivery of risk disclosures to customers, thetypes of transactions and trading strategiesthat could be recommended or effected forretail customers, compliance with the ‘‘knowyour customer’’ recordkeeping and other salespractice rules of the SROs, and conformanceto any trading objectives established by thecustomer or fund.

3. If the FCM acts as a CPO, verify that it hasobtained prior Board approval and is in com-pliance with any conditions in the Boardorder.

3250.0.10.4 Operations, Internal Controls,and Compliance

1. Determine the extent to which operatingrisk is evaluated and controlled through theuse of internal audits, contingency plan-ning, and other managerial and analyticaltechniques.

2. Review the most recent summary of man-agement points or similar document andalso respective correspondence issued bythe FCM’s DSRO or other primary futuresregulator. Discuss any criticism with FCMmanagement and confirm that correctiveaction has been taken.

3. Consider reviewing a small sample ofaccounts and transactions to confirm thatappropriate controls are used and that theFCM has incorporated operations risks intoits policies and procedures.

4. Review the organizational structure andreporting lines within the FCM and verifyseparation of sales, trading, operations, com-pliance, and audit functions.

5. Determine that the FCM’s policies and pro-cedures address the booking of transactionsby affiliates and employees and other poten-tial conflicts of interest.

6. If the FCM is authorized to act as a CPO,review the most recent NFA or other pri-mary futures regulator’s audit, includingany informal findings by examiners. Dis-cuss any criticism with the FCM manage-ment and confirm that corrective action hasbeen taken.

7. If the FCM executes and clears nonfinancialfutures, verify that the FCM has proceduresto avoid taking physical possession of thenonfinancial product when effecting‘‘exchange for physical transactions’’ forcustomers.



8. When the FCM takes physical delivery ofcommodities due to failure or unwillingnessof a customer to make or take delivery of itscontracts, determine whether the FCM hasand follows procedures to close out its posi-tion. Note if the FCM frequently takesdelivery of physical commodities.

9. Assess the adequacy of customer-complaintreview by reviewing the complaint file andhow complaints are resolved. Note if theFCM receives repeat or multiple complaintsinvolving one or more of its activities oremployees.

10. Determine whether the FCM has developedcontingency plans that describe actions tobe taken in times of market disruptions and

whether such plans address managementresponsibilities, including communicationswith its parent bank holding company,liquidity, the effect on customer-credit qual-ity, and communications with customers.

3250.0.10.5 Conclusions

1. Prepare inspection findings and draw conclu-sions as to the adequacy of the FCM’s risk-management, compliance, operations, inter-nal controls, and audit functions.

2. Present findings to FCM management andsubmit inspection findings to the examiner incharge of the parent company inspection.

3250.0.11 FCM Supplemental Checklist Questionnaire

Yes No

3250.0.11.1 General Questions

1. Is the FCM a separately incorporated subsidiary of the bank holding companyas required by Regulation Y, 12 C.F.R. 225.28(b)(6)(iv)?

2. Has the parent bank holding company provided a guarantee or otherwisebecome liable to an exchange or clearing association other than for those tradesconducted by a subsidiary for its own account or for the account of any affiliate(prohibited by Regulation Y (see 12 C.F.R. 225.28(b)(6)(iv))?

3. How long has the FCM been in operation? yrs.

4. Approximately how many customers does the FCM have?

5. What degree of market participation does the FCM have(mark (x) for the highest level of involvement)?

a. FCM, nonmember of futures exchange.Must execute trades through exchange members and issubject to NFA rules.

b. Exchange member. Holds membership on one ormore futures exchanges entitling FCM to execute trades on theexchange(s) and subjecting FCM to the rules of exchange(s).

c. Clearinghouse member. Holds membership in anexchange’s clearinghouse as well as exchange membership,thus enabling FCM to execute and clear its own transactions.Such FCM is subject to exchange and clearinghouse rules.

6. If FCM is an exchange member, on which exchange(s) (domesticand foreign) does the FCM have membership(s)?



Yes No

7. If FCM is a clearing member, list below the clearinghouse(s) ofwhich it is a member.

8. Does the FCM periodically make an adjusted net capital computation to verifythat it maintains capitalization fully adequate to meet its own commitmentsand those of its customers, including affiliates?

(NOTE: Under the CFTC’s net capital computations, there havebeen no capital requirements for ‘‘hedge’’ transactions by FCMaffiliate banks. It may be necessary to request that an adjusted netcapital computation be made to determine the amount of adjustednet capital required when affiliate trades are treated as third-partytransactions.)

9. Does a review of the FCM’s correspondence from its designatedself-regulatory organization reveal that the FCM meets CFTCrequirements with respect to capital rules, segregation of customerassets, and risk disclosure?

10. If an FCM will receive services from an affiliate (e.g., the lead bankassesses FCM customer-credit risk or monitors customer positionsand margin accounts), have the FCM and affiliate entered into aformal service agreement on an explicit fee basis?

3250.0.11.2 Management

1. Does the FCM’s management have expertise and previousexperience as a broker, dealer, or participant in cash, futures, orforward markets related to those in which the FCM executestransactions?

2. Does the FCM’s management have prior banking experience?

3. Does it appear that management has the expertise necessary toevaluate the viability of various hedging strategies?

4. Does it appear that FCM management has the ability to recognizeimprudent or unsafe customer activity that could endanger theFCM?

5. Does the board of directors have written policies that summarize the firm’sactivities and its oversight function (certain functions may be designated to aboard audit or other committee) with respect to—

a. risk appropriate for the FCM?

b. compliance monitoring and risk parameters?

3250.0.11.3 Controls of Risk Exposure with Customers

1. Does the FCM have a system for assessing and periodicallyre-evaluating customer-credit risk?



Yes No

2. Does the FCM take customer-credit risk into consideration and establish foreach customer—

a. position limits for each contract the customer wishes to trade?

b. an aggregate position limit for outstanding contracts held by eachcustomer?

3. Does the FCM have a system for monitoring customer positions to ensurepositions are within the limits imposed by the FCM?

4. Does the FCM have an adequate system in place to monitor its overall riskexposure, primarily customer-default risk, on a daily basis?

5. Do customer agreements and internal procedures enable the FCM to—

a. limit the types of trades a customer engages in?

b. refuse, when appropriate, to execute any trades except those resulting inliquidation of existing positions?

3250.0.11.4 Margin Requirements

1. Does the FCM have a system for daily monitoring of margin accounts toensure that margin calls are promptly issued and satisfied?

2. Does the customer agreement permit and has the FCM adopted procedures forliquidating a customer’s position if margin calls are not promptly satisfied?

3. Do customer-account agreements authorize the FCM to require higher initialand variation margin levels than those set by the exchanges?

4. Does the FCM have a system in place for obtaining higher customer margins ininstances when the FCM determines—

a. a customer’s futures position or deteriorating financial condition necessi-tates a greater amount of margin to protect the FCM?

b. volatile market conditions justify higher levels of margin than thoserequired by an exchange?

3250.0.11.5 Credit Risk

1. Is the credit-review approval independent from the limit-exceptions approval?

2. Does a senior officer monitor and approve limit-exception approvals?

3. Does the customer-credit review identify credit risks associated with thevolume of transactions executed or cleared for the customer?

4. Is adequate documentation required and maintained of credit limits for eachcustomer that reflect customers’ respective financial strengths and liquidity,trading objectives, and the potential market risk associated with the productstraded?

5. Has the FCM adopted procedures identifying when the FCM should take stepsto limit its customer-credit exposure (e.g., when to refuse a trade, grant a limitexception, transfer positions to another FCM, or liquidate customer positions)?

6. Is the credit-review process independent from the marketing/sales function andthe financing function?



Yes No

3250.0.11.6 Clearing-Only Risk

1. Is each arrangement in writing and does it—

a. identify the customer, executing brokers, and define and adequately docu-ment the respective rights and obligations of each party?

b. establish overall limits and trading parameters for the customer that arebased on the customer’s creditworthiness and trading objectives?

c. permit transaction limits to be adjusted to accommodate market conditionsor changes in the customer’s financial condition?

2. Has the FCM or its qualifying clearing firm verified that it has reviewed thecreditworthiness of each executing broker?

3. If the FCM acts as the primary clearing firm for locals or other customers, hasthe firm adopted procedures for monitoring and controlling exposure through-out the trading day?

3250.0.11.7 Carrying Brokers, Executing Brokers, and Pit Brokers

1. If the FCM uses other brokers to execute and/or clear transactions, either on anomnibus or fully disclosed basis, has it adequately reviewed the creditworthi-ness and approved the use of the other brokers?

2. Has the FCM been given an indemnification against any loss that results fromthe performance or failure of the other broker?

3. If the FCM uses nonaffiliated executing brokers, has it considered the reputa-tion of the broker’s primary clearing firm?

3250.0.11.8 Exchange and Clearinghouse Membership

1. Does the FCM complete a due-diligence study of each exchange and clearing-house before applying for membership in such organization?

2. Do the board minutes approving such memberships demonstrate a thoroughunderstanding of the loss-assessment provisions and other obligations ofmembership for each exchange and clearinghouse, as well as a general under-standing of the regulatory scheme?

3. In approving membership in a non-U.S. exchange or clearinghouse, do theboard minutes evidence a discussion of the regulatory environment and anyrelevant credit, liquidity, and legal risks associated with doing business in aparticular jurisdiction?

4. Does the FCM monitor the financial condition of each exchange and clearingorganization for which it is a member?

3250.0.11.9 Market Risk

1. If an FCM engages in proprietary trading, are policies and procedures in placeto control potential conflicts of interest between its brokerage business andtrading activities?

2. If an FCM has entered or plans to enter a foreign market, has the FCMperformed due-diligence reviews of relevant legal and regulatory issues, aswell as on local business practices?



Yes No

3250.0.11.10 Liquidity Risk

1. Has the FCM established and does it monitor daily settlement limits for eachcustomer to ensure liquidity sufficient to meet clearinghouse obligations?

2. Has the FCM established back-up liquidity facilities to meet unexpectedshortfalls?

3. Does the FCM monitor the amount of open interest (concentrations) byproduct that it holds, directly or indirectly, at each exchange?

3250.0.11.11 Reputation Risk

1. Is the FCM able to assess the extent of any material exposure to legal orreputation risk arising from its activities?

2. Does the parent company receive sufficient information from the FCM’sinformation systems to assess the extent of any material exposure to litigationor reputation risk arising from the FCM’s activities?

3. If the FCM provides investment advice to customers or commodity pools, doesit have procedures designed to minimize the risks associated with advisoryactivities?

4. If the FCM acts as a CPO, has it obtained prior Board approval and is it incompliance with any conditions in the Board order?

3250.0.11.12 Internal Controls

1. Does the FCM have written procedures pertaining to the following:

a. the types of futures and options on futures contracts which the FCM willexecute?

b. individuals authorized to effect transactions and sign contracts and confir-mations?

c. the firms or individuals with whom FCM employees may conduct business?

2. Does the FCM obtain written authorization from customers specifying theindividuals who are authorized to execute trades on behalf of the customers?

3. Does the FCM have written procedures governing—

a. the solicitation and acceptance of customers?

b. the execution of purchases and sales?

c. processing transactions?

d. accounting for transactions?

e. clearing of transactions?

f. safekeeping of customer margin deposits or securities deposited as margin?

4. Does the FCM have written contracts with all firms or individuals who mayconduct business on behalf of the FCM?

5. Does the FCM have proper segregation of duties to ensure that individualsinvolved in executing transactions are not able to make accounting entries?

6. Does the FCM have a numbered and controlled system of order tickets andconfirmations to prevent unauthorized trading and to verify the accuracy ofrecords and enable reconciliation throughout the system?



Yes No

7. Does the FCM have procedures to time stamp receipt of all orders at least tothe nearest minute and execute all orders strictly in chronological sequence (tothe extent consistent with the customers’ specifications)?

8. Does the FCM have a system for routing incoming confirmations to anoperating unit separate from the unit that executes transactions?

9. Does the FCM have a system for comparing internal and external confirma-tions to ensure that the FCM will not accept or deliver securities and/or marginpayments without proper authorization and documentation?

10. Does the FCM have procedures to ensure that someone outside the trading unitis responsible for resolution of trades in which incoming and outgoing confir-mations do not match?

11. With respect to transactions cleared by others, are procedures in place forverifying and agreeing clearing FCM open position and margin depositreports?

12. Does the FCM review daily outstanding contracts, customer positions, andmargin balances?

13. Does FCM management regularly review all adjustments affecting futurespositions or income recognition to verify that such adjustments were properand approved?

14. Are subsidiary ledgers regularly reconciled to the general ledger?

15. Has the FCM adopted written supervisory procedures for supervising brokersand others to ensure that they follow written policies and procedures?

16. Are there written procedures containing criteria for selecting and trainingcompetent personnel?

17. Does the FCM have a comprehensive reporting system for providing manage-ment with all the information necessary to effectively manage the FCM’soperations?

18. Are procedures in place to ensure that any futures advisory services (invest-ment advice) furnished—

a. reflect the views of persons authorized to supervise advisory activities?

b. are authorized under Regulation Y or by Board order?

19. Is there a formal and comprehensive internal audit program pertaining to FCMactivities?



3250.0.12 LAWS, REGULATIONS, INTERPRETATIONS, AND ORDERS

Subject Laws1 Regulations2 Interpretations3 Orders

Brokerage of gold and silver bul-lion and coins (provided subse-quent basis for FCM execution andclearance of futures contracts)

38 FederalRegister27,552(1973)

FCMs for the execution of futurescontracts for gold, silver, platinumbullion, and coins

1990 FRB 5521985 FRB 4671977 FRB 951

FCMs for the execution and clear-ance of futures contracts

1982 FRB 6511982 FRB 514

Engage in FCM activities: U.S. gov-ernment securities, negotiablemoney market instruments, foreignexchange

1983 FRB 7291983 FRB 216

FCM engaged in the execution andclearance of options

1983 FRB 733

Inclusion into Regulation Y per-missible nonbanking activities(1984 and 1987)

225.28(b)(7)(iv) 1984 FRB 531984 FRB 591

Execution and clearing of futurescontracts on a municipal bond indexand to provide futures advisoryservices

1986 FRB 1441985 FRB 8031985 FRB 6511985 FRB 111

Execute, purchase, and sale of goldand silver bullion and coins for theaccount of customers

1985 FRB 4671985 FRB 2511985 FRB 111

Advisory services for futures con-tracts on stock indexes and optionsthereon

1987 FRB 220

Advice on certain futures andoptions on futures

1988 FRB 820

Execution and clearance of futurescontracts on stock indexes, optionsthereon, and futures contracts on amunicipal bond index

1985 FRB 970

Execution and clearing futures con-tracts on stock indexes

1985 FRB 801

Providing investment advice onfinancial futures and options onfutures

225.28(b)(6)(iv)(Regulation Y)

1997 FRB 2751986 FRB 833




Providing investment advice ontrading futurescontractsandoptionson futures contracts in nonfinan-cial commodities

1991 FRB 126

Executing-only and clearing-onlytrades

1993 FRB 7281993 FRB 723

Discretionary portfolio manage-mentserviceson futuresandoptionson futures on financial commodities

1995 FRB 386

Discretionary portfolio manage-mentserviceson futuresandoptionson futures on nonfinancialcommodities

1995 FRB 803

FCM executing and clearing, andclearing without execution, futuresand options on futures on nonfi-nancial commodities

1993 FRB 1049

Trading for one’s own account infutures, options, and options onfutures contracts based on certifi-cates of deposit or other moneymarket instruments

1995 FRB 190

Commodity and index swaptransactions—originator, principal,agent, broker, or adviser

1995 FRB 1911995 FRB 190

Trading in futuresoptionson futurescontracts based on commodities oron stock, bond, or commodityindexes for one’s own account

1995 FRB 185

Discretionary portfolio manage-mentserviceson futuresandoptionson futures on financial commodities

1995 FRB 3861994 FRB 151

FCM execution, clearance, andadvisory services for contracts onfinancial and nonfinancial com-modities for noninstitutionalcustomers

1995 FRB 880

Serving as a commodity pooloperator

1996 FRB 569




Primary clearing firm for a limitednumber of floor traders and broker-age services for forward contractson financial and nonfinancialcommodities

1997 FRB 138

1. 12 U.S.C., unless specifically stated otherwise.2. 12 C.F.R., unless specifically stated otherwise.

3. Federal Reserve Regulatory Service reference.



4(c)(8)—Agency Transactional Services (Futures CommissionMerchant Board Orders) Section 3251.0

This section serves as a prelude to the futurescommission merchant activities (FCM) that areprovided as examples of previous Board FCMdecisions. Sections 3251.0.1 through 3251.0.13provide brief historical summaries of Boarddecisions that may have led to the authoriza-tions that have been incorporated into the April1997 revision of Regulation Y for this activity.The summaries provide the reader with somehistorical perspective as to how and why thecurrent provisions of Regulation Y evolved forFCMs. Certain conditions and commitmentswithin these orders may no longer apply to thecurrent provisions of Regulation Y. Therefore,reference must be made to the current Regula-tion Y, section 225.28(b)(7)(iv).

3251.0.1 FCM BROKERAGE OFFUTURES CONTRACTS ON AMUNICIPAL BOND INDEX

A bank holding company applied pursuant tosection 4(c)(8) of the BHC Act and section225.23(a)(3) of Regulation Y to engage de novo,through a wholly owned subsidiary located inthe state of New York, to execute and clearfutures contracts on a municipal bond index.The applicant also proposed to offer futuresadvisory services for a separate fee or as anintegrated package of services to futures com-mission merchant customers through thesubsidiary.

The Board had previously approved by regu-lation the activity of executing and clearingfutures contracts on bullion, foreign exchange,U.S. government securities, and money marketinstruments, primarily on the basis that banksmay hold and deal in the underlying cash items.The proposed futures contract on a municipalbond index was based on an index of generalobligation bonds selected by theThe Bond Buyer.The Bond Buyer Municipal Index is composedof 50 tax-exempt municipal revenue and generalobligation bonds chosen on the basis of criteriathat favor recently issued and actively tradedbonds. The index is intended to be an accurateindicator of trends and changes in the municipalbond market. The offering of futures contractsbased on the bond index (broad spectrum ofmunicipal securities) could provide FCM cus-tomers with a more effective tool for hedgingagainst the price risk associated with a portfolioof municipal bonds than any of the existinginterest-rate futures contracts.

Banks are permitted to hold and deal in gen-eral obligation bonds, and they are active par-ticipants in the cash markets for those bonds.Based on these facts, the Board determined thatthe applicant’s proposal was substantially simi-lar to proposals to broker other financial futurespreviously approved by the Board, and was thusclosely related to banking.

With regard to the proposed advisory activi-ties, the Board had previously approved by orderthe provision of advisory services relating toapproved FCM activities (1984 FRB 780). Theapplicant proposed to provide advisory serviceseither for a separate fee or as an integral pack-age of services to FCM customers. The serviceswould include written or oral presentations onthe historical relationship between the cashand futures markets, a demonstration of exam-ples of financial futures uses for hedging, andassistance in structuring a hedging strategy.The applicant would provide these servicesonly to major corporations and other financialinstitutions.

Based on all the facts provided, the Boardconcluded that—

1. the proposed activities by the applicant couldreasonably be expected to produce benefitsto the public;

2. the proposed FCM activities would entailrisks or conflicts of interests different thanthose considered and addressed by the Boardin its approvals of other FCM activities; and

3. the balance of the public-interest factors wasfavorable.

The Board noted, however, that trading of thefutures contract involved in the application hadnot been approved by the Commodity FuturesTrading Commission (CFTC). It therefore con-ditioned its December 21, 1984, approval of theapplication on the CFTC’s approval of the con-tract (1985 FRB 111).

3251.0.2 FCM BROKERAGE OFCERTAIN FUTURES CONTRACTS ONSTOCK INDEXES INCLUDINGOPTIONS

A bank holding company applied, under section4(c)(8) of the BHC Act and section 225.21(a) ofRegulation Y, to engage, de novo through its

BHC Supervision Manual December 1998Page 1

wholly owned futures corporation, in executingand clearing, on major commodity exchanges,futures contracts on stock indexes and optionson such futures contracts. The subsidiary wouldexecute and clear—

1. the Standard & Poor’s 100 Stock Price Indexfutures contract;

2. the Standard & Poor’s 500 Stock Price Indexfutures contract (S&P 500);

3. options on the S&P 500, all of which aretraded on the Index and Option Division ofthe Chicago Mercantile Exchange;

4. the Major Market Index futures contract, cur-rently traded on the Chicago Board of Trade;and

5. the FT-SE 100 Equity Index futures contract,currently traded on the London InternationalFinanced Futures Exchange.

The execution and clearance of stock indexfutures and options traded on major commodityexchanges appeared to be functionally and oper-ationally similar to securities brokerage, permit-ted for bank holding companies under section225.28(b)(6)(i) of Regulation Y. Like municipalbond index futures (an activity proposed by anapplicant which was previously approved byBoard order), these futures contracts are settledin cash and are designed to allow customers tohedge the market risk associated with holdingfinancial assets, in this instance, corporate equitysecurities. The equities represented by the listedindexes were chosen on the basis of criteria thatfavor a combination of securities that wouldaccurately reflect fluctuations in the stockmarket.

The Board approved the application onFebruary 4, 1985, based on the above analysisand on the fact that national banks have beenpermitted toexecuteandclearstock index futures,and options thereon, for the account of custom-ers, through their FCM operations subsidiaries(1985 FRB 251). It also took into considerationthe fact that trust departments of banks havebegun to use stock index futures contracts andoptions on such contracts to hedge the marketrisk facing diversified stock portfolios.

3251.0.3 LIMITED FCMCLEARING-ONLY ANDEXECUTING-ONLY TRADES

A bank holding company (the applicant) applied

for the Board’s permission under section 4(c)(8)of the BHC Act and section 225.23(a)(3) ofRegulation Y to engage de novo in variousFCM activities. The activities were to be con-ducted through its wholly owned FCM subsidi-ary (the company). The FCM activities con-sisted of—

1. executing and clearing, executing withoutclearing, and clearing without executing, asagent for institutional customers, the futurescontracts and options on futures contractslisted in appendix A of the order;

2. executing and clearing as agent for institu-tional customers, through omnibus tradingaccounts with unaffiliated FCMs, the futurescontracts and options on futures contractslisted in appendix B of the order; and

3. providingrelated investmentadvisoryservices.

The applicant proposed to conduct the activitiesthroughout the United States.

The applicant requested authority to conduct,through the company, both execution andclearing activities on the Chicago MercantileExchange (CME) and the Chicago Board ofTrade (CBOT). The company also planned toconduct FCM activities through omnibus cus-tomer trading accounts established in its ownname with clearing members of the exchangeson which the company would not be a member.1

The applicant also sought authority for thecompany to clear trades on the CME and theCBOT that had been executed by unaffiliatedbrokerspursuant to ‘‘give-upagreements.’’Underthe applicant’s proposal, the company wouldnot be the primary clearing member for anynonclearing member on the CBOT and wouldnot qualify any nonclearing member on theCME. The company also planned to executetrades that would be given up for clearance, atthe customer’s request, to an unaffiliated FCM.

The Board had previously determined, byregulation and order, that acting as an FCM inexecuting and clearing all of the proposed finan-cial futures contracts and options on futurescontracts, and providing investment advisoryservices with respect to such contracts, areactivities closely related to banking under sec-

1. An omnibus account is an arrangement between a mem-ber clearing firm of an exchange and a nonmember FCM thatseeks to conduct business on that exchange. Using thisarrangement, the member clearing firm executes and clearstransactions for the nonmember FCM and its customers. Theomnibus account reflects all positions of the FCM’s custom-ers but is divided into separate segments for each customer forthe purposes of calculating margin requirements, reportingcurrent holdings, and other matters.

4(c)(8)—Agency Transactional Services (FCM Board Orders) 3251.0


tion 4(c)(8) of the BHC Act with two excep-tions.2See section 225.28(b)(7)(iv) and (b)(6)(iv)of Regulation Y and the Board orders found at1992 FRB 953, 1991 FRB 64, 1990 FRB 881,and 1990 FRB 554.

On January 9, 1991, the Board denied a bankholding company’s application to engage,through a nonbanking subsidiary, in clearing-only activities related to securities options andother financial instruments. The applicant in thatcase had proposed that its subsidiary primarilyclear, but not execute, trades for professionalfloor traders (primarily market makers and spe-cialists) trading for their own accounts on majorsecurities and commodities exchanges. (See sec-tion 3700.12 and 1991 FRB 189.)

In the 1991 case, the Board was concernedthat, by not engaging in both the execution andclearance of a trade, the nonbanking subsidiarycould not decline transactions that posed unac-ceptable risk. It would have been obligated tosettle each trade entered into by one of its cus-tomers, even if the customer did not have thefinancial resources to honor the obligation. Nomechanism existed by which the nonbankingsubsidiary could contemporaneously monitorthe intra-day trading activities of the floor trad-ers, its primary customers. The Board decidedthat the proposed nonbanking activity exposedthe parent bank holding company to substantialcredit risk. This decision was based on (1) thesubsidiary’s inability to monitor and control therisks to be undertaken and (2) the fact thatclearing agents had to guarantee the financialperformance of their customers to the clearing-houses of the exchanges on which they operate.The public-benefit considerations therefore pre-cluded approval of that application under sec-tion 4(c)(8) of the BHC Act.

The applicant’s proposal differed from the1991 case in several respects. Under the pro-posal, the company would not serve as the pri-mary or qualifying clearing firm for any unaffili-ated customers. Also, the company would clearonly those trades that it executed, or that otherexecuting brokers executed and the companyaccepted for clearance pursuant to a customer’sgive-up agreement. The executing brokers wouldbe independent from the customers and would

have the opportunity to evaluate the trade beforeit was executed.

All of the company’s clearing-only activitieswould be conducted pursuant to give-up agree-ments. Under these give-up agreements andother customer agreements, the company wouldhave the right to refuse to accept for clearanceany customer trade that it deemed unsuitable.The refusal could stem, for example, from con-sideration of market conditions or the custom-er’s financial situation or objectives. Also, theapplicant represented that it would be able torestrict the number and types of positions to beheld by a customer as it deemed reasonable. Thecompany could then refuse to accept trades thatposed unacceptable risks.

The company established a framework forlimiting risk from the clearing-only activities.It would review the creditworthiness of eachpotential customer and, based on the review,approve or reject the customer and establishappropriate limits concerning trading, margin,credit, and exposure limits. The company hadcontrols in place to monitor the intra-day trad-ing activities and risk exposure of its customers.

The Board determined that the credit andother risk considerations associated with theproposed clearing-only activities on the CMEand CBOT were consistent with previousapprovals. The decision was based on (1) theframework for limiting risk from clearing-onlyactivities, (2) the commitments made by theapplicant, and (3) the other facts of record. Afterreviewing other required considerations, theBoard approved the application on May 6, 1993(1993 FRB 723). Approval was subject to thecommitments made by the applicant and theterms and conditions set forth in the order aswell as in other Board orders related to theproposed activities.

3251.0.4 FCM CLEARINGTRANSACTIONS BY PREAPPROVEDEXECUTION GROUPS

A foreign banking organization (the applicant)subject to the provisions of the BHC Act appliedfor the Board’s permission under section 4(c)(8)of the BHC Act and section 225.23(a) of Regu-lation Y to engage de novo in clearing trades ofsophisticated institutional investors relating tocontracts on futures and options on futures.Trades would be cleared through the applicant’smajority-owned clearing subsidiary (the com-

2. The two exceptions are the Deutsche Aktienindex 30Stock Index futures and the German Government Bond Indexfutures contracts traded on the Deutsche Terminborse GmbH.These two contracts had been approved as FCM activitiespursuant to Regulation K. The Board also noted that thesecontracts served the same functions as the futures contractsfor which FCM activities had previously been approved undersection 4(c)(8) of the BHC Act.



pany) on the Chicago Mercantile Exchange(CME) and the Board of Trade of the City ofChicago (CBOT) and executed by nonaffiliatedfloor brokers.

In particular, the applicant proposed to acceptfor clearance customer orders that are executedby preapproved execution groups pursuant to‘‘give-up agreements.’’3 The applicant expectedthat the company would initially provide onlylimited execution services. The company wouldnot be the primary clearing firm for any non-clearing member of the CBOT, and would notqualify any nonclearing member of the CME.

The applicant also sought approval to engagein other FCM and data processing and transmis-sion activities. The applicant committed that thecompany would conduct these activities accord-ing to the provisions and subject to the limita-tions of Regulation Y (section 225.28(b)(7)(iv)and (b)(14)).4 The company also planned toengage in certain other activities that the appli-cant maintained were incidental to its FCM ser-vices. These activities included the managementof institutional-customer funds under its control.The incidental activities would also include pro-viding to institutional customers, on request,general advice about (1) sources of information,(2) the selection and arrangement of an appro-priate execution group, (3) the availability ofcomputer software relating to futures and optionson futures, (4) order-placement alternatives, and(5) cost-reduction methods in the use of futuresand options on futures for hedging purposes.The company committed that it would not pro-vide investment advice relating to futures andoptions on futures or on any other matter notauthorized by the order.

The Board previously denied a proposal inwhich a nonbanking subsidiary of a BHC wouldhave cleared, but not executed, trades for profes-sional floor traders (primarily market makersand specialists) trading for their own account on

major securities and commodity exchanges. (See1991 FRB 189 and section 3700.12.) In thatorder, the Board was concerned that, by notengaging in both the execution and clearance ofa trade, the FCM nonbanking subsidiary couldnot decline transactions that posed unacceptablerisk. It would have been obligated to settle eachtrade entered into by one of its customers, evenif thecustomerdidnothave thefinancial resourcesto honor the obligation. No mechanism existedby which the FCM nonbanking subsidiary couldcontemporaneously monitor the intra-day trad-ing activities of the floor traders, its primarycustomers. The Board decided that the proposednonbanking activity exposed the parent bankholding company to substantial credit risk. Thisdecision was based on (1) the FCM’s inabilityto monitor and control the risks to be under-taken and (2) the fact that the clearing agentshad to guarantee the financial performance oftheir customers to the clearinghouses of theexchanges on which they operate. The public-benefit considerations therefore precludedapproval of that application under section 4(c)(8)of the BHC Act.

The applicant’s proposal differed from theabove-mentioned denied application in variousrespects. In the applicant’s case, the companywould not serve as the primary or qualifyingclearing firm for any broker that executes itsclearing-only trades or for any nonaffiliated cus-tomer. The company would clear only tradesthat it executes, or that other executing brokersexecute and the company accepts for clearancepursuant to the customer’s give-up agreement.

The applicant represented that, under thegive-up agreements, the company would havethe contractual right to refuse a customer’s tradethat exceeded established trading limits thatwere documented in the give-up agreement forthat particular customer. The company wouldhave a period of time within which it coulddetermine if the executed trade was properlyauthorized according to established limits, andcould decide to reject the trade.

The company’s customer base would consistof sophisticated institutional investors. The com-pany would review the creditworthiness andother characteristics of each potential customer.Based on that review, it would approve or rejectthe customer and establish appropriate trading,credit, margin, and exposure limits for the cus-tomer. It would accept for clearance only tradesthat had been executed by preapproved execu-tion groups trading on the CBOT and CME.Company would approve an execution grouponly if the floor brokers, and their primary orqualifying clearing firms, satisfied the com-

3. Under a give-up agreement, the executing floor broker(or give-in broker), pursuant to a customer’s instructions,gives up an executed order for clearance to a clearing memberother than the executing broker’s primary clearing member(or qualifying member). Such agreements are used primarilyto allow institutional customers to select a broker who hassuperior expertise and execution skills with respect to specificcontracts or types of orders, while maintaining their accountsand positions with a clearing firm in which they have financialconfidence.

4. Company would not trade for its own account except(1) to hedge a cash position in the related financial instrumentor (2) to offset or liquidate a clearing error arising in thenormal course of business.



pany’s financial, managerial, and operationalstandards.

The Board decided that the credit and theother risk considerations associated with theproposed nonbanking activities were consistentwith requirements for approval. The decisionwas based on (1) the framework described in theorder; (2) the fact that the company would notbe the primary or qualifying clearing firm forany broker that executed the company’s clearing-only trades, or for any nonaffiliated customer;(3) the other contractual and operational distinc-tions noted between this proposal and the previ-ous denied application (1991 FRB 189); and(4) the other facts of record.

The Board noted that it had recently approvedapplications by two bank-affiliated FCMs toengage in clearing-only activities, also on theCBOT and the CME (1993 FRB 723 and 1993FRB 728). For a brief summary of the initialorder, see section 3251.0.3.

The Board approved the application onAugust 2, 1993 (1993 FRB 961). The approvalwas subject to the facts of record, all the com-mitments made by the applicant, and the limita-tions and conditions stated in the order.

3251.0.5 FCM—EXECUTING ANDCLEARING, AND CLEARINGWITHOUT EXECUTING, FUTURESAND OPTIONS ON FUTURES ONNONFINANCIAL COMMODITIES

A bank holding company (the applicant, a BHCwithin the meaning of the BHC Act) applied forthe Board’s permission under section 4(c)(8) ofthe BHC Act and section 225.3 of the Board’sRegulation Y to act, through a wholly ownedsubsidiary (the company), as a futures commis-sion merchant (FCM) for unaffiliated customersin executing and clearing, and clearing withoutexecuting, futures and options on futures onnonfinancial commodities. Initially, the appli-cant proposed to conduct these activities infutures and options on futures on heating oil,crude oil, corn, wheat, soybeans, cattle, andhogs. The applicant must give at least 20 days’written notice to the Federal Reserve before itengages in FCM activities with respect to addi-tional contracts linked to other physical com-modities, unless other contracts are approvedfor any other bank holding company under theBHC Act.

The company is engaged in executing andclearingonmajorcommoditiesexchanges futuresand options on futures on financial commodi-ties and certain broad-based and widely traded

stock and bond indices.5 The company proposedto engage in its proposed activities on the CBOT,CME, and New York Mercantile Exchange(NYMEX).

The companywill not trade in the proposedderivative instruments for its own account. How-ever, when a customer defaults on a contractafter the termination of futures trading and thecompany is required to make or take delivery ofthe underlying commodity, or when it exercisesits right to liquidate a customer’s account, thecompany is permitted to take the necessaryactions to mitigate its damages. These actionsinclude acting for its own account in retenderingor redelivering the commodity, entering into anexchange-for-physical transaction, or enteringinto an offsetting transaction in the cash market,provided these and other appropriate actions aretaken as soon as practicable.

The company will limit its proposed servicesonly to institutional customers and will not pro-vide such services to retain brokerage custom-ers, locals, or market makers. Approximately10 percent of its business will be conducted onbehalf of managed commodity funds (regulatedby the Commodity Futures Trading Commis-sion (CFTC) and the National Futures Commis-sion). None of the managed funds would beowned, sponsored, advised by, or otherwiseaffiliated with the applicant. The company willnot act as a commodity trading advisor,6 orotherwise provide investment advice on the pro-posed instruments.

The Board had not previously approvedthe execution and clearance by bank holdingcompanies of futures and options on futures onnonfinancial commodities. The Board’s approvalhad been limited to acting as an FCM in theexecution and clearance on major commoditiesexchanges of futures and options on futures on avariety of financial commodities, such as gold

5. See 1985 FRB 970. The company already engages inFCM activities on the Chicago Mercantile Exchange (CME),Chicago Board of Trade (CBOT), Commodity Exchange,London International Financial Futures and Options Exchange,Marche a Terme International de France, and Singapore Inter-national Monetary Exchange.

6. As defined in the Commodities Exchange Act, a com-modity trading advisor includes, with certain exceptions, ‘‘anyperson who, for compensation or profit, engages in the busi-ness of advising others, either directly or through publicationsor writings, as to the value of commodities or as to theadvisability of trading in any commodity for future deliveryon or subject to the rules of any contract market, or who forcompensation or profit, and as part of the regular busi-ness, issues or promulgates analyses or reports concerningcommodities.’’ (7 U.S.C. 2)



and silver bullion and coins, foreign exchange,government securities, certificates of depositand money market instruments that banks maybuy and sell for their own accounts, and stockand bond indices.7

3251.0.5.1 BHC’s Execution andClearance of Futures and Options onFutures on Nonfinancial Commodities

National banks engage in a broad range of FCMactivities involving all types of exchange-tradedfutures and option contracts consisting of finan-cial and nonfinancial commodities for theaccountsofcustomers,and for theirownaccounts,for hedging purposes. The Office of the Comp-troller of the Currency (OCC) reasoned that theclearing process for any futures contract oroption on a futures contract involves essentiallyan extension of credit because, upon receivingan executed order from a customer, the clearingbroker supplies its own credit in an order onbehalf of the customer and then sends the orderto the exchange clearing organization for settle-ment. The OCC also determined that the execu-tion, clearance, and advisory services providedby an FCM to its customers are essentially thesame whether or not the underlying commodi-ties are financial or nonfinancial.

Some national banks act as an FCM in theexecution and clearance of futures and optionson futures on a broad array of financial andnonfinancial commodities. The state ofNew York Banking Department has also permit-ted several New York–chartered banks to engage,to a limited extent, in FCM activities involv-ing derivative instruments on nonfinancialcommodities.

The Board has previously authorized bankholding companies to conduct FCM activitiesinvolving numerous instruments based on finan-cial commodities. The Board determined thatacting as an FCM in connection with contractsinvolving nonfinancial commodities is opera-

tionally and functionally similar to conductingFCM activities with respect to derivative con-tracts involving financial commodities. In bothinstances, the FCM monitors customer creditrisk and trading exposure; assesses and collectsinitial and maintenance margins from custom-ers; and brokers, executes, and clears trades.

Acting as an FCM for derivative instrumentsinvolves functions, skills, risks, and expertisethat are substantially similar to those associatedwith the execution and clearance of financialfutures and option contracts that the Board pre-viously approved. The mechanics of executingand clearing trades are operationally the samewhether thecommodityunderlying theexchange-traded derivative instrument is financial or non-financial. The rules and regulations of the CFTC,as well as the rules, procedures, practices, capi-tal requirements, and safeguards of the variouscommodities exchanges, govern both the execu-tion and clearance of nonfinancial futures andoptions and the execution and clearance of finan-cial futures and options.

In 1991, the Board permitted bank holdingcompanies to provide investment advice on trad-ing futures contracts and options on futures con-tracts in nonfinancial commodities, such as agri-cultural and energy commodities. (See 1991FRB 126.) It concluded that (1) providing invest-ment advice on investing in futures and optionson nonfinancial commodities appeared to bethe functional equivalent of providing advice onfutures and options on futures on financial com-modities and (2) exchange-traded futures andoptions on futures involving nonfinancial com-modities were essentially financial instruments.

The Board concluded, based on an analysis ofthe range of FCM activities currently existing inbanking (as summarized above and cited in theorder), that the activity of acting as an FCM inthe execution and clearance of futures and optionson futures on nonfinancial commodities, as pro-posed by the applicant, is an activity that isclosely related to banking for the purposes ofthe BHC Act.

3251.0.5.2 FCM’s Execution andClearance of Futures and Options onFutures on Nonfinancial Commodities

The Board noted that both the company and thecommodities exchanges on which the proposedFCM activities would be conducted are subjectto regulatory oversight by the CFTC. The com-pany’s trading and clearance activities wouldalso be subject to regulation and review by theCFTC and the commodities exchanges. The

7. See section 225.28(b)(7)(iv) of Regulation Y (12 C.F.R.225). See also 1985 FRB 251, 1985 FRB 111, 1977 FRB 951,and 38Federal Register27,552 (1973). The applicant’s pro-posed clearing without execution activities were approved in1993 (FRB 723–728). The company proposed to conduct itsclearing-only activities subject to the same conditions andlimitations set forth in these Board orders, including the use ofthe ‘‘give-up agreement’’ by and among the company, itscustomers, and the nonaffiliated executing FCM that allowsthe company to refuse to clear trades that exceed specifiedrisk parameters.



applicant committed to conduct the proposedactivities subject to the same rules and proce-dures the Board imposed on FCM activities inderivatives of financial commodities, includingprohibitions on extending credit to customersfor the purpose of meeting margin requirements.The applicant committed to take several furthersteps in the event that one of the company’scustomers has an open position in a contractafter futures trading is ceased, and the customeris not willing or is unable to make or takedelivery. Based on the commitments made bythe applicant for conducting the proposed activi-ties, the limitations on the activities cited in theorder, and all the facts on record, the Boardapproved the application on September 28, 1993,subject to all the terms and conditions set forthin the order and the noted Board regulations andorders that relate to the proposed activities. (See1993 FRB 1049.)

3251.0.6 FCM AND RELATEDADVISORY SERVICES FOR OPTIONSON EUROTOP 100 INDEX FUTURESAND THE ONE-MONTH CANADIANBANKER’S ACCEPTANCE FUTURES

A foreign bank (the applicant) subject to theprovisions of the BHC Act applied for theBoard’s permission under section 4(c)(8) of theBHC Act and section 225.23 of Regulation Yfor its section 20 subsidiary (the company) toact as an FCM for and provide advisory servicesto nonaffiliated persons, in connection with thepurchase and sale of futures and options onfutures contracts that are based on bonds orother debt instruments; certain commodities; orstock, bond, or commodity indices. The appli-cant proposed contracts that were not previouslyconsidered by the Federal Reserve System:options on Eurotop 100 Index futures, to betraded on the Commodity Exchange, Inc. (Euro-top contracts), and the one-month CanadianBanker’s Acceptance Futures, to be traded onthe Montreal Exchange (banker’s acceptancefutures). These contracts are based on a finan-cial instrument or a broad-based financial indexand are comparable to contracts previously con-sidered by the Federal Reserve System. Theyhave essentially the same terms and serve thesame functions as futures and options contractsfor which FCM and related advisory serviceshave been approved by the Board under section4(c)(8) of the BHC Act. The Board concludedthat the skills necessary to engage in providingFCM and futures advisory services are the same

as those used to provide such services withregard to previously approved contracts. TheBoard thus approved the applicant’s provisionof these FCM and related advisory services forthese contracts by the company, concluding thatthe activity is closely related to banking withinthe meaning of section 4(c)(8) of the BHC Act.(See 1995 FRB 188–189.)

3251.0.7 FCM TRADING FOR ITSOWN ACCOUNT IN FUTURES,OPTIONS, AND OPTIONS ONFUTURES CONTRACTS BASED ONCERTIFICATES OF DEPOSIT OROTHER MONEY MARKETINSTRUMENTS

A foreign bank (the applicant) subject to theprovisions of the BHC Act applied for theBoard’s permission under section 4(c)(8) of theBHC Act and section 225.23 of Regulation Yfor its section 20 subsidiary (the company) totrade as an FCM in all futures, options, andoptions on futures contracts based on certificatesof deposit or other money market instrumentsthat are permissible investments for nationalbanks. The Board had previously authorizedcompany to trade for its own account, for pur-poses other than hedging, in futures, options,and options on futures contracts based on U.S.government securities that are permissible invest-ments for national banks and in similar con-tracts based on certain money market instru-ments. (See 1991 FRB 759.) In that order, theBoard noted that trading in these contracts wouldrequire a market judgment on interest rates. Itwas noted that banks, through their core lendingand funding activities, had developed expertisein judging interest-rate and price movements.For those reasons, and because that proposalwould not authorize company to trade in deriva-tive contracts based on securities or instrumentsthat a state member bank could not purchase forits own account, the Board determined the trad-ing activity to be closely related to bankingunder section 4(c)(8) of the BHC Act.

The Board concluded that its reasoning in the1991 order could be applied currently to thisexpanded 1994 proposal. The Board noted thatthe Office of the Comptroller of the Currencyhad determined that trading in futures and optionscontracts based on bank-eligible securities orinstruments is an activity that is within the



legally authorized powers of national banks(OCC Interpretive Letter No. 494 (December20, 1989)). The Board thus concluded that theproposed trading activity is conducted by banksand is so operationally and functionally similarto activities conducted by banks that banks areparticularly well-equipped to engage in theactivity. It therefore concluded that trading forone’s own account, for purposes other thanhedging, in futures, options, and options onfutures contracts based on certificates of depositor other money market instruments that are per-missible investments for national banks is anactivity that is closely related to banking withinthe meaning of section 4(c)(8) of the BHC Act.(See 1995 FRB 190.)

3251.0.8 FCM ENGAGING INCOMMODITY AND INDEX SWAPTRANSACTIONS AS ANORIGINATOR, PRINCIPAL, AGENT,BROKER, OR ADVISOR

A foreign bank (the applicant) subject to theprovisions of the BHC Act applied for theBoard’s permission under section 4(c)(8) of theBHC Act and section 225.23 of Regulation Yfor its section 20 subsidiary (the company) toengage in FCM activities and in acting as anoriginator, principal, agent, broker, or advisorwith respect to swaps and swap-derivative prod-ucts and over-the-counter option transactionsbased on certain commodities; stock, bond, orcommodity indices; or a hybrid of interest ratesand these commodities or indices (commodityand index swap transactions).8 Except for cer-tain advisory services, the Board had not deter-mined whether these proposed activities areclosely related to banking under section 4(c)(8)of the BHC Act. The Board had determined, byorder or regulation, that acting as an originator,principal, broker, agent, or advisor with respectto interest-rate and currency swaps and swap-derivative products relating thereto (financialswap transactions) are activities closely relatedto banking and are thus permissible for bankholding companies. (See Regulation Y, section225.28(b)(6) and 1993 FRB 345.)

The applicant anticipates that the section20 subsidiary’s swap transactions will be basedon a variety of stock and bond indices, similarto those previously approved in connection withproposed FCM activities (or to a speciallytailored basket of securities selected by theparties) (index transactions), or they could bebased on precious metals and energy productsor related commodity indices (commoditytransactions). They also could include hybridtransactions that are based on a combina-tion of interest rates and such indices orcommodities.

Commodity and index swap transactions areoperationally, structurally, and functionally simi-lar to financial swap transactions. Both types ofswaps involveprivatelynegotiatedfinancial trans-actions. The parties involved in the transactionagree to exchange specified payment streamsover a specific period of time, based on a prede-termined formula. For an interest-rate swap, thebasic structure is an exchange between twocounterparties of the payment streams that ariseout of different interest payment obligations,calculated on the basis of an agreed-uponnotional principal amount. With the commodityor index swap transaction, the parties exchangepayment streams based on a notional principalamount and the prices of certain commodities orthe value of or returns on certain securities orindices of securities, or on a combination ofthese and other measures such as interest rates.For both types of swap transactions, the partiesenter into these contracts to meet various com-mon investment objectives, including takingpositions in the market for the underlying assetsfor investment purposes, limiting one’s expo-sure to market uncertainties and future pricefluctuations, and preserving principal while par-ticipating in the potential returns of a particularfinancial market or economic sector. Since aswap transaction is negotiated between parties,the economic terms of the transaction (includingthe duration of the contract; notional principalamount; method of calculating and frequency ofpayments; and underlying assets, rates, or indi-ces upon which the payments are to be deter-mined) can be individually tailored to meet spe-cific financial goals and risk sensitivities of thecounterparty.

National banks have been authorized by theOCC to engage in activities that involve matchedand unmatched commodity and index swaptransactions (including related swap-derivativeproducts and over-the-counter options). The NewYork State Banking Department also approvedthese activities for state-chartered banks underits jurisdiction. In addition, the Board permits

8. The proposed activities are subject to the same commit-ments relating to interest-rate and currency swap transactionsand related swap-derivative products. (See 1993 FRB 345.)



statememberbanks toenter intoperfectlymatchedcommodity and index swap transactions, pro-vided the transactions are consistent with theirstate charters. Further, the Federal Reserve Bankof New York, acting under delegated authority,has approved proposals by state member banksto engage in such activities on an unmatchedbasis. (See 12 C.F.R. 208.128.)

For the foregoing reasons and based on thefacts of record, the Board determined thatengaging in commodity and index swap trans-actions is an activity conducted by banks. TheBoard also considered the similarities betweenthese transactions and the financial swap trans-actions noted above, as well as the fact thatbanks and other intermediaries play a similarrole in financial swap transactions and commod-ity and index swap transactions. It was notedthat all of these contracts represent forms offinancial intermediation that banks have histori-cally engaged in. Based on all the facts onrecord, the Board concluded that these proposedactivities are closely related to banking undersection 4(c)(8) of the BHC Act.

As noted previously, the company also pro-poses to provide advisory, agency, and broker-age services with respect to commodity andindex swap transactions. The Board believesthat the authority of banks to conduct theseactivities could be implicit in or incidental totheir authority to engage in the transactions asprincipal. In its analysis, the Board noted thatbanks can develop a familiarity and expertise asto the structure and economic effects of thesetransactions, which should well equip them toprovide the intended advisory, agency, and bro-kerage services. National banks have beenexpressly authorized to provide advisory, execu-tion, and other services with respect to exchange-traded futures and options on futures contractsbased on financial and nonfinancial commodi-ties. (See OCC Interpretive Letter No. 494.) Theexchange-traded transactions are used for pur-poses similar to the over-the-counter transac-tions for which the applicant proposes that thecompany render advisory, agency, and broker-age services. The pricing bases for, economiceffects of, and risk presented by the two types oftransactions are also similar in importantrespects.

Based on the facts on record, the Board deter-mined that the proposed advisory, agency, andbrokerage services are activities conducted bybanks or are operationally and functionally simi-lar to such activities. Thus, they are closelyrelated to banking under section 4(c)(8) of theBHC Act. (See 1995 FRB 190–191.)

3251.0.9 FCM TRADING IN FUTURES,OPTIONS, AND OPTIONS ONFUTURES CONTRACTS BASED ONCOMMODITIES OR ON STOCK,BOND, OR COMMODITY INDICESFOR ITS OWN ACCOUNT

A foreign bank (the applicant) subject to theprovisions of the BHC Act applied for theBoard’s permission under section 4(c)(8) of theBHC Act and section 225.23 of Regulation Yfor its section 20 subsidiary (the company) toengage intrading for its own accountfor pur-poses other than hedging in futures, options, andoptions on futures contracts based on certaincommodities or on stock, bond, or commodityindices—transactions thathavenotbeenexpresslyauthorized for banks. The instruments to betraded are generally the same as those previ-ously approved by the Board in consideringFCM and futures advisory activities of bankholding company subsidiaries, such as crude oilfutures, Standard & Poor’s 500 Stock PriceIndex futures, and municipal bond index futures.(See 1993 FRB 1,049 and 1994 FRB 151 andalso SR-93-27 (refer to Appendix A).) Theapplicant proposes to engage in FCM activitiesand go beyond furnishing those FCM and relatedadvisory services and seeks the Board’s permis-sion for the company to trade these instrumentsfor its own account. Such activities include arbi-trage operations, market making for customer-accommodation purposes, and proprietary trad-ing (taking positions for investment purposes),as well as hedging transactions.

The proposed activities could consist ofexchange-traded instruments that could be basedon commodities such as crude oil, providingfor delivery of the underlying commodity uponexpiration of the contract. The applicant con-firmed that it does not intend to take deliveryof such commodities but plans to take severalactions to avoid delivery of commodities otherthan precious metals. These actions includeclosing positions in expiring contracts duringtrading periods and engaging in exchange-for-physical transactions after trading closes. TheBoard stipulated, as a condition of approval,that the applicant could not take delivery of thecommodities, except in unusual circumstances.Whenever delivery is taken, the applicant isrequired to notify the Federal Reserve Systemand divest itself of the commodity promptly.The Board views the contracts as financialinstruments, despite the possibility that trading



in such contracts can result in the delivery andownership of commodities that banking organi-zations are generally not permitted to hold. TheBoard also noted, with respect to the proposedexchange-traded transactions that are based onan index of securities or commodities, that(1) the transactions would be settled in cash and(2) they would not provide for the delivery ofthe underlying securities or commodities.

The Board had not previously approved thistrading activity, with respect to the instrumentsproposed, for bank holding companies or theirsubsidiaries under section 4(c)(8) of the BHCAct. The Board has, however, authorized actingas an FCM and providing advisory serviceswith respect to the instruments to be traded. TheBoard also approved similar trading with respectto instruments based on U.S. government securi-ties and money market instruments. (See 1991FRB 759.) With respect to section 20 nonbanksubsidiaries, the Board has recognized the util-ity of trading in these instruments to hedgemarket exposure resulting from other tradingactivities, indicating that these bank holdingcompany subsidiaries may engage in such risk-management transactions as a necessary inci-dent to their underwriting and dealing activities.(See 1994 FRB 449.) No federal bank regula-tory authority had expressly permitted banks totrade in the proposed instruments for their ownaccounts for purposes other than hedging.

The Board believes that the proposed tradingactivities are closely related to banking. It notedthat banks engage in activities with respect tothe instruments in question that are similar to orrelated to the proposed trading activities andthat they engage in trading activities for thesame purposes with respect to similar instru-ments, includingexchange-tradedcontractsbasedon bank-eligible securities and instruments andover-the-counter transactions based on com-modities and various indices.

The Board further noted that banking organi-zations have substantial experience withexchange-traded derivative transactions basedon commodities or on commodity or securitiesindices. It also noted important similaritiesbetween the proposed instruments and transac-tions that have been authorized for banks fornonhedging purposes. Moreover, the Boardbelieves that the risks inherent in the proposedtrading activities are similar to those that areexperienced by banks that engage in swaps andother permissible transactions; hence, the pro-posed transactions require analytical skills; risk-

management policies, procedures, and tech-niques; and computer and operations systemssimilar to those used by banks for engaging inthose permissible transactions. Based on thisreasoning, the Board determined the proposedactivity to be closely related to banking undersection 4(c)(8) of the BHC Act. The Board’sDecember 23, 1994, approval is subject to allthe facts of record, all the commitments made inconnection with the application, and the condi-tions cited in the order. (See 1995 FRB 185.)These include adhering to future supervisory orexamination policies and guidance issued by theBoard for a banking organization’s derivativesbusiness, including policies or guidance withrespect to customer transactions, trading andmarketing practices and policies, and relatedsystems and controls.

3251.0.10 APPENDIX A—PREVIOUS PRIOR-APPROVALREQUIREMENTS FOR BANKHOLDING COMPANIES PROPOSINGTO ENGAGE IN FCM ACTIVITIES

In May 1993, the Board reduced the prior-approval requirements for bank holding compa-nies proposing to engage in certain futurescommission merchant (FCM) activities. (SeeSR-93- 27.) First, the Board delegated to ReserveBanks its authority to approve proposals bybank holding companies to act as an FCM inexecuting and clearing any futures contract on afinancial commodity or stock or bond index thatthe Board has previously approved, on anyBoard-approved exchange. The Board also del-egated to Reserve Banks its authority to approveproposals by bank holding companies to act asan FCM or commodity trading advisor in pro-viding investment advisory services for previ-ously approved financial instruments.

In addition, the Board modified and, in cer-tain cases, eliminated the prior-approval require-ment for bank holding companies seeking to actas an FCM for additional financial instrumentsor to act as an FCM on additional exchanges inwhich the bank holding company already hasFederal Reserve System approval to engagegenerally in FCM activities. Any bank holdingcompany that had previously received approvalto act as an FCM under either Board order or theformer sections 225.25(b)(18) and (b)(19) ofRegulation Y could act as an FCM subject tocertain limitations and conditions. Theserequirements were replaced by the April 1997RegulationYrevisionatsection225.28(b)(7)(iv).



3251.0.11 PROVIDINGDISCRETIONARY PORTFOLIOMANAGEMENT SERVICES ONFUTURES AND OPTIONS ONFUTURES ON FINANCIALCOMMODITIES

A foreign bank (the applicant), a bank holdingcompany within the meaning of the BHC Act,applied under section 4(c)(8) of the act to engagethrough company in providing discretionary port-folio management services with respect toexchange-traded futures and options on futureson financial commodities.9 The provision of dis-cretionary portfolio management services, withrespect to futures and options on futures onfinancial commodities, had not been previouslyconsidered by the Board as to whether it isclosely related to banking under section 4(c)(8)of the act.

In providing discretionary management ser-vices, company would manage customers’accounts and purchase and sell in its sole dis-cretion exchange-traded futures and optionson futures on financial commodities for suchaccounts. Company would provide discretion-ary management services in combination withproviding futures commission merchant (FCM)transactional services and would only providesuch services to institutional customers.10 Com-pany would not act as a counterparty on cus-tomer transactions or trade these instruments forits own account. In addition, company wouldnot purchase or sell over-the-counter contractsfor accounts over which it exercises discretion.

The Board has permitted bank holding com-pany FCMs and commodity trading advisors toprovide investment advice with respect tofutures and options on futures on financial andnonfinancial commodities. (See Regulation Y,section 225.28(b)(6) and 1994 FRB 151.) Thebank holding company argued that discretionarymanagement is a normal manner of providinginvestment advice to institutional customers.Indeed, the Board permits bank holding compa-nies to act as discretionary portfolio managersas part of providing investment advisory andfull-service brokerage services with respect to

securities. (SeeRegulationY, section225.28(b)(6)and (b)(7)(i).) In addition, the Office of theComptroller of the Currency permits nationalbanks to engage in discretionary funds manage-ment with respect to futures and options onfutures.11

The applicant also indicated that companywould provide the proposed futures-related dis-cretionary portfolio management services inaccordance with the limitations and conditionsthat would be imposed if company were provid-ing portfolio management services in the securi-ties context. In this regard, the applicant com-mitted that company would only provide theproposed discretionary portfolio managementservices to institutional customers and only atthe request of such customers.

The applicant also indicated that it wouldhave a fiduciary relationship with all customersto whom it provides the proposed discretionarymanagement services and has committed thatcompany would comply with applicable law,including fiduciary principles. As one method ofmeeting its fiduciary obligations, the bank hold-ing company committed that company wouldobtain the consent of customers before engag-ing, as principal or agent, in a transaction inwhich any affiliate of company acts as principalin futures or options on futures transactions onthe customer’s behalf. Company and its affili-ates also agreed not to share any confidentialinformation concerning their respective custom-ers without the consent of the customer. In addi-tion, the applicant stated that company wouldexercise its discretionary management authorityonly in purchasing and selling exchange-tradedinstruments. Therefore, concerns surroundingover-the-counter instruments, such as the poten-tial for abuses due to the lack of price transpar-ency, were not presented by the proposal.

For these reasons, the Board concluded thatproviding discretionary portfolio managementservices with respect to futures and options onfutures on financial commodities is closely relatedto banking and a proper incident to banking forpurposes of section 4(c)(8). The application wasapproved by the Board on February 9, 1995.(See 1995 FRB 386.)

9. The bank holding company also proposed to engage in avariety of data processing, securities, futures, and foreignexchange–related activities through company and another sub-sidiary. The Board previously has determined by order orregulation that these activities are closely related to banking.The bank holding company committed to conduct these activi-ties in accordance with the conditions established by theBoard in Regulation Y and prior orders.

10. Company would provide these services to commoditypools but would not become a commodity pool operator.

11. See OCC Interpretive Letter No. 494 (December 20,1989).



3251.0.12 FCM EXECUTION,CLEARANCE, AND ADVISORYSERVICES FOR CONTRACTS ONFINANCIAL AND NONFINANCIALCOMMODITIES FORNONINSTITUTIONAL CUSTOMERS

A foreign banking organization (the notificant)subject to the provisions of the Bank HoldingCompany Act (BHC Act) provided notice undersection 4(c)(8) of the BHC Act (12 U.S.C.1843(c)(8)) and section 225.23 of the Board’sRegulation Y (12 C.F.R. 225.23) of its proposalthat its indirect U.S. subsidiary (the indirectsubsidiary)12 acquire certain assets and assumecertain liabilities of a company.13 The notificantwould engage indirectly in FCM execution,clearance, and advisory activities with respect tofutures and options on futures on financial andnonfinancial commodities14 and in buying andselling foreign exchange in the spot, forward,and over-the-counter options markets on theorder of investors as riskless principal.15 TheBoard had previously determined by order andregulation that the above proposed activities areclosely related to banking within the meaning ofsection 4 of the BHC Act.16

3251.0.12.1 Providing FCM Services toCertain Sophisticated NoninstitutionalCustomers

First, the notificant proposed that the indirectsubsidiary would provide FCM execution, clear-ance, and advisory services with respect to con-tracts on both financial and nonfinancial com-modities to persons that do not qualify asinstitutional customers but who trade futuresand options on futures solely to hedge risksarising from their business activities (noninstitu-tional commercial hedger customers), such asfarmers. The Board has limited bank hold-ing companies to providing nonfinancialcommodities–related FCM services only to in-stitutional customers. Similarly, with respect tocontracts on financial commodities, the Board

12. The indirect subsidiary is wholly owned by the notifi-cant. The indirect subsidiary engages in various futures com-mission merchant, foreign-exchange, and securities-relatedactivities. See 1994 FRB 646 and 649.

13. The acquired firm was a clearing member of certainfinancial and nonfinancial commodities exchanges. The FBOstated that the indirect subsidiary would become a clearingmember of those exchanges. In addition, that subsidiary wouldprovide FCM services with respect to two exchange-tradedcontracts that had not previously been approved by the Board(heating oil crack-spread options and gasoline crack-spreadoptions) and would purchase and sell through the use ofomnibus account arrangements certain futures and options onfutures on nonfinancial commodities traded on two otherexchanges.

14. These activities include providing execution-only andclearing-only services to customers. See 1993 FRB 723 and1994 FRB 151.

15. The indirect subsidiary would provide the proposedriskless-principal services only to institutional customers,except that it would provide such services to certain noninsti-tutional customers when they direct it to convert funds fromone currency to another to trade futures and options on futurescontracts. Foreign exchange–related advisory services wouldnot be provided to these noninstitutional customers.

16. See 12 C.F.R. 225.28(b)(7)(iv) and 225.28(b)(6) and1990 FRB 649 (1990).



has not permitted bank holding companies toprovide execution-only or clearing-only ser-vices to noninstitutional customers and only per-mits bank holding companies to provide advi-sory services to financially sophisticatedcustomers that have significant dealings in theunderlying commodities.17

The indirect subsidiary’s noninstitutional com-mercial hedger customers would be engaged orwould be affiliated with a commercial enterprisethat is engaged in producing, manufacturing,processing, or merchandising products or in pro-viding services that are related to the com-modities underlying the futures and options onfutures contracts in which the customers wouldtrade. The noninstitutional commercial hedger-customers would not be engaged in executingtheir own trades on the floor of any commodi-ties exchanges. The notificant stated that theindirect subsidiary would require noninstitu-tional commercial hedger customers to state inwriting that they would only engage in ‘‘bonafide hedging transactions,’’ as defined by theCommodity Futures Trading Commission(CFTC).18 In addition, an initial credit-reviewprocess will be established to determine whethera noninstitutional commercial hedger custom-er’s proposed hedging activities are appropriatein light of the customer’s net worth and businessactivities. The indirect subsidiary will not per-mit noninstitutional commercial hedger custom-ers to trade in any commodities other than thosethat the customer would trade to hedge risksfrom its commercial activities, and it wouldestablish a system to detect any unauthorizedtrading activities.

By limiting transactional services and adviceto areas in which the customer has specialexpertise, the proposed limitations address theconcern that the customer would rely undulyon the bank holding company’s advice or thatthe customer would be unable to detect conflictsof interest or advice that is motivated by thebank holding company’s self-interest. More-over, the notificant will abide by all the otherlimitations designed to more specifically addressthe potential risks that may result from provid-

ing clearing-only and execution-only services tothese customers.

3251.0.12.2 Foreign-Exchange Activities

Second, in connection with the proposal that theindirect subsidiary will buy and sell foreignexchange on the order of customers as risklessprincipal, the notificant proposed that the indi-rect subsidiary be permitted to purchase and sellforeign exchange for its own account for limitedpurposes while also providing foreign-exchange-related execution and advisory services.19 Inseveral limited circumstances, the Board haspermitted a bank holding company to provideforeign-exchange-related transactional and advi-sory services in a subsidiary that purchases andsells foreign exchange for its own account.20

For example, the Board has permitted bankholding companies to provide foreign-exchange-related advice and transactional services througha subsidiary engaged in purchasing and sellingforeign exchange for its own account to hedgepositions in permissible interest-rate or currency-swap transactions or to hedge risks arising fromthe permissible securities underwriting and deal-ing activities of the subsidiary.21

The indirect subsidiary will take positions inforeign exchange only as a means to hedgefinancial-statement translations of income for itsforeign parent and as necessary for the paymentof invoices denominated in foreign currencies.It would not enter into a foreign-exchange trans-action for its own account with a customer if thecustomer is receiving foreign-exchange servicesrelating to such transaction from this subsidiary.The notificant committed that the indirect sub-sidiary will observe the standards of care andconduct applicable to fiduciaries with respect toits foreign-exchange-related advisory activitiesand will provide foreign-exchange-relatedexecution and advisory services only to institu-

17. See 1993 FRB 1049 and 12 C.F.R. 225.25(b)(19) (con-tracts on financial commodities). These limitations addressconcerns that, in futures transactions, unsophisticated custom-ers may place undue reliance on investment advice receivedfrom a banking organization and may not be able to detectinvestment advice that is motivated by the advisor’s self-interest. Similarly, in cases involving clearing-only transac-tions, the limitation helps address the added risk to the bankholding company that results from its more limited ability toreview and reject trades that have been executed throughanother FCM.

18. See 17 C.F.R. 1.3(z).

19. The indirect subsidiary currently provides foreign-exchange-related execution and advisory services to its cus-tomers. In permitting bank holding companies to provideforeign-exchange execution and advisory services on a com-bined basis, the Board has relied on the representation that thesubsidiary providing the foreign-exchange-related serviceswould not purchase or sell foreign exchange for its ownaccount.

20. The Board also previously has noted that in conductingforeign-exchange operations, commercial banks combine thefunctions of giving advice, executing transactions, and takingpositions in foreign exchange.

21. See 1994 FRB 157 and 1993 FRB 892.



tional customers. The notificant also committedthat the indirect subsidiary’s personnel engagedin purchasing and selling foreign exchange forits own account will not have access to informa-tion about the foreign-exchange trading activi-ties of customers and that customer representa-tives will not have access to information aboutthe foreign-exchange activities of personnelengaged in purchasing and selling foreignexchange for the indirect subsidiary’s ownaccount.22

3251.0.12.3 Board’s Decision on theProposed FCM Activities

Based on the foregoing and all the facts ofrecord, the Board approved the notification sub-ject to all the terms and conditions set forth inthe order and in the above-noted Board regula-tions and orders that relate to these activities.The Board’s determination is subject to all theterms and conditions set forth in the Board’sRegulation Y, including those in sections 225.7and 225.23(b). The Board’s decision is specifi-cally conditioned on compliance with all thecommitments made. The notice was approvedon July 14, 1995 (see 1995 FRB 880).

3251.0.13 FCM SERVING AS APRIMARY CLEARING FIRM FOR ALIMITED NUMBER OF FLOORTRADERS AND BROKERAGESERVICES FOR FORWARDCONTRACTS ON FINANCIAL ANDNONFINANCIAL COMMODITIES

A foreign banking organization and its parentholding companies (the notificants), bank hold-ing companies within the meaning of the BankHolding Company Act, requested the Board’s

approval under section 4(c)(8) of the BHC Act(12 U.S.C. 1843(c)(8)) and section 225.23 of theBoard’s Regulation Y (12 C.F.R. 225.23) toacquire all the voting securities of a company(the company) and thereby engage in a widerange of nonbanking activities, includingsecurities- and derivatives-related activities. Thecompany and its principal subsidiary (the sub-company) engage worldwide in a wide range ofinvestment advisory, securities underwriting, andfutures-related activities. The notificants pro-posed to merge the subcompany and the com-pany into the notificants’ existing nonbank sec-tion 20 company (the section 20 company). Thesection 20 company would continue as a regis-tered broker-dealer with the Securities andExchange Commission under the SecuritiesExchange Act of 1934 and as a member of theNational Association of Securities Dealers. Thesection 20 company would also become regis-tered as a futures commission merchant (FCM)and a commodity trading advisor (CTA).23

The notificants proposed to engage in a vari-ety of FCM-related activities the Board previ-ously had determined, by regulation or order,were so closely related to banking as to beproper incidents thereto within the meaning ofsection 4(c)(8) of the BHC Act. The proposedactivities included engaging in execution-only,clearing-only, and omnibus account activitieswith respect to futures and options on futuresbased on financial and nonfinancial commodi-ties, and providing discretionary portfolio man-agement services with respect to futures andoptions on futures on financial and nonfinancialcommodities.24 (See 1997 FRB 138–142.) Thesection 20 company committed to providingthese futures-related execution-only, clearing-only, and discretionary portfolio managementservices only to institutional customers and cer-tain sophisticated noninstitutional commercialhedger customers.25

3251.0.13.1 Primary Clearing Firm for aLimited Number of Professional FloorTraders

The notificants also proposed that the section 20

22. To address potential conflicts of interest in connectionwith providing the proposed foreign-exchange riskless-principal services, the notificant committed that the indirectsubsidiary will disclose to each customer that receives advicerelating to over-the-counter transactions in the foreign-exchange market that it may have an interest as a counterpartyprincipal in the course of action ultimately chosen by thecustomer. Also, in any case in which the indirect subsidiaryhas an interest in a specific over-the-counter foreign-exchangetransaction as counterparty principal, it will advise its cus-tomer of that fact before recommending participation in thattransaction.

23. The subcompany was already registered as an FCMand CTA.

24. The notificants committed that the section 20 companywould provide these services in accordance with the limita-tions previously established by the Board. See 1993 FRB 723,1993 FRB 1049, and 1994 FRB 151.

25. The notificants stated that all noninstitutional commer-cial hedger customers would meet the requirements previ-ously reviewed by the Board. See 1995 FRB 880.



company provide clearing-only services to, andserve as the primary clearing firm for, certainprofessional floor traders on two exchanges withrespect to the futures contracts and options onfutures contracts traded on such exchanges.26

The Board previously has determined that pro-viding clearing services with respect to exchange-traded securities, options, futures, and optionson futures contracts is closely related to bankingwithin the meaning of section 4(c)(8) of theBHC Act. In 1991, however, the Board deniedan application by the notificants to engage denovo in providing the proposed services to anunlimited number of market makers and otherprofessional floor traders dealing for their ownaccounts.27

In the 1991 order, the Board recognized that acompany serving as the primary clearing firmfor professional floor traders may be exposed tosignificant financial risks because the companygenerally would not have the ability to reject anexecuted trade presented to it for clearance,even when the company believes the trade pre-sents unacceptable risks in light of market con-ditions or the traders’ financial position. TheBoard also noted that, at the time of the 1991application, the applicants lacked appropriateoperational systems to track and manage theintraday risks arising from the trading activitiesof the floor traders. This lack of a mechanism tomonitor intraday trading activities presented thepossibility that a professional floor trader couldincur substantial losses through the trading ofoptions or futures contracts, which the appli-cants would be obligated to clear and guarantee,before the applicants could act to mitigate theircredit-risk exposure.

It was noted that since 1991, the Board andbank holding companies have gained substantialexperience with the conduct, methods, proce-dures, and regulation of clearing-only activities.Also, since 1991, the Board had authorized bankholding companies to provide clearing-only ser-vices with respect to futures contracts and optionson futures contracts for customers other thanprofessional floor traders, subject to certain con-

ditions designed to ensure that the bank holdingcompanies have the ability to manage the atten-dant financial risks.28

The Board concluded that the facts of recordindicated that the subcompany had and the sec-tion 20 company would have sufficient risk-management policies, procedures, and systemsto permit the notificants and the section 20company to adequately monitor and control therisks, including the intraday risks, associatedwith the section 20 company’s proposal to serveas the primary clearing firm for a limited num-ber of professional floor traders on the twoexchanges. Specifically, the section 20 companywould use the subcompany’s established trad-ing, credit, margin, and exposure limits for eachprofessional floor trader for which the sec-tion 20 company serves as the primary clearingfirm. Adherence to these limits is monitored onan intraday basis by experienced personnel whoare physically present on the floor of the twoexchanges. These personnel visually monitorthe trading activities of floor traders on theexchanges and review trades submitted by thefloor traders for clearance.29 If an employee ofthe section 20 company determines that a floortrader is exceeding the limits it has established,or is otherwise engaged in questionable tradingactivities, the employee would have the ability

26. A primary clearing firm is obligated to accept and clearall trades submitted by a professional floor trader, even if thetrade was initially presented to, and rejected by, anotherclearing firm. Once a primary clearing firm clears a trade for aprofessional floor trader, the firm becomes obligated to settlethe trade in the event of a default by the professional floortrader. The company served as the primary clearing firm forprofessional floor traders on the two exchanges. The notifi-cants requested authority for the section 20 company to act asthe primary clearing firm for up to 20 professional floortraders on one exchange and 40 professional floor traders onthe other.

27. See 1991 FRB 189.

28. In particular, the bank holding companies agreed toprovide the clearing-only services pursuant to ‘‘give-up’’agreements, which provide the bank holding companies withthe right to refuse to accept for clearance any customer tradethat the bank holding company deems unsuitable in light ofmarket conditions or the customer’s financial situation orobjective. In addition, the bank holding companies agreed toestablish procedures to monitor the intraday trading activitiesand risk exposure of their clearing-only customers.

29. The Board recognizes that trades on the two relevantexchanges are not electronically submitted to the clearing firmor the exchange. Instead, trading cards for each trade aresubmitted by each professional floor trader to its clearing firm,which enters the trade into the exchange’s clearing system.Both exchanges require that the subcompany collect the trad-ing cards from each floor trader at least once during eachhalf-hour period, thereby providing the subcompany person-nel with an opportunity to review the intraday trading activi-ties of floor traders. The rules of one exchange also requirethat thesubcompanyenterall collected trades into theexchange’son-line clearing system within 45 minutes of the end of thehalf-hour period during which the trades were collected. Thatexchange’s on-line clearing system also permits the subcom-pany to monitor the trading activities of floor traders, bothindividually and in the aggregate, on an intraday basis, andallows the subcompany to identify any potentially unmatchedtrades. Although the other exchange does not operate anon-line clearing system, the subcompany personnel maintaintally sheets that are updated every 30 minutes and reflect alltrades submitted by each professional floor trader throughoutthe day.



to limit or halt the floor trader’s activities,require the floor trader to post additional mar-gin, partially or entirely liquidate the floor trad-er’s positions, or immediately revoke the floortraders membership on the exchange.30 Thenotificants’ operations managers on the twoexchanges also would personally guarantee thesection 20 company against any losses that itmay incur from serving as the primary clearingfirm for floor traders on the exchanges, therebyproviding such personnel with an incentive toclosely monitor the trading activities of the floortraders. The notificants also stated that the sec-tion 20 company would install an on-line risk-management system that would provide its per-sonnel with intraday data on the trading activitiesof the professional floor traders, and the abilityto analyze its exposure to such trading activitieson an intraday basis.

The Board noted that the type of risk-management systems necessary to appropriatelymanage the risks arising from a particular activ-ity necessarily depends on the scope and natureof the proposed activity. In this regard, theBoard noted that the section 20 company pro-posed to serve as the primary clearing firm foronly a limited number of professional floor trad-ers on two exchanges. These exchanges haverelatively small trading areas and volumes, whichpermit personnel on the floors of the exchangesto monitor trading activity. The Board noted thatthe Federal Reserve Bank had conducted anon-site operational and managerial infrastruc-ture review used by the subcompany to monitorand control the financial risks associated with itsprimary clearing activities on the two exchanges.Based on that review and other facts of record,the Board concluded that the subcompany hadthe managerial and operational resources andsystems to adequately monitor and control thefinancial risks arising from its role as primaryclearing firm on the two exchanges.

The Board also noted that approval of theproposal could reasonably be expected to pro-duce public benefits. Specifically, the Boardnoted that the subcompany served as the pri-mary clearing firm for a significant percentageof the professional floor traders on the twoexchanges and that the notificants’ proposalwould permit the section 20 company to con-

tinue providing primary clearing services tosuch professional floor traders.

In light of all the facts of record, includingthe limited nature of the section 20 company’sproposed clearing-only activities for profes-sional floor traders, the commitments providedby the notificants, and the operational and mana-gerial systems that the section 20 company willhave in place to monitor and control the risksarising from the proposed activities, the Boardconcluded that the credit and other risk consid-erations associated with the proposed clearing-only activities for professional floor traders onthe two exchanges are consistent with approvalof this notice and that, therefore, the proposedactivity is a proper incident to banking withinthe meaning of section 4(c)(8) of the BHC Act.

3251.0.13.2 Brokerage Services withRespect to Forward Contracts Based onCertain Financial and NonfinancialCommodities

The notificants also proposed that the section 20company act as broker with respect to forwardcontracts based on certain financial and nonfi-nancial commodities. In this capacity, the com-pany would assist customers in arranging for-ward contracts with third parties pursuant towhich the customers would make (or receive)delivery of financial and nonfinancial commodi-ties on a future date.31 The section 20 companywould act as a broker only with respect toforward contracts that are based on those finan-cial and nonfinancial commodities that also serveas the basis for an exchange-traded futures con-tract.32 The Board recognized that banking regu-lators had not expressly permitted banks toengage in the proposed activity.

Bank holding companies are permitted to actas a broker in the execution and clearance offutures contracts and options on futures con-tracts based on financial and nonfinancial com-modities.33 As noted above, the forward con-tracts that the section 20 company proposed tobroker would be based on the same financialand nonfinancial commodities that underliefutures contracts that bank holding companies

30. The subcompany’s risk-management personnel alsoelectronically receive trade information from the two exchangesup to four times a day. Reports based on such data areprepared by risk-management personnel and reviewed daily.

31. Because the section 20 company will act only as abroker, the section 20 company will not itself be requiredto take physical delivery of the nonfinancial commoditiesunderlying the forward contracts that it arranges under anycircumstances.

32. Exchange-traded futures contracts may be based on awide variety of commodities, including precious metals, oil,cocoa, or wool.

33. See 1993 FRB 1049.



are permitted to broker as an FCM. Bank hold-ing companies also are permitted to broker for-ward contracts on foreign exchanges and arrangeswap transactions that are based on nonfinancialcommodities or indices of nonfinancial com-modities.34 Accordingly, based on these andother facts of record, the Board concluded thatacting as a broker for forward contracts basedon those financial and nonfinancial commodities

that underlie an exchange-traded futures con-tract is a permissible activity for bank holdingcompanies under section 4(c)(8) of the BHCAct.

3251.0.13.3 Conclusion

Based on all the facts of record, the Boardapproved the notice subject to all the terms andconditions discussed in the order and in thesection 20 orders, as modified by the modifica-tion orders. (See 1997 FRB 138.)34. See 1995 FRB 185.



Section 4(c)(8) of the BHC Act—Agency Transactional Services forCustomer Investments (Other Transactional Services)Section 3255.0

With the adoption of the April 1997 revision toRegulation Y, the Board authorized certain typesof other transactional services in section225.28(b)(7)(v). Bank holding companies canprovide to customers asagenttransactional ser-vices with respect to swaps and similartransactions—

1. any transaction that is described in section225.28(b)(8) of the regulation;

2. any transaction that is permissible for a statemember bank; and

3. any other transaction involving a forwardcontract, option, futures, option on a futuresor similar contract (whether traded on anexchange or not) relating to a commoditythat is traded on an exchange.

Under this provision of the current rule, abank holding company can provide transac-tional services for customers involving anyderivative or foreign-exchange transaction thatthe bank holding company is permitted to con-duct for its own account (item 1 above). A bankholding company may also act as a broker withrespect to forward contracts based on a financialor nonfinancial commodity that also serves asthe basis for an exchange-traded futures con-tract. This permits a bank holding company toact as agent in a forward contract that involvesthe same commodities and assessment of riskthat underlie the permissible FCM activities ofbank holding companies. This authority is notextended to forward contracts for the delayedsale of commercial products (such as automo-biles, consumer products, etc.) or real estate.

Before the incorporation of the above transac-tions into the authority of Regulation Y, suchactivities had been previously approved indi-vidually by Board order. This section provides,as historical examples, summaries of suchactivities that were previously approved by Boardorder. Such orders led to the incorporation of thenonbanking activity into the April 1997 Regula-tionY ‘‘laundry list.’’Thereaderof theseexamplesshould only consider the current provisions for‘‘other transactional services’’ as found in sec-tion 225.28(b)(7)(v) of Regulation Y. Thereshould be no reliance on previous Board ordercommitments, supervisory policies, and inter-pretations that relate to this nonbanking activitythat were in existence before April 21, 1997,unless such provisions remain. Certain formerprovisions or commitments may no longer beapplicable.

3255.0.1 BROKERING OPTIONS ONSECURITIES ISSUED ORGUARANTEED BY THE U.S.GOVERNMENT AND ITS AGENCIESAND OPTIONS ON U.S. ANDFOREIGN MONEY-MARKETINSTRUMENTS

A bank holding company applied for the Board’sapproval under section 4(c)(8) and section225.21(a) of the Board’s Regulation Y to engagede novo, through a wholly owned indirect sub-sidiary, in certain futures commission merchantand broker-dealer activities. One of the activi-ties proposed for Board approval consisted ofengaging in brokerage activities with respect tooptions on certain physicals, that is, securitiesissued or guaranteed by the U.S. governmentand its agencies and U.S. and foreign money-market instruments. The Board concluded thatan option on a physical appears to serve thesame function as other instruments in that itoffers the investor a means to hedge portfoliorisk. The Board had previously approved appli-cations to engage in discount securities broker-age for retail customers with respect to corpo-rate securities, and had added discount securitiesbrokerage to the list of permissible nonbankingactivities for bank holding companies generally.As a broker for options on physicals, it wasstated that the indirect subsidiary would actsolely as agent on behalf of nonaffiliated per-sons for the purchase and sale of options.1 Theservices performed by a broker of options on theproposed securities appeared to be similar tothose of other brokers. The Board thus con-cluded on December 8, 1983, that the proposalwas closely related to banking (1984 FRB 238).

3255.0.2 BROKERING OPTIONS INFOREIGN CURRENCY ONEXCHANGES REGULATEDBY THE SEC

A BHC applied for the Board’s approval undersection 4(c)(8) of the BHC Act and section225.21(a) of the Board’s Regulation Y to engage

1. A broker of options on U.S. government and agencysecurities and options on money market instruments is asecurities broker under the securities laws.


de novo, through a wholly owned subsidiary, inexecuting and clearing options in foreign cur-rency. The Board referenced its approval to aprevious order regarding the brokering of optionson certain financial physicals (see subsec-tion 3255.0.1 above). The Board concluded thatits rationale for this prior action was equallyapplicable to the brokerage of options in foreignexchange. The Board noted that the applicanthad been active in the cash and forward marketsfor foreign currency and had the expertise toprovide the proposed services to customers. TheBoard concluded on March 19, 1984, that, in themanner proposed, the applicant’s proposal tobroker options in foreign currency was closelyrelated to banking (1984 FRB 368).

In considering the potential for adverse effects,the Board took into account and relied on theregulatory framework established pursuant tolaw by the SEC for the trading of options. Inaddition, the Board noted that the applicantwould not trade any of the options involved forits own account.

3255.0.3 EXECUTING ANDCLEARING CFTC-REGULATEDOPTIONS ON BULLION ANDFOREIGN EXCHANGE ONAUTHORIZED COMMODITYEXCHANGES

A BHC applied for the Board’s approval undersection 4(c)(8) of the BHC Act and section225.21(a) of the Board’s Regulation Y to engagede novo through its wholly owned subsidiary inexecuting and clearing options. As part of that

request, the BHC requested the Board to approvethe executing and clearing of CFTC-regulatedoptions on bullion and foreign exchange onauthorized commodity exchanges. In making adetermination that the activity was closely relatedto banking, the Board noted—

1. that it previously determined the brokeringof futures and options on futures in bullionand foreign exchange to be a permissiblenonbanking activity under the former section225.25(b)(18) of Regulation Y (currently sec-tion 225.28(b)(7)(iv));

2. that options on physicals serve essentiallythe same function as futures and options onfutures; and

3. that the brokering of options on certain physi-cals, that is,U.S.governmentsecurities,moneymarket instruments, and options on foreigncurrency regulated by the SEC, is closelyrelated to banking (1984 FRB 368, see sub-section 3255.0.2, above).

TheBoarddetermined that theproposedCFTC-regulated options on physicals are functionallyand operationally comparable devices for hedg-ing investment-portfolio risk. The Board alsodetermined that the applicant’s proposal wassubstantially similar to proposals to engage inoptions activities previously approved by theBoard. It noted that the applicant had beenactive in the cash and forward markets for bul-lion and foreign currency and that it possessedthe expertise to provide the proposed services tocustomers. The Board therefore concluded theactivity to be closely related to banking andapproved the application on June 5, 1984, in themanner proposed (1984 FRB 591).

4(c)(8)—Agency Transactional Services for Customer Investments (Other Transactional Services) 3255.0


Section 4(c)(8) of the BHC Act—Investment Transactionsas Principal Section 3260.0

Under Regulation Y, a bank holding companymay engage in—

1. underwriting and dealing in government obli-gations and money market instruments (seesection 3260.0.1),

2. certain investing and trading activities asprincipal, and

3. buying and selling bullion and relatedactivities.1

A bank holding company may engage or tradeas principal in the following:

1. foreign exchange2. forward contracts, options, futures, options

on futures, swaps, and similar contracts,whether traded on exchanges or not, basedon any rate, price, financial asset (includinggold, silver, platinum, palladium, copper, orany other metal approved by the Board),nonfinancial asset, or group of assets, otherthan a bank-ineligible security,2 if—a. a state member bank is authorized to

invest in the asset underlying the contract;b. the contract requires cash settlement;c. the contract allows for assignment, termi-

nation, or offset prior to delivery or expi-ration, and the company—(1) makes every reasonable effort to avoid

taking or making delivery of the assetunderlying the contract; or

(2) receives and instantaneously transferstitle to the underlying asset, by opera-tion of contract and without taking ormaking physical delivery of the asset;or

d. the contract does not allow for assign-ment, termination, or offset prior to deliv-ery or expiration and is based on an assetfor which futures contracts or options onfutures contracts have been approved fortrading on a U.S. contract market by theCommodity Futures Trading Commission,and the company—(1) makes every reasonable effort to avoid

taking or making delivery of the assetunderlying the contract; or

(2) receives and instantaneously transferstitle to the underlying asset, by opera-

tion of contract and without taking ormaking physical delivery of the asset

3. forward contracts, options,3 futures, optionson futures, swaps, and similar contracts,whether traded on exchanges or not, basedon an index of a rate, a price, or the value ofany financial asset, nonfinancial asset, orgroup of assets, if the contract requires cashsettlement

Before the incorporation of these activitiesinvolving investment transactions as principalinto the authority of Regulation Y, certain of theactivities had been approved individually byBoard order. Following the Board’s adoption ofthe April 1997 revised Regulation Y, a bankholding company can continue to trade in for-eign exchange and bank-eligible securities. Bankholding companies, however, are no longerrequired to have a separate subsidiary to provideadvice to customers when engaging in tradingactivities as principal.

This section provides, as historical examples,summaries of such activities that were previ-ously approved by Board order. Such ordersmay have led to the incorporation of the non-banking activity into the April 1997 RegulationY ‘‘laundry list.’’ The reader of these examplesshould only consider the current regulatory pro-visions as currently found in section 225.28(b)(8)of Regulation Y. Only minimum reliance shouldbe placed on previous Board order commit-ments, supervisory policies, and interpretationsthat relate to this nonbanking activity that werein existence before April 21, 1997, unless suchprovisions remain currently. Certain formerprovisions or commitments may no longer beapplicable.

3260.0.1 UNDERWRITING ANDDEALING IN GOVERNMENTOBLIGATIONS AND MONEYMARKET INSTRUMENTS

A bank holding company may engage in under-writing and dealing in obligations of the UnitedStates, general obligations of states and their

1. A bank holding company is authorized to buy, sell, andstore gold, silver, copper, platinum, and palladium bullion,coins, bars, and rounds, and any other metal approved by theBoard.

2. See sections 3260.0.4.6 and 3920.0.

3. This does not include acting as a dealer in options basedon indexes of bank-ineligible securities when the options aretraded on securities exchanges. These options are securitiesfor purposes of the federal securities laws.


political subdivisions, and other obligations thatstate member banks of the Federal Reserve Sys-tem may be authorized to underwrite and deal inunder 12 U.S.C. 24 and 355. This activity includesbanker’s acceptances and certificates of deposit,under the same limitations as would be applica-ble if the activity were performed by the bankholding company’s subsidiary member banks orits subsidiary nonmember banks as if they weremember banks. See Regulation Y, section225.28(b)(8)(i) and section 3240.0.

3260.0.2 FOREIGN EXCHANGE

A bank holding company may engage as princi-pal in foreign exchange. See Regulation Y, sec-tion 225.28(b)(8)(ii)(A).

3260.0.3 DEALING IN GOLD, SILVER,PLATINUM, AND PALLADIUMBULLION AND COINS

On September 27, 1973, the Board approved aforeign banking organization’s request to acquire30 percent of the voting shares of a domesticcompany engaged in the trading and arbitrage ofgold and silver bullion on various exchangesand in the open market. The subsidiary is enabledto participate in the domestic gold bullion mar-ket under 12 U.S.C. 24 (para. 7), which specifi-cally authorized national banks to deal in bullion.

The Board found that buying and selling goldand silver bullion and silver coin, dealing inexchange and silver futures, and arbitraginggold and silver in markets throughout the worldare activities closely related to banking or man-aging or controlling banks. Thus, in approvingthe application, the Board maintained its basicposition that it will benefit the public to allowforeign banks to engage in U.S. activities on anondiscriminatory basis. (See 1973 FRB 775.)

In another case, a BHC applied for the Board’spermission to engage in certain activities relatedto dealing in gold and silver bullion. The activi-ties consisted of (1) buying and selling gold andsilver bullion, bars, rounds, and bullion coinsfor its own account and the account of others;(2) financing the production, refining, and fabri-cation of gold and silver, including lending andborrowing gold and silver in connection withsuch financing; (3) arbitraging gold and silver inmarkets throughout the world; and (4) providingvarious incidental services for customers, such

as arranging for the safe custody, assaying, andshipment of gold and silver.4

The Board determined previously that manyof the proposed activities are permissible forBHCs. A BHC may engage in the purchase andsale of gold and silver for its own account andfor the account of others.5 The Board believedthe assaying and arranging for transport to bepart of this activity.6 Financing activities for theproduction and fabrication of gold and silver arepermissible activities. (See section 225.28(b)(1)of Regulation Y—Extending credit and servic-ing loans.) The Board approved the applicationby order on November 24, 1986 (1987 FRB 61).(See SR-87-7.)

In a subsequent case, a foreign banking orga-nization presented its application to the Board,pursuant to section 4(c)(8) of the BHC Act,requesting permission to engage in the activity,through its wholly owned subsidiary, of pur-chasing and selling platinum coins issued by theCanadian and Australian governments as legaltender. The subsidiary would acquire the plati-num coins issued by the Canadian and Austra-lian governments solely for the purpose ofeffecting distribution. It would maintain an inven-tory of the coins. However, it would not pur-chase the coins for investment or speculation forits own account or offer its customers invest-ment advice regarding their purchase and sale. Itwould enter into forward contracts with its cus-tomers. In considering the BHC’s application,the Board noted that the Office of the Comptrol-ler of the Currency had authorized nationalbanks to purchase and sell platinum coins andthat the proposed activities were operationallyand functionally similar to purchasing and sell-ing gold and silver coins. The Board found thepurchasing and selling of platinum coins thatfunction as legal tender to be closely related tobanking. The related application was approvedon June 25, 1990 (1990 FRB 681).

In a more recent case, a foreign bank subjectto the provisions of the BHC Act applied for the

4. The applicant further notified the Board of its intentionto purchase and sell for its own account options, futures, andoptions on futures on gold and silver bullion. The applicantcommitted to take positions in these investments only as ameans of hedging its position in the underlying commodity,that is, gold and silver. The activity was thus permissibleunder section 4(c)(1)(C) of the BHC Act, which allows BHCsto furnish services to or perform services for such BHCs or itsbanking subsidiaries.

5. See 1986 FRB 345, 1986 FRB 146, 1985 FRB 467, and1981 FRB 635.

6. The Board allowed another BHC to provide storagefacilities, weighing, coin-counting, and transportation servicesfor bullion and coin. (See 38 Fed. Reg. 27,552 (1973).)

Section 4(c)(8) of the BHC Act—Investment Transactions as Principal 3260.0


Board’s permission under section 4(c)(8) of theact and section 225.23 of Regulation Y for itssection 20 subsidiary to trade platinum coin andbullion for its own account. The Office of theComptroller of the Currency has determinedthat a national bank may engage in this activity.(See OCC Interpretive Letter No. 553, May 2,1991, relying, in part, on the fact that severalcountries had recently introduced platinum coins.)The Board had not previously determined thatthis activity was closely related to bankingunder section 4(c)(8) of the act. As stated previ-ously, it had determined that the purchase andsale of platinum coins that function as legaltender is an activity that is closely related tobanking. (See 1994 FRB 346 and 1990 FRB681.) The Board had also approved as a non-banking activity, under Regulation K, trading inplatinum by bank holding company subsidiarieslocated abroad (1994 FRB 177 and 1990 FRB552). On the basis of these decisions, the Boardconcluded that the proposed activity is closelyrelated to banking. (See 1995 FRB 190.)

With respect to palladium, a bank holdingcompany applied for the Board’s approval undersection 4(c)(8) of the act and section 225.23 ofthe Board’s Regulation Y (12 C.F.R. 225.23) toengage de novo through a wholly owned asset-management subsidiary that will be establishedto serve as the general partner of limited partner-ships (the partnerships) for investing in a widevariety of commodities and exchange-traded andover-the-counter instruments, including tradingin precious metals. The partnerships would tradeand invest in coin and bullion consisting of suchprecious metals as palladium, platinum, gold,and silver.

The Board has previously determined that itis closely related to banking under the act forbank holding companies to trade in all theinstruments and commodities it proposed for thepartnerships, except palladium.7 Banks currentlyare permitted to engage in palladium trading.8Therefore, the Board concluded that trading pal-ladium coin and bullion is closely related tobanking within the meaning of section 4(c)(8)of the act.

3260.0.4 ENGAGING AS PRINCIPALIN DERIVATIVES INVOLVINGFINANCIAL ASSETS ANDNONFINANCIAL ASSETS ORGROUPS OF ASSETS

A bank holding company may engage as princi-pal in forward contracts, options, futures, optionson futures, swaps, and similar contracts, whethertraded on exchanges or not, based on any rate,price, financial asset, nonfinancial asset, or groupof assets, other than a bank-ineligible security.A financial asset includes gold, silver, platinum,palladium, copper, and any other metal approvedby the Board. See Regulation Y, section225.28(b)(8)(ii)(B).

3260.0.4.1 Trading for a Company’sOwn Account in Futures, Options, andOptions on Futures Based on U.S.Government Securities and CertainMoney Market Instruments

A foreign bank, subject to the provisions of theBHC Act, applied to the Board under section4(c)(8) and section 225.23 of the Board’s Regu-lation Y to engage through a wholly ownedsubsidiary in trading activities for its own account.The trading included futures, options, and optionson futures based on U.S. government securitiesthat are permissible investments for nationalbanks (bank-eligible securities) andcertainmoneymarket instruments.9

The Board had previously determined thatBHCs could purchase derivative instrumentsbased on government securities for the purposeof reducing interest-rate exposure. (See 12 C.F.R.225.142, Statement of Policy Concerning BankHolding Companies Engaging in Futures, For-ward, and Option Contracts on U.S. Govern-ment and Agency Securities and Money MarketInstruments.) Previously, the Board approvedapplications to trade in derivative instrumentsbased on foreign exchange for the company’sown account for other than hedging purposes.(See 1989 FRB 217.) Section 225.28(b)(7)(iv)and 225.28(b)(6)(iv) of Regulation Y detail aBHC’s ability to act as futures commission mer-chant and to offer advice with regard to futures

7. See 12 C.F.R. 225.28(b)(6)(iv), 1987 FRB 61 (tradinggold and silver bullion and coin), and 1995 FRB 190 (tradingplatinum coin and bullion for a BHC’s own account).

8. See OCC Interpretive Letters Nos. 683 (1995) and 553(1991).

9. See 1991 FRB 759 for a listing of the derivative instru-ments to be traded, which are listed in appendix A. Thesubsidiary would hedge its positions in these instruments withthe instruments listed in appendix B of the order.



and options on futures on bank-eligible securi-ties, respectively.

The purchasing and selling of derivativeinstruments that represent the right to purchaseand sell bank-eligible securities is considered bythe Board to be closely related to banking.10 Theexperience gained by banks in dealing with thesecurities underlying these instruments wouldequip the banks to trade in instruments based onthese securities. In addition, the derivativeinstruments based on money market instrumentsrequire a market judgment on interest rates.Banks have developed an expertise in such judg-ments through their lending and funding activi-ties. The Board thus concluded on July 12,1991, the activity of trading for a company’sown account in derivative instruments based onbank-eligible securities and certain money mar-ket instruments to be closely related to banking.(See 1991 FRB 759).

3260.0.4.2 Dealing as a RegisteredOptions Trader on Foreign-ExchangeOptions

A foreign bank subject to the BHC Act appliedunder section 4(c)(8) of the act to deal, throughits wholly owned U.S. subsidiary, as a registeredoptions trader (trader) on foreign-exchangeoptions. As a trader, the subsidiary would act asdealer and market maker in such options toassist in the maintenance of a ‘‘ fair and orderly’’market on the designated exchange. A traderdeals for its own account in order to maintain a‘‘ fair and orderly’’ market in certain optionswhen a lack of price continuity or temporarydisparity exists on options for which the tradermakes a market. The subsidiary would be obligedto make a market in the proposed foreign-currency options, or bid and offer, for all traderswho approach it on the designated exchange.The subsidiary would not be obliged in any wayas to the price and quantity it bids and offers. Atrader is permitted to ‘‘ leave the floor,’’ that is,not trade, if it meets minimum trading levelseach quarter.

The Board previously recognized that foreign-exchange activities have traditionally been con-ducted at banks and are permissible activities

under the BHC Act.11 The Board noted that theOffice of the Comptroller of the Currency autho-rized national banks to deal in foreign-currencyoptions as a trader on a securities exchange. Italso noted that through bank participation in theinterbank market for foreign-currency options,banks developed experience in dealing, marketmaking, and risk management, which are deemedessential elements of the activities proposed.For these reasons and the facts presented in theBHC’s application, the Board approved the non-banking activity as being closely related tobanking. The application was approved by theBoard on July 30, 1990 (1990 FRB 776).

3260.0.4.3 Acting as a Specialist inOptions on Foreign Exchange

A foreign bank subject to the BHC Act appliedfor the Board’s approval under section 4(c)(8)of the act (12 U.S.C. 1843(c)(8)) and section225.21(a) of the Board’s Regulation Y (12 C.F.R.225.21(a)) for its wholly owned subsidiary (thecompany) to act as the sole specialist in deut-sche mark options on a specified exchange (theexchange). As a specialist, the subsidiary wouldact as a dealer and market maker in theseoptions for the purpose of assisting in the main-tenance of a fair and orderly market on theexchange.

The Board found the activity of engaging as aspecialist in foreign-currency options on theexchange to be closely related to banking forpurposes of section 4(c)(8) of the BHC Act.Banks provide services that are operationallysimilar to the activities proposed. The Boarddeemed banking organizations to be particularlywell equipped to provide the proposed activi-ties. The Board believes that banks possess sub-stantial experience in dealing in foreign exchangeand related services that are similar to the func-tions involved in the BHC’s proposed specialistactivity. Foreign-exchange activities were notedas having been traditionally conducted by banksthat are major participants in all aspects of theforeign-exchange markets. Banks act as marketmakers in various currencies. Banks trade fortheir own account as well as for their customersin virtually all foreign-exchange markets andinstruments, including trading in foreign-currency options on regulated exchanges, asproposed by this BHC applicant.

The Board believes the financial risk in thiscase to be sufficiently minimized since (1) therules of the exchange allow the specialist to set

10. The applicant was not authorized to purchase deriva-tive instruments based on securities or instruments that a statemember bank may not purchase for its own account.

11. See 1989 FRB 217, 308, and 580.



the price and quantity that it will buy and sell inorder to limit its risk in an adverse or volatilemarket; (2) the specialist is prohibited fromspeculating; and (3) the BHC has committed notto write unhedged options, having developedsubstantial experience with hedging from itsexisting foreign-currency and options business.The company will be a registered broker-dealerwith the Securities and Exchange Commission(SEC) and will thus be subject to the SEC’s netcapital rule. The Board expects that the com-pany will maintain capital adequate to supportits activity and to cover reasonable expensesand losses at all times.

The Board considered its earlier decision(1986 FRB 141) to deny a proposal to act as aspecialist in French franc options on the exchange,summarized insection3700.8.TheBoardbelievesthat the facts and circumstances in this casewere different in several significant respectsfrom the current situation. The current proposaldid not raise the issues relating to potentialconflicts of interest and risk raised by the earlierdecision (1986 FRB 141). The markets for deut-sche marks and deutsche mark options are moreliquid than they were for French francs at thattime. Further, the market for foreign-currencyoptions has broadened significantly on theexchange, and the involvement of commercialbanks in that market has become more wide-spread. The Board approved the BHC’s applica-tion by order on June 22, 1989. (See 1989 FRB580.)

3260.0.4.4 Acting as a Dealer, Brokerwith Respect to Interest-Rate andCurrency Swaps and Related Transactions

A bank holding company applied pursuant tosection 4(c)(8) of the BHC Act and section225.23(a) of the Board’s Regulation Y for itswholly owned subsidiary to engage de novoin—

1. intermediating in the international swap mar-kets by acting as originator and principalin interest-rate swap and currency-swaptransactions;

2. acting as an originator and principal withrespect to certain risk-management productssuch as caps, floors, and collars, as well asoptions on swaps, caps, floors, and collars(swap-derivative products);

3. acting as a broker or agent with respect to theforegoing transactions and instruments; and

4. acting as an adviser to institutional custom-ers regarding financial strategies involving

interest-rate and currency swaps and swap-derivative products.

The Board has permitted bank holding com-panies under section 4(c)(8) of the act to pro-vide advice in connection with interest-rate andcurrency swaps, interest-rate caps, and similartransactions.12 (See 1987 FRB 59 and 1989 FRB308.) However, the Board had not previouslyapproved the remaining activities proposed undersection 4(c)(8) of the act. The Board determinedthat the remaining activities proposed are closelyrelated to banking for the reasons summarizedbelow.

Intermediating in the International Swap Mar-ket; Acting as an Originator and Principal withRespect to Certain Risk-Management Products—Caps, Floors, Collars, and Options on Swaps,Caps, Floors, and Collars

1. Banks, in particular, the money center banks,do conduct the proposed intermediation

12. Swap terminology:Interest-rate swap. An exchange between two counterpar-

ties of different payment streams arising out of fixed-rateand floating-rate payment obligations. The exchange is madeusing the same currency and is calculated by reference to amutually agreed-upon ‘‘ notional’’ principal amount.

Currency swap. An exchange between two counterpartiesof a fixed-rate interest obligation in one currency for a fixed-rate interest obligation in another currency. Currency swapsmay involve an initial physical exchange of principal at anagreed-upon current exchange rate or an exchange of interestpayments in different currencies on an agreed-upon notionalamount with no actual transfer of principal. In either case,there will be periodic exchange of fixed-rate interest paymentsover the course of the swap. Upon maturity, there would be are-exchange of the original principal amounts.

Cap. An agreement under which one party purchases fromthe other a promise to pay, at predetermined future times, theexcess, if any, of a specified floating interest rate over a fixedper annum rate. Caps may be sold separately or packaged withan interest-rate swap.

Floor. An agreement under which one party purchases apromise by another to pay the amount, if any, by which aspecified floating interest rate is lower than a fixed per annumrate at specified times during the life of the agreement. Floorsmay be sold separately or packaged with an interest-rateswap.

Collar. The simultaneous sale of a cap and purchase of afloor, or purchase of a cap and sale of a floor.

Agent or broker in swap market. An agent or broker in theswap market locates, for a fee, a suitable counterparty for aparty seeking to enter into a swap agreement.

Intermediary in swap market. A party that is willing to stepbetween the two parties of a swap agreement and act as aprincipal counterparty with each of the other participants, thustaking on the credit risk of each of the participants. Uponentering into a swap with one counterparty, the intermediaryenters into an equivalent and offsetting swap with anothercounterparty.



activities within the international swap market.2. Banks have participated in the swap markets

for several years as end-users, entering intoswaps and purchasing swap-derivative prod-ucts in order to hedge other business risks orto match assets and liabilities.

Acting as a Broker or Agent with Respect toThese Transactions and Instruments

1. Banks provide services that are operationallysimilar to the proposed activities.

2. The Board had previously determined thatacting as a broker with respect to foreign-exchange forward transactions is closelyrelated to banking since banks have histori-cally engaged in the provision of assistancewith respect to foreign exchange. (See 1983FRB 221.) Currency swaps are very similarto foreign-exchange forward transactions. Theprimary difference is the exchange of interestrates in connection with currency swaps.Interest-rate swaps are similar to currencyswaps in that they involve agreements toexchange different payment streams that ariseout of a prescribed principal amount. Simi-larly, caps, floors, and collars involve agree-ments to pay an amount by reference to aprescribed interest rate.

The Board approved the application on June26, 1989 (see 1989 FRB 582), subject to thecommitments included in the order to minimizethe potential risk (that is, credit, price, basis,portfolio, and operations risk) and the possibleconflicts of interest.

3260.0.4.5 Currency Swaps for Hedginga BHC’s Own Position in ForeignCurrency

A foreign bank, subject to section 4 of the BHCAct, applied for the Board’s permission to acquire,through its wholly owned subsidiary, all theshares of a company located in New York, NewYork. The acquired company would engage inseveral nonbanking activities. One of the activi-ties, not previously approved by the Board forBHCs, consisted of entering into currency-swaptransactions for hedging the BHC’s own posi-tion in foreign currency. The Board previouslyfound that banks engage in this activity and thusconcluded that the activity is closely related to

banking.13 In conducting this activity, the appli-cant is to use the same policies, quantitativelimitations, and internal controls and audit pro-grams applicable to its trading in futures, options,and options on futures and similar contractsused for hedging, including the guidelines in theBoard’s policy statement.14 The application wasapproved on August 15, 1990 (1990 FRB 860).

3260.0.4.6 Derivative Transactions asPrincipal (Commodities UnderlyingDerivative Contracts)

On June 27, 2003, the Board amended section225.28 of Regulation Y (12 C.F.R. 225.28(b)(8)(ii)(B)), effective August 4, 2003, topermit bank holding companies (BHCs) to enterinto commodity derivative contracts (commod-ity contracts) that are settled by the BHC receiv-ing and transferring title to the underlying com-modity instantaneously, by operation of contract,without taking physical possession of the com-modity. The Board also modified the existingcondition in Regulation Y that generally pre-vented BHCs from engaging as principal in aphysically settled commodity contract unless thecontract specifically provides for assignment,termination, or offset before delivery (the con-tractual offset requirement).

The restrictions in Regulation Y that wereeffective before August 4, 2003, were designedto reduce the potential that BHCs would becomeinvolved in and bear the risks of physical pos-session, transport, storage, delivery, and sale ofbank-ineligible commodities. These restrictionsensured that the commodity derivatives businessof a BHC was largely limited to acting as afinancial intermediary that facilitates transac-tions for customers who use or produce com-modities or are otherwise exposed to commodity-price risk as part of their regular business.

The former Regulation Y derivatives restric-tions, however, impeded the ability of BHCs toparticipate substantially in certain derivativesmarkets. Notably, in some over-the-counter(OTC) forward markets (U.S. energy markets,for example), the physically settled derivativecontracts traded by market participants do notspecifically provide for assignment, termination,or offset prior to delivery and, thus, did notconform to the contractual offset requirement of

13. See 1989 FRB 582.14. Statement of Policy Concerning Bank Holding Compa-

nies Engaging in Futures, Forward and Options Contracts onU.S. Government and Agency Securities and Money MarketInstruments. See 12 C.F.R. 225.142 (establishing guidelinesfor trading in forward, futures, and option contracts on finan-cial instruments).



Regulation Y. Moreover, participants in thesemarkets generally settle contracts by tempo-rarily taking and making delivery of title to theunderlying commodities and, thus, did not com-ply with the requirement in Regulation Y thatthe BHC make every reasonable effort to avoidtaking or making delivery of the asset under-lying the contract (the delivery avoidancerequirement).

Financial intermediary participants in thesemarkets generally enter into back-to-backderivative contracts with third parties that effec-tively offset each other. That is, financial inter-mediaries in these markets that enter into acontract to buy, for example, a certain numberof barrels of oil from a certain counterparty in acertain future month generally also will enterinto another contract, before the expiration ofthe original contract, to sell the same number ofbarrels of oil to another counterparty in thesame future month on substantially identicaldelivery terms. These market practices typicallyresult in the creation of a chain of contractualrelationships that begins with a commodity pro-ducer, passes through a number of intermediar-ies who have entered into matched contractsboth to buy and sell the same commodity at thesame future time, and ends with a purchaser thatintends to take physical delivery of the com-modity. On the maturity date of the derivativecontracts, the producer will be responsible formaking physical delivery, and the ultimate buyerwill be responsible for accepting physical deliv-ery, while each intermediate participant in thechain will be deemed, by operation of contract,to have instantaneously received and transferredlegal title to the commodity.

The Board believes that a BHC that takes titleto a commodity on an instantaneous, pass-through basis takes no risk that is greater than ordifferent in kind from the risk that the BHC hasas a holder of a commodity derivative contractthat met the former requirements of RegulationY. Instantaneous receipt and transfer of title to(but not physical possession of) commoditiesdoes not appear to involve the usual activitiesrelating to, or risks attendant on, commodityownership. Instead, such transactions involvethe routineoperations functionsofpassingnotices,documents, and payments—functions that BHCsregularly perform in their role as financial inter-mediaries in other markets. Moreover, althoughBHCs that receive and transfer title to commodi-ties on an instantaneous, pass-through basis facedefault risks, they are not significantly differentthan the default risks associated with cash-settled derivative contracts or derivative con-tracts that include the assignment, termination,

or offset provisions previously required by Regu-lation Y. In addition, banking organizations thatengage in derivatives activities, including themodified Regulation Y commodity derivativesactivities, will remain subject to the generalsecurities, commodities, and energy laws andthe rules and regulations of the Securities andExchange Commission, the Commodity FuturesTrading Commission (CFTC), and the FederalEnergy Regulatory Commission.

For the above reasons, the Board modifiedRegulation Y by changing the delivery avoid-ance requirement to allow BHCs to take ormake delivery of title to commodities under-lying commodity derivative transactions on aninstantaneous, pass-through basis. A BHC takesand makes delivery of title to a commodity onan instantaneous, pass-through basis for pur-poses of Regulation Y only if the BHC takesdelivery of title to the commodity from a sellerand immediately thereafter makes delivery oftitle to the commodity to a buyer. Accordingly,the revised delivery avoidance requirement doesnot provide authority for a BHC to take physicaldelivery of commodities for use or investmentor to make physical delivery of commodities outof the inventory of the BHC. In other words, theBHC must not be the original seller of thecommodity in the initial position in the deliverychain or the ultimate buyer of the commodity inthe last position in the delivery chain.

The Board’s modification of Regulation Yalso changed the contractual offset requirementto permit BHCs to participate in physicallysettled derivative markets in which the standardindustry documentation does not allow forassignment, termination, or offset. In particular,the modified Regulation Y allows BHCs to enterinto commodity contracts that do not requirecash settlement or specifically provide forassignment, termination, or offset before deliv-ery so long as the contracts involve commodi-ties for which futures contracts have beenapproved for trading on a U.S. futures exchangeby the CFTC (and the BHC complies with therevised delivery avoidance requirement).15

15. The CFTC publishes annually a list of the CFTC-approved commodity contracts. See, for example, CommodityFutures Trading Commission, FY 2001 Annual Report toCongress 126. With respect to granularity, the Board intendsthis requirement to include all types of a listed commodity.For example, any type of coal or coal derivative contractwould satisfy this requirement, even though the CFTC listspecifically approves only Central Appalachian coal.



The Board’s modifications of the derivativesprovisions in Regulation Y are effective for all

BHCs. (See 2003 FRB 385.)


Subject Laws 1 Regulations 2 Interpretations 3 Orders

Investment transactions asprincipal

225.25(b)(8)

Investing and trading activities—engaging as principal

1843(c)(8)—section 4(c)(8)of the BHCAct

225.28(b)(8)(ii)

BHCs can (1) take and makedelivery of title to commoditiesunderlying commodity deriva-tives contracts on an instanta-neous, pass-through basis and(2) enter certain commodityderivative contracts that do notrequire cash settlement orspecifically provide for assign-ment, termination, or offset priorto delivery

225.28(b)(8)(ii)(B) 2003 FRB 385

1. 12 U.S.C., unless specifically stated otherwise.2. 12 C.F.R., unless specifically stated otherwise.3. Federal Reserve Regulatory Service reference.



Section 4(c)(8) of the BHC Act (Real Estateand Personal Property Appraising) Section 3270.0

Effective December 31, 1980, the Board amendedsection 225.28(b) of Regulation Y (12 C.F.R.225.28(b)(2)(i)) to include the performance ofreal estate appraisals in the list of activitiespermissible for bank holding companies to engagein. The Board concluded that banks perform realestate appraisals either in connection with exten-sions of credit involving real estate lending or asa discrete activity. In addition, such an appraisalactivity calls upon the necessary skills andresources often possessed by banking organiza-tions. The Board thus determined that the activ-ity of performing appraisals of real estate isclosely related to banking and that its perfor-mance by bank holding companies will yield netbenefits to the public.

In addition to authorizing the appraisals ofreal estate as a nonbanking activity, the Boardhas previously determined by order that theappraisal of certain types of personal property,both tangible and intangible, is closely related tobanking (1985 FRB 118). Providing personalproperty appraisals was added to the list ofpermissible nonbanking activities in RegulationY. It was combined with the already-approvedactivity of providing real estate appraisals (12C.F.R. 225.28(b)(2)(i)). The action was approvedby the Board on October 31, 1986, effectiveDecember 15, 1986, without any conditions. Inpermitting bank holding companies to engage inthe activity of providing valuations of compa-nies, the Board noted that the commercial lend-ing and trust departments of banks commonlymake valuations of a broad range of tangibleand intangible property, including the securitiesof closely held companies. Providing valuationsof companies necessarily involves the appraisalof various types of intangible personal property,such as securities of closely held corporations,as well as any tangible personal property that acompany might possess.

Banks currently engage in the appraisal ofpersonal property through their trust depart-ments. Trust departments value private businessinterests for their own trust accounts and othertypes of personal property in a customer’s estatefor probate and tax purposes. Banks engage inproperty appraisal activities in connection withsecured lending activities and routinely appraiseproperty which they take as collateral on loans,including perishable commodities, durable goods,computer software, crops, livestock, machinery,and equipment.

Banks also engage in appraisal activities inconnection with their leasing activities. Withregard to leasing, banks determine the residual

value of leased property, such as vehicles andequipment, in order to establish the terms of alease. Some money-center banks have appraisedaircraft and locomotives, in connection withtheir leasing or lending transactions. Finally,banks may become involved in personal prop-erty appraising when they appraise real prop-erty, since certain types of real property, such asfactories or apartment buildings, contain fix-tures or other personal property that must beevaluated separately to determine the value ofthe real property.

3270.0.1 SCOPE OF INSPECTION

As noted within the subsequent inspection pro-cedures, a sampling of real estate and personalproperty appraisals is to be reviewed to deter-mine whether the appraised value of the prop-erty is reasonable and the documentation sup-ports the appraisal.

Regulatory appraisal standards for federallyrelated transactions are discussed below andmust be considered in determining the scope ofthe inspection. The types, components, and pro-cedures that should be used in evaluating realestate appraisals are included in section 2231.0,which contains guidelines for use by bank hold-ing companies and subsidiaries for real estateappraisal and evaluation programs. Personal prop-erty appraisal involves estimating or determin-ing the value of property other than real property.

3270.0.2 APPRAISAL STANDARDSFOR FEDERALLY RELATEDTRANSACTIONS

The Board approved, on June 27, 1990, AppraisalStandards for Federally Related Transactions 1

that represent amendments to Regulation H (12C.F.R. 208) and Regulation Y (12 C.F.R. 225)that are designed to protect federal financial andpublic policy interests in real estate transactionsrequiring the services of an appraiser. The regu-lations are intended to supplement the Board’sappraisal guidelines currently in effect. Section

1. ‘‘Federally related transaction’’ refers to any real estate–related financial transaction entered into on or after August 9,1990, that (1) the Board or any regulated institution engagesin or contracts for and (2) requires the services of an indepen-dent appraiser.


208.50 of Regulation H refers to the appraisalstandards for federally related transactionsenteredinto by state member banks. The appraisal stan-dards for federally related transactions are foundin subpart G, section 225 of Regulation Y. Theamendments were the result of implementingprovisions of title XI of the Financial Institu-tions Reform, Recovery, and Enforcement Actof 1989 (FIRREA) regarding real estate apprais-als. The Regulation Y amendments identifywhich transactions require an appraiser (section225.63),2 set forth minimum standards for per-forming appraisals (section 225.64), and distin-guish those appraisals requiring the services of astate-certified appraiser from those requiring astate-licensed appraiser (section 225.63). Theeffective dates are August 9, 1990, for theappraisal standards and July 1, 1991, for theappraiser certification and licensing require-ments. Other provisions address appraiser inde-pendence (section 225.65), professional associa-tion membership, and competency.

3270.0.3 APPRAISER’SQUALIFICATIONS

With respect to an institution’s selection ofappraisers, examiners need to consider thefollowing:1. The professional certification, license, or other

recognition of the competence of the appraiser.For real estate appraisals, the appraiser musthave the proper state certification or licenserequired by section 225.63 of Regulation Y.Examiners should also consider the Septem-ber 1992 Guidelines for Real Estate Appraisaland Evaluation Programs. For personal prop-erty appraisals, the appraiser’s qualificationsmight be evidenced by certification from anationally recognized personal propertyappraisal organization or they may be sup-ported by license or other recognition of thecompetence of the appraiser.

2. The reputation and standing of the specialistin the view of his peers and others familiarwith the person’s capability of performance.

3. The relationship, if any, of the appraiser tothe bank holding company in order to deter-mine independence and objectivity.

4. The appraiser’s documented accomplish-ments (for example, the appraiser’s personal‘‘qualifications statement’’ or job historyresume).

5. Whether theappraiser’sexperienceandknowl-edge or expertise relates to the propertyappraised.

6. Whether the appraiser meets continuing-education requirements for licensing orcertification. Membership or the absence ofmembership in any particular appraisal orga-nization should not be accepted as primafacie evidence of an appraiser’s qualifications.

3270.0.4 KEY COMPONENTS OF APERSONAL PROPERTY APPRAISALREPORT

When reviewing personal property appraisals,the appraisal should describe the following:1. the kind of value being determined, such as

fair market value, liquidation value,replacement/reproduction value, etc.

2. the property being valued3. the detailed procedures used to estimate the

values, such as—a. analysis of comparable sales,b. estimation and analysis of income, andc. the appraised values as of a specific date

4. the name of the individual who made theappraisal and who is responsible for its valid-ity and objectivity (to the person receivingthe appraisal, to third parties, and to thepublic)

5. the personal qualifications data of theappraiser

3270.0.5 APPRAISAL OFCONSTRUCTION ANDCONSTRUCTION-ANALYSISSERVICES

The activity of providing construction-analysisservices, including appraisal of constructionprojects at various stages of development anddisbursement of construction loan funds inaccordance with the terms of the loan agree-ment, is included within the permissible activi-ties of real estate appraising and loan servicing.

2. The Appraisal Standards for Federally Related Transac-tions that are found in Regulation Y were amended, effectiveDecember 28, 1998, to exclude from the Board’s appraisalrequirements transactions involving the underwriting of ordealing in mortgage-backed securities. The amendment per-mits bank holding company subsidiaries engaged in the under-writing of and dealing in securities to underwrite and deal inmortgage-backed securities without demonstrating that theloans underlying the securities are supported by appraisalsthat meet the Board’ s appraisal requirements.

Section 4(c)(8) of the BHC Act (Real Estate and Personal Property Appraising) 3270.0



1. To determine what financial effect the activityhas on the parent holding company and thebank subsidiaries.

2. To determine whether the company has for-mal written policies and procedures. For realestate appraisals, the policies and proceduresshould be consistent with the Guidelines forReal Estate Appraisal and evaluation pro-grams in section 2231.0.

3. To determine if there is compliance with theappraisal standards for federally related trans-actions detailed in the Board’s Regulations Hand Y.

4. To determine whether the appraisals wereperformed on an independent basis.

5. To determine whether the individuals per-forming the appraisals are qualified and thatthe appraisals are reasonable.

6. To determine whether the appraisals are cur-rent, complete, and reasonably accurate.

7. To determine if real estate appraisals areperformed by state-licensed or state-certifiedappraisers.


1. Review the company’s financial statements

and determine if there are any factors ortrends that could have an adverse impact onthe parent holding company or the banksubsidiaries.

2. Review the company’s policies and proce-dures to determine that the following arepresent:a. Adequate minutes are prepared of the

board and board committee meetings.b. Professional liability insurance and

blanket bond coverage, if appropriate,are in place and the coverage appearssufficient.

c. Only qualified individuals are authorizedto perform appraisals.

3. Review a sampling of the real estate andpersonal property appraisals to determinehow a value is derived and whether thisvalue is adequately substantiated.

4. For the appraisals reviewed in procedure 3,determine the reason for each appraisal. If itis for the purpose of valuing collateral for aloan extended by or to a bank affiliate, doesthe value appear realistic in relation to theloan amount?

5. Check for compliance with section 106(b) ofthe 1970 Amendments of the BHC Act (pro-hibition against tie-in arrangements). (Seesection 3500.0.)



Real estate appraisalactivity approval

225.28(b)(2)(i) 1980FRB962and 9841997FRB275

Acquisition of a nonbankingsubsidiary that performsvaluations of companiesand of large blocks of stockfor a variety of purposes

1985FRB118

Personal property appraisalactivity approval

225.28(b)(2)(i) 1986FRB8331997FRB275

Appraisal standards forfederally relatedtransactions

225 subpart G,225.61–225.67

4–053 1990FRB6391999 FRB 50


3. Federal Reserve Regulatory Servicereference.

Section 4(c)(8) of the BHC Act (Real Estate and Personal Property Appraising) 3270.0


Section 4(c)(8) of the BHC Act(Check-Guaranty and Check-Verification Services)Section 3320.0

The activities of check-guaranty and check-verification services permit bank holding com-panies to authorize the acceptance by subscrib-ing merchants of certain personal checks tenderedby the merchant’s customers in exchange forgoods and services, and to purchase validlyauthorized checks from merchants in the eventthe checks are subsequently dishonored.

The Board determined, previously, that check-guaranty services were closely related to bank-ing, and had approved applications by bankholding companies on a case-by-case basis toengage in the activity (1979 FRB 263 and 1981FRB 740). See also 1999 FRB 582, 1996 FRB348 (fraud-detection services), 1994 FRB 1107,and 1995 FRB 492 (ATM network services).

The Board noted the potential for unfair com-petition or conflicts of interest with respect tothe authorization of checks not drawn on affili-ated banks. To minimize this possibility, theBoard has maintained a condition in RegulationY, noted in previous orders, stating that thecheck guarantor cannot discriminate againstchecks drawn on unaffiliated banks.


1. To determine the extent of exposure to guar-anteed bad-check losses.

2. To determine whether management is quali-fied and effective in controlling losses.

3. To determine whether administrative andoperating procedures and check-guaranty andcheck-verification transactions are processedin accordance with established Board or Boardcommittee authorization policies and proce-dures, including adequate internal controlprocedures.

4. To determine whether recordkeeping and dataprocessing are adequate and current to avoidlosses resulting from outdated or inaccurateinformation.

5. To determine whether any significant contin-gent liabilities exist.

6. To determine whether the financial conditionof the nonbanking subsidiary will have anadverse influence on the financial conditionof the consolidated corporation.


1. Review financial statements to determine thefinancial condition of the company and pastand current operating trends. Test the accu-racy of those records against the financialstatements for each material asset, liability,and equity account.

2. Review the minutes of the board of directorsand executive committees and correspon-dence exchanged with the company’s legalcounsel.

3. Review authorization records for check-guaranty and check-verification services foradequacy to determine whether check clear-ance is verified and whether the company hasan accurate record of its contingent liabilityfor guaranteed checks.

4. Review collection records to determinewhether follow-up procedures on purchasedguaranteed bad checks are adequate andwhether they evidence timely collection con-tacts and successful recoveries.

5. Determinewhethercollection-problemchecksare turned over to attorneys or collec-tion agencies for appropriate collective orlegal action on a timely basis.

6. Review the company’s history of bad-checklosses and the current status of uncollectedbad checks, and determine whether adequatereserves have been set aside for those losses.

7. Determine whether fee calculations and bill-ing procedures ensure accuracy and propriety.




Engage de novothrough a new nonbanksubsidiary in the activityof check verification

1979 FRB 263

Retail check-authorizationand check-guarantyactivities

1981 FRB 7401999 FRB 582

Fraud-detection services 1996 FRB 348(see footnote 15)

Amendment ofRegulation Y addingcheck verification as apermissible activity

225.28(b)(2)(iii) 1986 FRB 8331997 FRB 275


3. Federal Reserve Regulatory Servicereference.

Check-Guaranty and Check-Verification Services 3320.0


Section 4(c)(8) of the BHC Act(Operating a Collection Agency) Section 3330.0

The Board authorized the addition of operatinga collection agency to the list of approved activi-ties. A collection-agency subsidiary seeks tocollect payment on the overdue bills of debtors,charging the party submitting the claim a flatdollar amount or a specified percentage commis-sion contingent on the amount collected. TheBoard determined that operating a collectionagency is closely related to banking as banksengage in debt-collection activities for loansthey originate and service, including overduecredit-card accounts.

The Board recognized the potential for unfaircompetition and conflicts of interest through theoperation of a collection agency. Accordingly,the Board established the following conditionson operating a collection agency:

1. The collection agency shall not obtain thenames of customers of competing collectionagencies from an affiliated depository institu-tion that maintains trust accounts for thoseagencies

2. The collection agency shall not provide pref-erential treatment to an affiliate or a customerof such affiliate seeking collection of an out-standing debt.


1. To determine whether the collection agencyis obtaining the names of customers of com-peting collection agencies from an affiliateddepository institution that maintains trustaccounts for those agencies.

2. To determine whether the collection agencyprovides preferential treatment to an affiliateor a customer of such affiliate seeking collec-tion of an outstanding debt.

3. To determine what effect the activity has onthe parent company, its subsidiaries, and theoverall consolidatedorganization,andwhetherthe company or activity evidences a goingconcern.

4. To determine whether the company has for-mal written policies and operating and inter-nal control procedures to successfully admin-ister the activity.

5. To determine the extent of managementexpertise, experience, and involvement withthe administration of the activity.

6. To determine the extent of compliance withlaws, regulations, and interpretations associ-ated with the activity, including the FairCredit Reporting Act, Fair Debt Collection

Practices Act, and Right to Financial PrivacyAct.

7. To determine whether the company adminis-ters formal training programs which includeproper operating and compliance methods.

8. To determine whether any significantcontingent liabilities exist and whether thoseliabilities resulted from the failure of thebank holding company or its nonbankingsubsidiary to fulfill its responsibilities as anagent for its customers.


1. Review financial statements to determine thefinancial condition of the company and pastand current operating trends. Test the accu-racy of the financial statements against thecompany’s financial records and other sup-portive corroborating evidence.

2. Review the minutes of the board of directorsand executive committees, and correspon-dence exchanged with the company’s legalcounsel with regard to possible contingencylosses.

3. Review collection records for adequacy, anddetermine whether the amount of paymentsreceived is independently verified.

4. Review collection records—tickler files—todetermine whether follow-up procedures onacquired accounts are adequate and whetherthey evidence timely collection contacts andsuccessful recovery rates.

5. Determine whether appropriate legal actionis used and authorized by customers on atimely basis.

6. Determine whether fee calculations and bill-ing procedures ensure accuracy and propriety.

7. Review parent company and subsidiaryadministrative and operating policies, anddetermine whether the collection agency isprohibited from obtaining the names of cus-tomers of competing collection agencies froman affiliated depository institution that main-tains trust accounts for those agencies.

8. Review customer lists and billings and anyprioritized collection schedules, and deter-mine whether the collection agency is pro-viding any preferential treatment to an affili-ate or a customer of such affiliate seekingcollection of an outstanding debt.




Amendment of Regulation Yadding collection-agencyservices as a permissibleactivity

225.28(b)(2)(iv) 1986 FRB 8331997 FRB 275



Section 4(c)(8) of the BHC Act (Operating a Collection Agency) 3330.0


Section 4(c)(8) of the BHC Act(Operating a Credit Bureau) Section 3340.0

A bank holding company that engages in theactivity of operating a credit bureau gathers,stores, and disseminates factual informationrelating to the identity and paying habits ofconsumers. Credit bureaus then provide thisinformation for a fee to credit grantors, such asretailers, banks, and finance companies, to enablethe institutions to arrive at prudent credit-granting decisions. The Board concluded thatthe activity is closely related to banking asbanks maintain credit files and analyze creditinformation as part of their consumer-lendingfunction.

The Board recognized that possible adverseeffects could result from a potential conflict ofinterest when a bank holding company performscredit bureau activities. For example, under theFair Credit Reporting Act, a credit bureau isrequired to investigate the accuracy of any itemof information disputed by a consumer (15U.S.C. 1681(i)). A bank holding company creditbureau may not conduct an impartial investiga-tion if the disputed information originates withan affiliate. The Board thus imposed the condi-tion that a credit bureau could not provide pref-erential treatment to a customer of an affiliatedfinancial institution.

Regulation Y allows bank holding companiesto engage only in consumer-credit-reportingactivities rather than credit-reporting activitiesconcerning large commercial institutions.

3340.0.1 Inspection Objectives

1. To determine whether the activity is limitedto only consumer-credit-reporting activities.

2. To determine whether the bank holding com-pany gives preferential treatment to a cus-tomer of an affiliated financial institution.

3. To determine the adequacy of internal poli-cies and operating and internal controlprocedures.

4. To determine whether any significant contin-gent liabilities exist which arose from thefailure of the holding company and its non-banking subsidiary to fulfill their responsi-bilities as an agent for their customers.

5. To determine whether appropriate steps havebeen taken to ensure compliance with theFair Credit Reporting Act, Equal CreditOpportunity Act, and Right to Financial Pri-vacy Act.

6. To determine whether adequate controls existto prevent unauthorized access into any com-puterized credit bureau credit files to pre-serve the confidentiality of the informationstored for customers’ use.


1. Review the company’s financial statementsfor accuracy, and determine if there are anyfactors or trends that could have an adverseimpact on the parent company or its bankingor nonbanking subsidiaries.

2. Review recordkeeping practices, and deter-mine whether such management informationsystems are adequate to service customersand limit the risk of loss resulting from weakrecordkeeping activities.

3. Review customer logs or client lists, anddetermine whether the activity is limited toonly consumer-credit-reporting activities.

4. Review the activity and billings for a cus-tomer of an affiliated financial institution,and compare those findings to the activitiesand billings of other customers. Determinewhether the bank holding company is givingpreferential treatment to a customer(s) of anaffiliated financial institution.

5. Review the company’s policies and operat-ing and internal control procedures for theactivity, and determine whether they havebeen documented and whether they are beingtested for compliance as part of the compa-ny’s internal/external audits.

6. Review correspondence with legal counsel,and determine whether any significant con-tingent liabilities exist due to the failure ofthe holding company and its nonbanking sub-sidiary to fulfill their responsibilities as anagent for their customers.

7. Determine whether internal control proce-dures and compliance audits test for compli-ance with the Fair Credit Reporting Act,Equal Credit Opportunity Act, and Right toFinancial Privacy Act.

8. Determine what steps have been taken toprevent unauthorized access to any comput-erized credit bureau credit files to preservethe confidentiality of the information storedfor customers’ use.




Denial of a BHC’sproposal to engage inproviding credit ratingsfor large businesses

1985 FRB 118

Activity is closely relatedto banking and apermissible nonbankingactivity for consumer-credit reporting only

225.28(b)(2)(v) 1986 FRB 8331997 FRB 275



Section 4(c)(8) of the BHC Act (Operating a Credit Bureau) 3340.0


Tie-In Considerations of the BHC ActSection 3500.0

Section 106(b) of the Bank Holding CompanyAct Amendments of 1970 (12 U.S.C 1972(b))generally prohibits a bank from conditioning theavailability or price of one product or service(the ‘‘tying product’’) on a requirement that thecustomer obtain another product or service (the‘‘tied product’’) from the bank or an affiliate ofthe bank. The central purpose of section 106 isto prevent banks from using their market powerin banking products, including credit, to gain anunfair competitive advantage in other products.The restrictions of section 106(b) on banks arebroader than those of the antitrust laws, as noproof of economic power in the tying-product(or desired-product) market or anticompetitiveeffects in the tied-product market are requiredfor a violation to occur. Although banks, liketheir nonbank competitors, are subject to gen-eral antitrust prohibitions on tying, section 106was enacted because Congress concluded thatspecial restrictions were necessary given theunique role of banks in the economy.

The intent behind section 106(b) is to affirmthe principles of fair competition by eliminatingthe use of tying arrangements that have thepotential to suppress competition. A prohibitedtie-in can occur if a bank (1) varies the consider-ation (that is, the amount charged) for a bankproduct or service (the ‘‘tied product’’) on thecondition that a customer obtain another productor service from the bank or its affiliate or(2) requires a customer to purchase anotherproduct or service from the bank or any of itsaffiliates as a condition for providing a productor service to the customer.

Although the 1970 legislation amended theBank Holding Company Act, the tying prohibi-tion isapplicable toall commercialbanks,whetheror not they are subsidiaries of holding compa-nies. The term ‘‘company’’ is not used in section106(b) but in another part of the 1970 legisla-tion. Therefore, it is not relevant to section 106.

3500.0.1 ANTI-TYING RESTRICTIONSAND OTHER PROVISIONS

Section 106 of the BHC Act Amendments hasfive restrictions that are applicable to banks.These restrictions apply only when the productsare separately available for purchase. The firsttwo restrictions prohibit conditions constitutingtraditional tying arrangements; restrictions threeand four prohibit reciprocal-dealing arrange-ments; and the fifth, with certain exceptions,prohibits an exclusive-dealing arrangement.

Exempted fromtheseprohibitedconditional trans-actions are ‘‘traditional banking products.’’

Specifically, section 106 prohibits a bankfrom fixing or varying, in any manner, the con-sideration for extending credit, leasing or sellingproperty of any kind, or furnishing any serviceon the condition or requirement that a customer—

1. obtain additional credit, property, or servicefrom the bank, other than a loan, discount,deposit, or trust service (a ‘‘traditional bankproduct’’);

2. obtain additional credit, property, or servicefrom the bank’s parent holding company orthe parent’s other subsidiaries;

3. provide additional credit, property, or serviceto the bank, other than those related to andusually provided in connection with a loan,discount, deposit, or trust service;

4. provide additional credit, property, or serviceto the bank’s parent holding company or anyof the holding company’s other subsidiaries;or

5. not obtain other credit, property, or servicefrom the competitors of the bank, the bank’sparent holding company, or the holding com-pany’s other subsidiaries, except that thelending bank may reasonably impose condi-tions and requirements in a credit transactionto ensure the soundness of the credit.

3500.0.1.1 Section 106 StatutoryException

The statutory ‘‘traditional-bank-product’’ excep-tion of section 106 permits a bank to tie anyproduct to a traditional bank product (a loan,discount, deposit, or trust service) offered bythat bank, but not by any affiliated bank ornonbank. For example, a bank could conditionthe use of its messenger service on a customer’smaintaining a deposit account at the bank.Although the statutory traditional-bank-productexception appears to have been effective in pre-serving traditional relationships between a cus-tomer and bank, the statutory exception is lim-ited in an important way. It does not extend totransactions involving products offered by affili-ates. Section 106(b) also grants the Board theauthority to prescribe exceptions by regulationor order when it determines that an exceptionwill not be contrary to the purposes of thissection.


Before the 1997 implementation of the revi-sions to Regulation Y, the tie-in provisions ofsection 106(b) applied to bank holding compa-nies and their nonbank subsidiaries as thoughthey were banks. The nonbank provisions wereapplied under section 4(c)(8) of the Bank Hold-ing Company Act. A bank holding company andany nonbank subsidiary were prohibited fromtying their products or services either to otherproducts or services offered by the same com-pany or to products or services offered by anyaffiliate, including a bank affiliate. With the1997 revisions, the tie-in prohibitions were elimi-nated for bank holding companies and theirnonbank subsidiaries, except when electronicbenefit transfer services are provided. Bankholding companies and their nonbank subsidi-aries are still subject to anti-tying restrictionswith respect to electronic benefit transfer ser-vices, as set forth in section 7(i)(11) of the FoodStamp Act of 1977 (7 U.S.C. 2016(i)(11)). (Seethe tie-in arrangements discussion in section3070.0.7.4.)

Section 106 prohibits not only tying arrange-ments but also reciprocity arrangements. In areciprocity arrangement, a bank conditions theavailability of, or varies the consideration of,one product on a customer’s provision of anotherproduct to the bank or one of its affiliates. Thestatutory prohibition on reciprocity arrange-ments contains an exception intended to pre-serve traditional banking practices. The excep-tion provides that a bank may condition theavailability of a product or service on a custom-er’s providing to the bank some product orservice ‘‘ related to and usually provided in con-nection with’’ a loan, discount, deposit, or trustservice. The 1997 Regulation Y revision extendedthis statutory exception to cover reciprocityrequirements imposed by banks that require cus-tomers to provide a ‘‘ usually related’’ product orservice to a bank affiliate.1

3500.0.2 REGULATORY EXCEPTIONS

3500.0.2.1 Traditional-Bank-ProductException

The traditional-bank-product exception of Regu-lation Y (12 C.F.R. 225.7 (b)(1)) permits a bank

to extend credit, lease or sell property, provideany service, or fix or vary its consideration onthe condition that a customer obtain a traditionalbank product (that is, a loan, discount, deposit,or trust service) from an affiliate of the bank.

3500.0.2.2 Safe Harbor forCombined-Balance Discounts

On April 19, 1995 (effective May 26, 1995), theBoard issued a revised rule on the anti-tyingprovisions of section 106 of the Bank HoldingCompany Act Amendments of 1970. The ruleestablished a ‘‘ combined-balance discount’’ safeharbor for a banking organization offering vari-eties of services to its customers and wishing tooffer them discounts based on the customers’overall relationship with the bank or its holdingcompany and subsidiaries.

A bank may vary the consideration for anyproduct or package of products based on a cus-tomer’s maintaining a combined minimum bal-ance in certain products specified by the bank(eligible products) if—

1. the bank offers deposits, and all such depos-its are eligible products, and

2. balances in deposits count at least as much asnondeposit products toward the minimumbalance. (See Regulation Y, section 225.7(b)(2).)

A question was raised as to whether insur-ance products may be included among the prod-ucts offered by a bank as part of a combined-balance discount program (eligible products)operated pursuant to the Board’s safe harbor,if the program otherwise meets the requirementsof the safe harbor. If insurance products aredeemed to be eligible products, it was also ques-tioned whether the principal amount of annuityproducts may be counted towards the minimumbalance, and whether insurance premiums maybe counted towards the minimum balance fornon-annuity insurance products.

Board staff issued the following response tothe questions: To qualify for the Board’s safeharbor, all deposits must be eligible productsunder the combined-balance discount program,and deposit balances must be weighed at least asmuch as nondeposit products towards the mini-mum balance.2 The Board’s requirement thatdeposit balances be weighed at least as much as

1. See Chairman Greenspan’s August 23, 1994, letter tothe Honorable John D. Dingell, Chairman, Committee onEnergy and Commerce, U.S. House of Representatives. Seealso the Board’s issuance of anti-tying exceptions on Decem-ber 15, 1994, and April 20, 1995.

2. Eligible products under the safe harbor are those ‘‘ prod-ucts specified by the bank’’ as part of the combined-balance

Tie-In Considerations of the BHC Act 3500.0


nondeposit products towards the minimum bal-ance was included in the safe harbor to allowbanks and their affiliates to price products theyinclude in a combined-balance program in aneconomically rational way—while limiting thebank’s ability to use product weighting to requirethe purchase of certain nontraditional products.This requirement specifically provides for theinclusion of certain products with values thatcould be greater than the typical retail deposit,while allowing deposits to remain a viable wayfor customers to reach the minimum balance.

On this basis, any financial products offeredby a bank or its affiliates, including insuranceproducts, may be properly included among theeligible products in that bank’s combined-balance discount program. The principal amountof an annuity may be counted in determining thesize of the customer’s balance in eligible prod-ucts, as may the premiums paid in a givenpolicy year on non-annuity insurance products.The principal amount of an annuity is closelyanalogous to the principal amount of a deposit,as both represent a customer’s initial cash invest-ment with the relevant financial institution. Simi-larly, insurance premiums are money actuallypaid by the customer to the insurance underwriter.

3500.0.2.2.1 Combined-BalanceDiscount—Members of a Household orFamily, Taken Together, May Constitutea ‘‘Customer’’

A bank holding company’s legal counsel raiseda question as to whether members of a house-hold or family, taken together, may be consid-ered a ‘‘ customer’’ for purposes of the combined-balance discount safe harbor set forth insection 225.7(b) of Regulation Y.

The bank holding company desired to offerits customers discounts on the products andservices of its subsidiary banks if a customer’shousehold maintains a specific minimum bal-ance with its banks and their affiliates. Theminimum balance would be computed by add-ing the balances held by an individual customerin products (both bank and nonbank) specifiedby thecompany’saffiliatedbank, includingdepos-its, to balances held in the same products by allother members of that customer’s household.

Board staff noted that the safe harbor wouldbe available only if all deposits are eligibleproducts under the combined-balance discountprogram and deposit balances are weighed atleast as much as nondeposit products towards

the minimum balance. Board staff also notedthat aggregating balances held at the bank hold-ing company’s affiliates by members of a familyor household would make it easier for custom-ers to achieve the minimum balance necessaryto receive the favorable pricing on bank prod-ucts and services, and thus appear to be pro-consumer and not anticompetitive.

Accordingly, Board staff opined 3 that theterm ‘‘ customer,’’ as used in section 225.7(b)(2)of Regulation Y, may include separate individu-als who (1) are all members of the same imme-diate family (as defined in section 225.41(b)(3)of Regulation Y) and (2) reside at the sameaddress. Staff also indicated that the bank hold-ing company must not operate the program in ananticompetitive manner.

3500.0.2.3 Safe Harbor for ForeignTransactions

The Board has adopted a safe harbor from theanti-tying rules for transactions with corporatecustomers that are incorporated or otherwiseorganized and that have their principal place ofbusiness outside the United States. This safeharbor also applies to individuals who are citi-zens of a foreign country and are not resident inthe United States. (See Regulation Y, section225.7(b)(3).) However, the safe harbor wouldnot protect tying arrangements involving a cus-tomer that is a U.S.-incorporated division of aforeign country. Furthermore, the safe harborwould not shelter a transaction from other anti-trust laws if they were otherwise applicable.

3500.0.2.4 Bank Holding CompanySubsidiary Banks Issuing Securities-BasedCredit

3500.0.2.4.1 A BHC’s Subsidiary BanksIssuing Securities-Based Credit CanRequire Borrowers to Keep the SecuritiesCollateral in an Account at the BHC’sBroker-Dealer Affiliate

A BHC’s legal counsel requested that the Boardgrant an exception to the anti-tying prohibitionsof section 106 of the Bank Holding CompanyAct Amendments of 1970. The exception would

discount program. (See 12 C.F.R. 225.7(b)(2).)

3. See the Board staff opinion dated November 26, 2002.



allow the subsidiary banks (the banks) of theBHC to require borrowers whose bank loans aresecured with publicly traded securities to keepthose securities in accounts at the BHC’s broker-dealer affiliate.

The request stated that the banks often makeloans that are collateralized by marketable secu-rities and that these securities are generally heldin accounts at broker-dealers unaffiliated withthe BHC, subject to collateral agreements. TheBHC requested its subsidiary banks be grantedan exception from section 106 that would allowthem to require borrowers to keep securitiespledged as loan collateral from the banks in anaccount at a broker-dealer affiliate. The require-ment would give the BHC more control over thecollateral (for example, to prevent it from beingsold or exchanged for different securities) andwould allow the BHC to monitor the value ofthe collateral more closely than when the securi-ties are held at an unaffiliated institution.

The Board’s August 18, 2003, response to therequest was as follows: Section 106 allows thebanks to require borrowers to place securitiespledged as collateral in trust accounts at thebanks. A specific exception in section 106 allowsbanks to condition the availability of any prod-uct, including credit, on the customer’s obtain-ing a trust service. The BHC preferred, how-ever, touse thesystemsforholdingandmonitoringsecurities in brokerage accounts at its broker-dealer affiliate for reasons based on cost, effi-ciency, and improved monitoring. The banks, itwas contended, would receive more cooperationwhen inquiring about the status of securitiespledged as collateral from the BHC’s broker-dealer affiliate than they would receive fromunaffiliated broker-dealers, who have littleincentive to help the banks protect their collateral.

The BHC made the following representationsin support of its request: (1) The banks wouldonly require the customer to use an account ofthe BHC’s broker-dealer affiliate for the pur-pose of holding securities that collateralize aloan from the banks; (2) no securities other thanthose pledged as collateral for a loan from thebanks could be held in these accounts; and(3) securities held in these accounts could not betraded by the customer without the prior approvalof the BHC’s credit department for each trade.4These restrictions would both protect the banks’interest in and the value of the collateral pledged

and would ensure that the banks do not requirecustomers to establish brokerage accounts for apurpose other than protecting bank collateral.The BHC proposed to require the use of affili-ated broker-dealer accounts solely for the pur-poseof securingandmonitoringcollateralpledgedfor loans extended by the banks to their accountholders.

The Board’s response letter stated that (1) sec-tion 106 permits this practice when securitiescollateralizing a loan are maintained in trustaccounts in the banks or their affiliates or areotherwise provided to and held by the banks;(2) the proposal would not appear to give theBHC any competitive advantage over otherbroker-dealers in obtaining general securitiesbrokerage business from customers; and (3) thedescribed restrictions would cause the securitiesaccounts at the broker-dealer to be the func-tional equivalent of bank trust accounts, in whichthe banks currently may require borrowers toplace securities used to collateralize loans. TheBoard’s response also stated that the Board con-tinues to evaluate whether the BHC’s proposedprogram is prohibited by section 106. Subject tothis potential determination, the Board believedthat granting an exception for the program wouldnot be contrary to the purposes of section 106.The response noted that the limitations on whenan affiliated broker-dealer account would berequired and how the account would be usedhelp ensure that the accounts at the BHC’sbroker-dealer affiliate would only be used topreserve customers’ collateral pledged for loansand would not be used to gain a competitiveadvantage over the broker-dealer affiliate’s com-petitors, particularly because a customer’s abil-ity to trade in the account would be severelyrestricted. Accordingly, on this basis, the Boardgranted an exception to the restrictions of sec-tion 106 for the BHC’s proposed program.Approval of the exception was subject to therestrictions on the relevant accounts at the BHC’sbroker-dealer affiliate described in the BHC’srequest and in its correspondence, and to theBoard’s potential determination that the pro-posed requirement is not in fact subject to sec-tion 106. Any changes in the facts and represen-tations are to be reported to Board staff.

3500.0.2.4.2 Bank Customers ReceivingSecurities-Based Credit Can Be Requiredto Hold Securities Collateral at aBroker-Dealer Affiliate Account

A bank’s external legal counsel inquired about

4. The BHC will not give customers permission to tradegenerally through these accounts.



the application of section 106 to certain lendingprograms offered by the bank and its broker-dealer affiliate. In a letter dated February 2,2004, Board staff responded that section 106does not prohibit a bank from requiring borrow-ers that obtain securities-based credit from thebank to keep the securities collateral in anaccount at a bank’s broker-dealer affiliate, solong as the collateral requirement is limited inscope.

The inquiry stated that the bank and its broker-dealer affiliate offer securities-based loans—that is, loans collateralized by securities or othermarketable investment assets (securities)—subject to the requirement that the securitiescollateralizing the loans be kept in collateralaccounts with their broker-dealer affiliate.5 Theinquiry also stated that customers are (1) notcharged for establishing or maintaining the col-lateral accounts or for transferring securities tothe collateral accounts; (2) not obligated to tradein the collateral accounts or any other accountsor to purchase any other products or servicesfrom the bank, its affiliate, or the broker-dealeraffiliate, or any of their affiliates; (3) not requiredtomaintainanysecurities in thecollateral accountsbeyond those necessary, in the bank’s creditjudgment or that of its affiliate, as the case maybe, to support the credit extensions;6 (4) requiredto obtain prior approval from the bank or itsaffiliate, as appropriate, before withdrawing assetsfrom the collateral accounts; (5) not charged afee for effecting such withdrawals; and(6) required to ensure that the value of thesecurities in the collateral account equals orexceeds the lender’s (the bank or its broker-dealer affiliate) collateral requirement for theloan on an ongoing basis.

Board staff responded by stating that section106 generally prohibits a bank from condition-ing the availablility or price of a product on arequirement that the customer obtain anotherseparate product from, or provide another sepa-rate product to, the bank or an affiliate of thebank. Board staff stated that it believed thesecurities-based lending programs, when con-ducted in the manner described in the inquiry

and in the bank’s correspondence with the Board,are permissible under and consistent with thepurposes of section 106. In support of this deter-mination, Board staff stated that (1) by requiringcollateral for a securities-based loan, the bankand its broker-dealer affiliate are not requiringthat the customer obtain any product separatefrom the loan itself and (2) the fact that the bankand its affiliate require the pledged securities tobe held in an account at an affiliate does notmake the collateral or the account a productseparate from the loan that the collateral secures.The Board’s staff opinion was not altered by thefact that (1) borrowers are permitted to holdsecurities in the collateral account beyond thoseminimally required to satisfy the lender’s collat-eral requirement and to trade securities in thecollateral;7 (2) a customer must pay the broker-dealer affiliate its standard brokerage commis-sion if the customer decided to effect trades inthe collateral account;8 or (3) in the event thatthe value of the securities in the collateral accountfalls below the lender’s collateral requirementfor the related loan, the customer must eliminatethe collateral shortfall.

3500.0.3 APPLICABILITY OFANTI-TYING EXCEPTIONS TOENTITIES OTHER THAN BANKS

The Board’s anti-tying rules adopt a definitionof bank that clarifies that any exemptions affordedto banks would generally be applicable to creditcard and other limited-purpose institutions andto U.S. branches and agencies of foreign banks.

3500.0.4 TYING ARRANGEMENTSRELATING TO NONBANK BANKS

The Competitive Equality Banking Act, effec-tive August 10, 1987, made nonbank banks andtheir affiliates subject to the anti-tying provi-

5. The inquiry stated that the bank and its broker-dealeraffiliate generally allow customers to trade securities held inthe collateral accounts (however, see footnote 3 of the responseletter) and that the broker-dealer affiliate charges customersits standard brokerage fee for any trades made by customersthat involve securities held in the collateral accounts. Custom-ers are also not restricted in their ability to maintain brokerageaccounts with other securities firms not affiliated with thebank or its affiliate.

6. All securities in the collateral accounts are pledged ascollateral to support the securities-based loans extended bythe bank or its affiliate.

7. Allowing a customer to trade securities or to placeexcess securities in a collateral account underlying a securities-based loan enhances customer choice without reducing theintegral connection between the loan and the collateral account.The inquiry represented that the customer is allowed to tradeand deposit excess securities in the account, and the customeris not required to trade or deposit excess securities. Thus, anytrading in the account or placement of excess securities in theaccount is voluntary.

8. A customer is not required to trade in the account, andtrades effected by the customer in the account generallywould be unrelated to the loan.



sions of section 106 of the Bank Holding Com-pany Act Amendments of 1970 and to the insiderand preferential lending restrictions of section22(h) of the Federal Reserve Act. Thus, thenonbank bank may not condition the granting ofcredit on the purchase of a product or servicefrom the parent holding company or vice versa.

3500.0.5 VOLUNTARY VERSUSINVOLUNTARY TYINGARRANGEMENTS

Voluntary as well as involuntary tying arrange-ments have been a matter of concern. The cus-tomer, hoping to enhance his or her chance forbank accommodations (especially during periodsof tight money), voluntarily patronizes subsidi-aries of the bank. Voluntary tie-ins are said tohave ‘‘ just as serious’’ an economic effect ascoercive ones because competition would belessened to the extent that the tied product is nolonger bought entirely on its economic merit.


1. To determine whether the bank holding com-pany has adequate policies and procedures toensure the compliance of its subsidiary bankswith section 106(b) of the Bank HoldingCompany Act Amendments of 1970.

2. To evaluate transactions between a companyorganized as a direct subsidiary of a bankholding company and affiliated banks fortheir compliance with federal laws and regu-lations and related policy guidance.

3. To ascertain, to the extent possible, that noinvoluntary overt tying arrangements arepresent in credits extended by any BHC sub-sidiary bank.


The Federal Reserve, as part of its inspectionsof bank holding companies and their subsidi-aries and of its examinations of state memberbanks and their subsidiaries, has had a long-standing policy that examiners should evaluatecompliance with section 106(b) and the prohibi-tions against tying arrangements. During thecourse of all holding company inspections, theexaminers should follow the inspection instruc-tions set forth below, focusing on a bank hold-

ing company’s responsibility to oversee andsafeguard against potentially illegal tyingarrangements by its banking subsidiaries andaffiliates. The examiner’s review should focuson—

1. the bank holding company’s establishmentand monitoring of the internal controls andprocedures foreachbanksubsidiaryoraffiliate,and on its monitoring of compliance withwritten policies and procedures pertaining totying arrangements,

2. the training provided to management andstaff who are responsible for monitoring bank-ing subsidiaries and affiliates for compliancewith anti-tying provisions, and

3. the extent to which the bank holding com-pany oversees internal loan reviews of perti-nent bank extensions of credit to borrowerswhose credit facilities or services may besusceptible to improperly imposed tyingarrangements in violation of section 106(b)or the Board’s regulations.

At a minimum, during the course of all bankholding company inspections, examiners are tothoroughly evaluate the organization’s monitor-ing and overseeing of compliance with section106(b) and the Board’s regulations by its bank-ing subsidiaries and affiliates. Examiners shoulduse the following inspection procedures andchecklist. In addition, before beginning aninspection of any banking organization, ReserveBank staff should evaluate the activities of thetarget banking organization to determine whetherany activities present an increased opportunityfor a bank to illegally tie its services or creditfacilities to other services or facilities. If so, thecurrent inspection procedures, plus the check-list, should be used to check for compliancewith section 106(b) and the Board’s anti-tyingregulations.

Following are the inspection procedures fortying arrangements:

1. Review the BHC’s internal controls that areintended to prevent illegal tie-ins by its banksubsidiaries and affiliates.

2. Review the holding company’s program tomonitor subsidiary banks and their affiliates’internal loan reviews. Such reviews shouldinclude the inspection of credit files for loanagreements and other documentation thatplace conditions or restrictions on borrowersthat indicate a possible tying arrangement.The bank holding company should conductor oversee internal loan reviews of files forinsurance applications, particularly if an



insurance subsidiary maintains a consistentlyhigh penetration rate on credits granted bybank affiliates, which could indicate the pres-ence of involuntary tying arrangements.

3. Ascertain whether the bank holding com-pany has policies requiring the periodic reviewof servicing contracts between the bank andits affiliates, as well as policies for reviewingthe substance of actual transactions, todetermine—a. the capacity in which the bank and its tied

affiliate are acting (for example, is it act-ing as principal on its own behalf or as anagent for the affiliate bank);

b. the nature of all services provided; andc. billing arrangements, the frequency of

billing, the method of computation, andthe basis for such fees.

4. Review the bank holding company’s policystatement on the prohibition of tying arrange-ments, the adequacy of training provided toemployees, and whether management and itsinternal auditors have periodically confirmedthat there is full compliance with such aninternal policy.

5. Report on the ‘‘ Examiner’s Comments andMatters Requiring Special Board Attention’’page any significant comments on reviewedprohibited tying arrangements. (Commentswould also be appropriate if controls to pre-ventprohibited tyinghadnotbeenestablished.)

3500.0.8 INSPECTION CHECKLISTFOR COMPLIANCE WITH THETYING PROHIBITIONS

The following checklist of questions has beendesigned to ensure, during Federal Reserveinspections, an examiner’s adequate, completeevaluation of a banking organization’s compli-ance with section 106(b) of the Bank HoldingCompany Act Amendments of 1970 and theBoard’s anti-tying regulations. The checklistgenerally addresses written policies and proce-dures in this area, as well as training and inter-nal audit programs.

A. Written Policies and Procedures

1. Does the bank holding company have aholding-company-wide policy statementthat—a. states that certain tying arrangements are

illegal andb. provides specific examples of impermis-

sible practices relevant to the productlines?

2. Do the bank holding company’s bank subsid-iaries and affiliates have copies of the hold-ing company’s written policy statementreferred to in question A.1, and has the pol-icy been revised, as appropriate, to providespecific examples of impermissible practicesrelevant to the particular product line?

3. Is the policy statement reviewed and updatedregularly to ensure that the examples accu-rately reflect the products and services offeredby the holding company and its subsidiaries?

4. Does the policy statement contain proce-dures for employees to follow if questionsarise concerning the application of the prohi-bitions against tie-ins?

5. If the bank holding company does not havethe holding-company-wide policy statementreferred to in question A.1 (and that meetsthe requirements in questions A.2, 3, and 4),does each of the holding company’s bankingsubsidiaries and affiliates have its own policystatement that meets those requirements?

B. Training

1. Do the bank holding company and its banksubsidiaries have training programs thatemphasize compliance with the anti-tyingrequirements and ensure that employees areaware of the prohibitions against illegal tyingarrangements?

2. Is participation in a training program requiredof new employees?

3. Is an annual compliance-review programrequired for employees?

C. Audit Procedures

1. Do the bank holding company and its banksubsidiaries and affiliates have annual auditprocedures in place to ensure compliancewith the prohibitions on tying arrangements?

2. Do counsel or other competent experts reviewtransactions in the appropriate areas of thebank holding company, its bank subsidiaries,and affiliates to ensure compliance with theprohibitions against tying arrangements?



Sections 4(c)(9) and 2(h) of the BHC Act (NonbankingActivities of Foreign Banking Organizations) Section 3510.0

A foreign bank that operates in the United Statesthrough a branch, agency, or commercial lend-ing company subsidiary, or that owns or con-trols a U.S. bank or Edge corporation, mustconform to the nonbanking restrictions of theBHC Act.

The BHC Act also provides exemptions thatpermit a foreign bank with U.S. banking opera-tions to engage in certain nonbanking activities.As with domestic bank holding companies, pur-suant to section 4(c)(8), a foreign bank may ownshares of any company that the Board hasdetermined to be so closely related to bankingor managing or controlling banks as to be aproper incident thereto. As described below, aforeign bank may also qualify for additionalexemptions pursuant to sections 4(c)(9) and2(h). These latter exemptions apply only to for-eign banking institutions and seek to limit theextraterritorial application of federal bankinglaw while preserving national treatment of theseinstitutions’ domestic counterparts.

3510.0.1 REGULATION K

Regulation K implements the nonbankingrestrictions of section 4 of the BHC Act byapplying the limits to any foreign banking orga-nization (FBO). An FBO is (1) any foreign bankthat either operates a branch, agency, or com-mercial lending company subsidiary in the UnitedStates, or that controls a U.S. bank, and (2) anycompany that owns or controls a foreign bankdescribed in (1). (See 12 C.F.R. 211.21(o) toapply these limits.) Regulation K requires anyFBO that engages in activities in the UnitedStates to conform those activities to the non-banking restrictions by either limiting the activi-ties or obtaining an exemption. (See 12 C.F.R.211.23(n).)

Regulation K implements statutory exemp-tions from the BHC Act for certain activities offoreign banks. Sections 4(c)(9) and 2(h) of theBHC Act provide exemptions that are availableto ‘‘qualifying foreign banking organizations’’(QFBOs).

Section 2(h) allows a foreign company that isprincipally engaged in banking business outsidethe United States to own foreign affiliates thatengage in impermissible nonfinancial activitiesin the United States, subject to certain require-ments. These include requirements that the for-eign affiliate must derive most of its businessfrom outside the United States and that it mayengage in the United States in only the same

lines of business it conducts outside the UnitedStates.

Section 4(c)(9) allows the Board to exemptforeign companies from the nonbank activityrestrictions of the BHC Act when the exemptionwould not be substantially at variance with theBHC Act and would be in the public interest.Under this authority, the Board has exempted,among other things, all foreign activities ofQFBOs from the nonbanking prohibitions of theBHC Act.

To qualify as a QFBO (and, hence, to beeligible for the 4(c)(9) and 2(h) exemptions), anFBO must chiefly engage in banking activitiesworldwide; that is, it must demonstrate thatmore than half of its business is banking andthat more than half of its banking business isoutside the United States. Regulation K setsforth a multistep test for determining when anFBO primarily engages in banking activitiesworldwide. This so-called QFBO test is met if‘‘disregarding [the FBO’s] U.S. banking busi-ness, more than half of [the FBO’s] worldwidebusiness is banking; and more than half of itsbanking business is outside the United States.’’(See 12 C.F.R. 211.23(a).)

Under the QFBO test, an FBO must satisfy atleast two of the following criteria:

1. the banking assets held outside the UnitedStates must exceed total worldwide nonbank-ing assets;

2. revenues derived from the business of bank-ing outside the United States must exceedtotal revenues derived from its worldwidenonbanking business; or

3. net income derived from the business ofbanking outside the United States must exceedtotal net income derived from its worldwidenonbanking business.

In addition, the FBO must meet at least two ofthe following criteria:

1. the banking assets held outside the UnitedStates must exceed the banking assets held inthe United States;

2. revenues derived from the business of bank-ing outside the United States must exceed therevenues derived from the business of bank-ing in the United States; or

3. net income derived from the business ofbanking outside the United States must exceed


net income from the business of banking inthe United States.Regulation K provides rules on how to calcu-

late the assets, revenues, and net income of theFBO and its foreign subsidiaries.1 In calculatingassets, revenues, or net income held or derivedfrom the business of banking ‘‘ outside the UnitedStates,’’ the FBO may not include assets, rev-enues, or net income, whether held or deriveddirectly or indirectly, of a subsidiary bank, abranch, an agency, a commercial lending com-pany, or another company engaged in the busi-ness of banking in the United States, includingany territory of the United States, Puerto Rico,Guam, American Samoa, or the Virgin Islands.

Regulation K provides a broader definition of‘‘ banking’’ for use in the QFBO test. A QFBOmay include assets, revenues, and income fromany activity that a U.S. bank holding companymay perform abroad pursuant to section 211.10of Regulation K, if the activity is conducted bythe foreign bank itself or by a subsidiary. Thus,for example, an FBO may treat certain insur-ance and securities activities as banking activi-ties for determining QFBO status. (See 12 C.F.R.211.23(b)(2) and 211.10.) However, this broaderdefinition of banking applies to the QFBO testonly. It does not define the types of permissiblebanking activities that a QFBO may perform inthe United States.

An FBO may be unable to satisfy the QFBOtest because a substantial part of its financialactivities is conducted outside of the foreignbank itself. This might occur, for example, whenan FBO conducts substantial life insuranceactivities through a parent or sister company ofthe foreign bank. Such an FBO may neverthe-less be eligible for some more limited exemp-tive relief if it meets a modified test. Under thismodified test, when calculating assets, revenues,or net income for the prong of the QFBO testthat measures whether more than half of anFBO’s business is banking, the FBO may countbanking activities conducted outside the foreignbanking chain. For the other prong of the test,which determines whether more than half of anFBO’s banking business is outside the UnitedStates, the banking-chain requirement would

still apply. An FBO that meets this modified testwill be eligible for all of the exemptions otherthan the exemption for limited commercial andindustrial activities provided under section 2(h)(as implemented by 12 C.F.R. 211.23(f)(5)).2However, any foreign banks within the FBOthat independently meet the QFBO test wouldbe eligible for all of the exemptions available toQFBOs. The modified test is intended to limitthe extraterritorial effect of the BHC Act onforeign firms and to avoid penalizing a consoli-dated group that engages mostly in activitiespermissible for a U.S. banking organization.

An FBO that does not qualify, or that ceasedto qualify for two consecutive years (as reportedin the Annual Report of Foreign Banking Orga-nizations, Form FR Y-7, that the FBO filed withthe Board), is not eligible for the exemptionsafforded by sections 2(h) and 4(c)(9). An FBOthat does not qualify for these exemptions mayonly engage in activities in the United Statesthat are permissible for a domestic bank holdingcompany. An FBO that no longer qualifies underthe QFBO test may seek a determination ofcontinued eligibility from the Board. Otherwise,the FBO may only continue to engage in activi-ties begun, or retain investments acquired, beforethe end of the first fiscal year in which it failedto qualify. Other activities or investments mustcease or be divested within three months of thefiling of the second FR Y-7, which demonstratesthat the foreign bank no longer qualifies for theexemptions. The Board also has the authority togrant exemptive relief under Regulation K toforeign organizations that do not include foreignbanks. (See 12 C.F.R. 211.23(e).)

3510.0.2 NONBANKINGEXEMPTIONS FROM THE BHC ACTFOR QFBOs UNDER SECTIONS4(C)(9) AND 2(H)

Sections 2(h) and 4(c)(9) of the BHC Act areexemptive provisions that seek to limit theextraterritorial impact of federal banking law.While there is considerable overlap in these twosections (for example, only a QFBO is eligiblefor both kinds of exemptions), they also havesignificant differences (for example, section 2(h)only exempts certain types of activities, whereas

1. A subsidiary is any company that either (1) has 25 per-cent or more of its voting shares directly or indirectly owned,controlled, or held with the power to vote by a company,including a foreign bank or a foreign banking organization, or(2) is otherwise controlled or capable of being controlled by aforeign bank or foreign banking organization. See 12 C.F.R.211.21(z).

2. Any FBO that qualifies as a financial holding company(FHC) would be able to make merchant banking investmentsand investments in connection with its insurance business inthe United States to the extent permitted for an FHC. The lackof eligibility for the exemption in section 211.23(f)(5) wouldnot negate or otherwise affect such authority.

Sections 4(c)(9) and 2(h) (Nonbanking Activities of FBOs) 3510.0


section 4(c)(9) may also exempt specific activi-ties or investments upon Board order).

3510.0.2.1 Section 4(c)(9) of theBHC Act

Section 4(c)(9) of the BHC Act authorizes theBoard to exempt the U.S. activities of a QFBO,through order or regulation, if the exemption‘‘would not be substantially at variance with thepurposes of [the BHC Act] and would be in thepublic interest.’’ The Board has implementedthis provision in Regulation K to permit a QFBOto engage directly or indirectly in any activityoutside of the United States; hold the shares ofany company that engages in activities in theUnited States that are ‘‘incidental’’ to foreignbusiness; hold a noncontrolling interest in anychiefly foreign company that engages in anyactivity in the United States, if the foreign com-pany derives more than half its assets and rev-enues from outside the United States; or own orcontrol voting shares of any company acquiredin good faith in a fiduciary capacity as permittedby section 4(c)(4) of the BHC Act. An FBO isnot permitted to own more than 10 percent ofthe shares of a foreign company that directly orindirectly engages in underwriting, selling, ordistributing securities to an extent not permittedfor bank holding companies.3 (See 12 C.F.R.211.23(f)(1), (2), (3), (4), and 5(i) and (ii).)

The provision that permits a QFBO to ownshares of a foreign company that engages inincidental, international activities in the UnitedStates has been defined by interpretation. Thatis, an activity is ‘‘incidental’’ to a foreign com-pany’s activities outside of the United Statesonly if it is an activity that an Edge or agree-ment corporation may perform in the UnitedStates. Section 211.6 of Regulation K definesthe permissible activities of an Edge or agree-ment corporation.4 An application to the Federal

Reserve is not required before a QFBO engagesin an activity that is incidental to internationalbusiness under this exemption.

A QFBO may also request a specific exemp-tion from the BHC Act under section 4(c)(9) toperform otherwise impermissible activities inthe United States. The Board considers theserequests on a case-by-case basis.

3510.0.2.2 Section 2(h) of the BHC Act

Section 2(h) of the BHC Act permits a QFBO toown or control the voting shares of a foreigncompany that is principally engaged in businessoutside of the United States and that engagesdirectly or indirectly in activities in the UnitedStates that are the same as or related to thecompany’s lines of business abroad.

Section 2(h) is designed to allow a QFBOthat has foreign commercial or industrial affili-ates to continue to hold those affiliates, even ifthe affiliate engages in activities in the UnitedStates that would ordinarily be prohibited bysection 4 of the BHC Act. The U.S. activitiesmust be the same kind of activity the affiliateconducts outside the United States and the for-eign affiliate must be chiefly foreign, that is, itmust derive more than half of its assets andrevenues from outside the United States. TheU.S. branches and agencies of a QFBO may notlend to an affiliate held under section 2(h)except on an arm’s-length basis.

A QFBO may not engage in financial activi-ties in the United States on the basis of section2(h). Regulation K provides a list of activitiesthat are considered ‘‘financial.’’ These activitiesshould be referenced to Division H (Finance,Insurance, and Real Estate) of the StandardIndustrial Classifications (SIC), as well as toselected activities in other divisions of the SICthat are considered financial in nature.5

3. Specifically, Regulation K permits a QFBO to (1) engagein activities of any kind outside the United States; (2) engagedirectly in activities in the United States that are incidental toits activities outside the United States; (3) own or controlvoting shares of any company that is not engaged, directly orindirectly, in any activities in the United States other thanthose that are incidental to the international or foreign busi-ness of such company; and (4) own or control voting shares ofany company in a fiduciary capacity under circumstances thatwould entitle such shareholding to an exemption under sec-tion 4(c)(4) of the BHC Act if the shares were held oracquired by a bank.

4. Generally, these activities must have an internationalnexus and may consist of receiving deposits from foreigngovernments and persons; receiving deposits from other per-sons under certain conditions; holding or investing liquidfunds in certain forms or instruments; engaging in certain

credit activities or borrowing funds; receiving or collectingpayments under certain conditions; performing foreign-exchange activities; acting as a fiduciary, an investment ad-viser, or a broker or performing other activities related toinvesting under certain conditions; providing banking servicesfor employees; and engaging in other activities with priorBoard approval. See 12 C.F.R. 211.6(a).

5. The North American Industry Classification System(NAIS) replaces the use of SIC codes. The NAICS codesdiffer from the SIC codes. To evaluate compliance with sec-tion 2(h) of the BHC Act, examiners should consult Regula-tion K directly when determining whether particular activitiesare permissible. Regulation K refers to NAICS codes.



Section 2(h) is implemented in Regulation Kas follows: A QFBO may own or control votingshares of a foreign company that is engageddirectly or indirectly in business in the UnitedStates other than that which is incidental to itsinternational or foreign business, subject to thefollowing limitations:

1. More than 50 percent of the foreign compa-ny’s consolidated assets shall be located,and consolidated revenues derived from, out-side the United States.6 (See 12 C.F.R.211.23(f)(5)(i).)

2. The foreign company shall not directly under-write, sell, or distribute, nor directly own orcontrol more than 10 percent of the votingshares of a company that underwrites, sells,or distributes, securities in the United Statesexcept to the extent permitted bank holdingcompanies. (See 12 C.F.R. 211.23(f)(5)(ii),12 C.F.R. 225.124, and section 3510.0.2.3.)

Regulation K places additional restrictions onthe 2(h) exemption when a QFBO owns a for-eign company that is a subsidiary. Specifically,the foreign company must be, or must control,an operating company. Its direct or indirectactivities in the United States are subject to thefollowing limitations:

1. The foreign company’s activities in the UnitedStates shall be the same kind of activities orrelated to the activities engaged in directly orindirectly by the foreign company abroad, asmeasured by the ‘‘establishment’’ categoriesof the SIC. An activity in the United Statesshall be considered related to an activityoutside the United States if it consists ofsupply, distribution, or sales in further-ance of the activity. (See 12 C.F.R.211.23(f)(5)(iii)(A).)

2. The foreign company may engage in activi-ties in the United States that consist of bank-ing securities, insurance or other financialoperations, or types of activities permitted byregulation or order under section 4(c)(8) ofthe BHC Act only under regulations of the

Board or with the prior approval of theBoard, subject to the following:a. Activities within Division H (Finance,

Insurance, and Real Estate) of the SICshall be considered banking or financialoperations for this purpose, with theexception of acting as operators of non-residential buildings (SIC 6512), opera-tors of apartment buildings (SIC 6513),operators of dwellings other than apart-ment buildings (SIC 6514), operators ofresidential mobile home sites (SIC 6515),and operating title abstract offices (SIC6541).

b. The following activities shall be consid-ered financial activities and may be engagedin only with the approval of the Boardunder section 211.23(g) of Regulation K:7credit reporting services (SIC 7323); com-puter and data processing services (SIC7371 to 7379); armored car services (SIC7381); management consulting (SIC 8732,8741, 8742, and 8748); certain rental andleasing activities (SIC 4741, 7352, 7353,7359, 7513, 7514, 7515, and 7519);accounting, auditing, and bookkeeping ser-vices (SIC 8721); courier services (SIC4215 and 4513); and arrangement of pas-senger transportation (SIC 4724, 4725,and 4729).

The restriction in paragraph 2b. above reflectsthe fact that section 2(h) is not the source ofauthority for a QFBO to engage in banking,securities, or other financial activities in theUnited States through a subsidiary.

The section 2(h) exemption only applies tothe nonfinancial, nonbanking activities of anFBO. To preserve competitive equity, theexemption does not permit an FBO to control aforeign nonbanking company that engages in, orthat holds more than 5 percent of the votingshares of another company that engages in,banking, securities, insurance, real estate, orother financial activities in the United States.These activities may be performed only withFederal Reserve approval under section 4(c)(8)or 4(c)(9) of the BHC Act.

3510.0.2.3 Foreign Banks’ Underwritingof Securities

A number of foreign banks, which are subject to

6. If the foreign company fails to meet the requirements ofparagraph (f)(5)(i) (12 C.F.R. 211.23) for two consecutiveyears (as reflected in annual reports (FR Y-7) the FBO filedwith the Board), the foreign company must be divested or itsactivities must be terminated within one year of the filing ofthe second consecutive annual report that reflects nonconfor-mance with the requirements of paragraph (f)(5)(i), unless theBoard grants consent to retain the investment under 12 C.F.R.211.23(g).

7. Section 211.23(g) of Regulation K permits a foreignbanking organization to request a case-by-case exemptionfrom the nonbanking restrictions to engage in otherwiseimpermissible activities pursuant to section 4(c)(9) of theBHC Act.



the BHC Act, had participated as co-managersin the underwriting of securities that were dis-tributed in the United States. These banks didnot have the authority to engage in securitiesunderwriting activity in the United States. TheU.S. offices of affiliates of the foreign bankswere used to engage in activities conducted insupport of the underwriting transactions, forwhich these U.S. offices were compensated bythe foreign bank. The foreign bank became amember of the underwriting syndicate but it didnot distribute any of the securities in the UnitedStates or elsewhere. The foreign banks took theposition that they were not engaged in under-writing in the United States because any under-writing obligation was booked outside the UnitedStates.

A foreign bank that is subject to the BHC Actmay engage in underwriting activities in theUnited States only if it has been authorizedunder section 4 of that act. Section 225.124 ofthe Board’s Regulation Y states that a foreignbank will not be considered to be engaged in theactivity of underwriting in the United States ifthe shares to be underwritten are distributedoutside the United States. In the transactions inquestion, all of the securities were distributed inthe United States.

In 1985, the Board amended Regulation K insection 211.23(f)(5)(ii) to provide clarificationthat a foreign banking organization shall not‘‘directly underwrite, sell, or distribute, nor ownor control more than 10 percent of the votingshares of a company that underwrites, sells, ordistributes securities in the United States, exceptto the extent permitted bank holding compa-nies.’’ When proposing this provision, the Boardstated ‘‘...that no part of the prohibited under-writing process may take place in the UnitedStates and that the prohibition on the activitydoes not depend on the activity being conductedthrough an office or subsidiary in the UnitedStates.’’

Regulation K defines ‘‘engaged in business’’and ‘‘engaged in activities’’ to mean conductingan activity through an office or subsidiary in theUnited States. The Regulation K definition of‘‘engaged in business,’’ adopted in 1979, how-ever, does not authorize foreign banking organi-zations to evade regulatory restrictions on secu-rities activities in the United States by usingU.S. offices and affiliates to facilitate the prohib-ited activity. Also, the framework of the Gramm-Leach-Bliley Act (the GLB Act) requires thatbanking organizations meet certain financial andmanagerial requirements of the GLB Act andthe Board’s Regulation K to engage in theseactivities in the United States.

The Board therefore issued an interpretationon February 7, 2003 (effective February 19,2003), clarifying that the underwriting by for-eign banks of securities to be distributed in theUnited States is an activity conducted in theUnited States, regardless of the location at whichthe underwriting risk is assumed and the under-writing fees are booked. Consequently, any bank-ing organization that wishes to engage in suchactivity must either be a financial holding com-pany under the GLB Act or have authority toengage in underwriting activity under section4(c)(8) of the BHC Act (so-called section 20authority). Revenue generated by underwritingbank-ineligible securities in such transactionsshould be attributed to the section 20 companyfor those foreign banks that operate under sec-tion 20 authority. (See 12 C.F.R. 211.605.)

3510.0.3 GRANDFATHER RIGHTS

Section 8 of the International Banking Act (IBA)provides grandfather rights to foreign banks thatoperated a branch, agency, or subsidiary com-mercial lending company at the time of enact-ment of the IBA.

Section 8(c) of the IBA permanently grand-fathers activities engaged in directly or throughan affiliate on or before July 26, 1978, or forwhich an application to engage in such activitieshad been filed on or before that date.8 Grand-fathered nonbanking activities may not beexpanded through the acquisition of any interestin or the assets of a going concern engaged inthe same activities. The Board may, subject toopportunity for hearing, terminate these grand-father rights where it is necessary to preventundue concentration of resources, decreased orunfair competition, conflicts of interest, orunsound banking practices in the United States.A foreign bank that is required to terminate itsindirect grandfathered activity may retain own-ership of the shares of the grandfathered com-pany for a period of two years from the date ofthe Board’s action.

Grandfather rights conferred under section8(c) of the IBA shall terminate immediatelyupon the filing of an FHC declaration by theforeign bank or foreign company. With respectto a foreign bank or foreign company that did

8. The term ‘‘affiliate’’ means any company that controls,is controlled by, or is under common control with the foreignbank or the parent of the foreign bank.



not file an FHC declaration by November 12,2001, the Board has the authority, giving dueregard to the principle of national treatment andequality of competitive opportunity, to imposesuch restrictions and requirements on the con-

duct of any grandfathered activities as are com-parable to those imposed on a U.S. FHC, includ-ing a requirement to conduct such activities incompliance with any prudential safeguardsestablished under 12 U.S.C. 1828a.



Foreign bankingorganizations

1841(h)1843(c)(9)3106

211.23(f)(5)

Underwriting of securitiesin the United Statesis an activity conductedin the United States

211.605 3–693





Section 4(c)(10) of the BHC Act (Grandfather Exemption fromSection 4 for BHC’s Which Are Banks) Section 3520.0

This section provides a ‘‘grandfather’’ exemp-tion from the general prohibitions of section 4for a small group of bank holding companieswhich are themselves banks. For such bankholding companies and their wholly-owned sub-sidiaries, the exemption provides for continuedownership of nonbank shares which were law-fully acquired and owned directly or indirectlyprior to enactment of the Act (May 9, 1956). Atthe time of its enactment, this section accommo-dated only three bank holding companies.

It should be noted that this section, in refer-

ring to shares indirectly owned through subsidi-aries, limits the exemption to ‘‘wholly-ownedsubsidiaries.’’ The reason for this limitationapparently ties to the Federal Reserve Act andother federal banking statutes which permitNational and member banks to engage throughwholly-owned operating subsidiaries in variousbank-related activities.

It is required that the shares covered underthis section have been continuously held sinceMay 9, 1956. Such interpretation is in keepingwith other sections of the Act.


Section 4(c)(11) (Authorization for BHCs to Reorganize Share OwnershipHeld on the Basis of Any Section 4 Exemption) Section 3530.0

Section 4(c)(11) was adopted to authorize bankholding companies to reorganize share owner-ship held on the basis of any section 4 exemp-tion. Reorganization is permitted with respect tosection 4(a)(2) grandfathered activities engagedin prior to June 30, 1968, retaining indefinitegrandfather authority. Shares held pursuant toBoard approval under section 4(c)(8) or anyother section 4 exemption also come withinsection 4(c)(11)’s reorganization authority.Under section 4(c)(11), a bank holding com-

pany is authorized to reorganize its share owner-ships, shift its activities among its various enti-ties and form new subsidiaries without Boardapproval as long as there is no change in theactivities of the bank holding company system.Congress also felt it entirely appropriate for

these companies to expand their activities solong as such expansion did not produce anti-competitive or other adverse effects. Accord-ingly, internal expansion of the grandfatheredactivities was permitted but the provision wasadded that this section does not authorize thegrandfathered companies to acquire, eitherdirectly or indirectly, any interest in or the assetsof any going concern outside the holding com-pany system (unless the acquisition is pursuantto a contract entered into before June 30, 1968).Congress reasoned that purchasing a going con-cern engaged in the grandfathered activities of aholding company would tend to have an anti-competitive effect in that it would reduce thenumber of firms competing against each other ina given activity.


Section 4(c)(12) of the BHC Act (Ten Year Exemptionfrom Section 4 of the BHC Act) Section 3540.0

This section provided an exemption from thegeneral prohibitions of section 4 for shares heldor activities which became subject to the Act bythe 1970 amendments.Section 4(c)(12) provided not only for contin-

ued ownership of shares or performance ofactivities so held or performed as of December31, 1970, but also for others permitted afterwardby the Board. As stated in subparagraphs (A)and (B) of section 4(c)(12), the 10-year exemp-tion applied if such bank holding companies:(A)(i) ceased to be bank holding companies byDecember 31, 1980; or (A)(ii) ceased to retaindirect or indirect ownership of the nonbankshares or engage in the nonbank activities byDecember 31, 1980; or (B) complied with suchother condition as the Board may prescribe.A company was required to file an irrevoca-

ble declaration that it would cease to be a bankholding company by January 1, 1981, unless theBoard granted it hardship exemption under sec-

tion 4(d) of the Act. Such a company could thenexpand its nonbanking activitiesde novowith-out notification to the Board and could acquire agoing concern nonbank company 45 days afterinforming the appropriate Reserve Bank of theproposed acquisition unless notified otherwisewithin that time. If an irrevocable declarationwas not filed, then no acquisition could havebeen made or activities commenced under sec-tion 4(c)(12) except with prior Board approval.These limitations did not apply to acquisitionsmade pursuant to a binding commitment enteredinto before March 23, 1971.Few bank holding companies have claimed

anexemptionundersection4(c)(12). It isunlikelythat many situations involving section 4(c)(12)will be encountered by inspection personnel.However, if a 4(c)(12) company has committedto cease the nonbanking activities examinersmust ensure that the divestiture has occurred.



Divestitures 225.138

Successor rights 1977 FRB 946




Section 4(c)(13) of the BHC Act (InternationalActivities of Bank Holding Companies) Section 3550.0

Section 4(c)(13) of the BHC Act governs theinternational activities of bank holding compa-nies. In general, the act authorizes the Board topermit domestic bank holding companies toinvest in companies that do no business in theUnited States except what is incidental to inter-national or foreign business. Bank holding com-panies may invest in the same companies asEdge corporations.

3550.0.1 INVESTMENTS ANDACTIVITIES ABROAD

The investment provisions of Regulation K (sec-tions 211.8, 211.9, and 211.10) implement sec-tion 4(c)(13) of the BHC Act. In general, an‘‘investor’’ under Regulation K may invest,directly or indirectly, in a subsidiary or jointventure or may make portfolio investments, sub-ject to the limits in section 211.8 and the generalprovisions in section 211.9(a). (See SR-02-03and SR-02-02.)

Bank holding companies may invest in thesame types of entities as Edge and agreementcorporations.However,memberbanksmay investdirectly in only foreign banks; domestic or for-eign organizations formed for the sole purposeof holding shares of a foreign bank; foreignorganizations formed for the sole purpose ofperforming nominee, fiduciary, or other bankingservices incidental to the activities of a foreignbranch or foreign bank affiliate of the memberbank; and subsidiaries established pursuant tosection 211.4(a)(8) of Regulation K (that is, acompany that engages solely in activities inwhich the member bank is permitted to engageor that are incidental to the activities of themember bank’s foreign branch). (See all sec-tions of Regulation K for any other activity orinvestment authorizations, limitations, require-ments, or prohibitions not discussed in thissection.)

In general, the Board has limited the types ofactivities that a bank holding company mayengage in through the ownership of foreigncompanies to banking or financially relatedactivities, and to those that are necessary tocarry on such activities. These include all of theactivities permitted under section 211.10 ofRegulation K and section 4(c)(8) of the BHCAct, including equity securities underwritingand management consulting. Many of the activi-ties permitted abroad are not subject to the samelimits as those imposed domestically under sec-

tion 4(c)(8) (for example, brokerage of all typesof insurance is permitted abroad).

Activities abroad, whether conducted directlyor indirectly, are to be confined to activities of abanking or financial nature and to those that arenecessary to carry on such activities. At alltimes, investors1 must act in accordance withhigh standards of banking or financial prudence,having due regard for diversification of risks,suitable liquidity, and adequacy of capital. TheBoard follows the policy of allowing activitiesabroad to be organized and operated as bestmeets corporate policies. The following pro-vides a limited discussion of general investmentactivities under Regulation K. The regulationshould be referred to for more specific require-ments and limitations.

In general, an investor may make (1) aninvestment in a subsidiary, (2) an investment ina joint venture, or (3) a portfolio investment inan organization. With regard to an investment ina subsidiary, the subsidiary must engage inactivities authorized under section 211.10 ofRegulation K, or in other activities that theBoard has determined to be permissible (for aparticular case). In the acquisition of a goingconcern, existing activities that are not other-wise permissible for a subsidiary may accountfor not more than 5 percent of either the acquiredorganization’s consolidated assets or consoli-dated revenues. For an investment in a jointventure, no more than 10 percent of the jointventure’s consolidated assets or consolidatedrevenues can be attributable to activities that arenot listed in section 211.10.

For portfolio investments in an organization,the investor and its affiliates’ total direct andindirect portfolio investments in an organizationthat is engaged in activities not permissible forjoint ventures, when combined with all othershares in the organization (held under any otherauthority), cannot exceed—

1. 40 percent of the total equity of the organiza-tion, or

2. 19.9 percent of the organization’s votingshares.

In addition to the individual investment limits,these portfolio investments are subject to an

1. For purposes of sections 211.8, 211.9, and 211.10 ofRegulation K, a direct subsidiary of a member bank is deemedto be an investor.


aggregate equity limit. (See section 211.10(a)(15)of Regulation K.) For investments in organiza-tions engaged in activities that are not permis-sible for joint ventures, when combined withshares held directly and indirectly by the inves-tor and its affiliates under the equity dealingprovisions of Regulation K, the investmentscannot exceed—

1. 25 percent of the bank holding company’stier 1 capital, where the investor is a bankholding company;

2. 20 percent of the investor’s tier 1 capital,where the investor is a member bank;2 and

3. the lesser of 20 percent of any parent insuredbank’ s tier 1 capital or 100 percent ofthe investor’s tier 1 capital, for any otherinvestor.

3550.0.2 INVESTMENT PROCEDURES

Except as the Board may otherwise determine,direct and indirect investments must be made inaccordance with the general-consent, limited-general-consent, prior-notice, or specific-consent procedures of section 211.9 of Regula-tion K. The investment procedures of section211.9(a) include the following requirements:

1. Minimum capital adequacy standards. Theinvestor, the bank holding company, and themember bank must be in compliance withapplicable minimum standards for capitaladequacy set out in the capital adequacyguidelines. If the investor is an Edge oragreement corporation, the minimum capitalrequired is total and tier 1 capital ratios of8 percent and 4 percent, respectively.

2. Composite rating. For an investor to makeinvestments under the general-consent orlimited-general-consent procedures of sec-tions 211.9(b) and (c), the investor and anyparent insured bank must have received acomposite rating of at least 2 at the mostrecent examination.

3. Modification or suspension of procedures.The Board may, at any time upon notice,modify or suspend the investment proce-dures for any investor or for the acquisitionof shares of organizations engaged in particu-lar kinds of activities.

4. Long-range investment plan. Any investormay submit a long-range investment plan tothe Board for its specific consent. If approvedby the Board, the plan shall be subject to theother procedures of section 211.9 only to theextent the Board determines is necessary toensure the safety and soundness of the opera-tions of the investor and its affiliates.

5. Prior specific consent for initial investment.For its initial investment in its first subsidiaryor joint venture under subpart A of Regula-tion K, an investor must apply for and receivethe prior specific consent of the Board, unlessan affiliate previously has received approvalto make such an investment.

6. Expiration of investment authority. Authorityto make investments that was granted underprior-notice or specific-consent proceduresshall expire one year from the earliest dateon which the authority could have been exer-cised, unless the Board determines a longerperiod shall apply.

7. Conditional approval; access to information.The Board may impose such conditions oninvestment authority granted under section211.9 as it deems necessary. The Board mayalso require termination of any activities con-ducted under subpart A of Regulation K, ifan investor is unable to provide informationon its activities or those of its affiliates thatthe Board deems necessary to determine andenforce compliance with U.S. banking laws.

3550.0.3 GENERAL CONSENT FORWELL-CAPITALIZED ANDWELL-MANAGED INVESTORS

The Board has granted its limited general con-sent to make investments by well-capitalizedand well-managed investors. For these general-consent provisions to apply, the investor, anyparent-insured bank, and any parent bank hold-ing company must be well capitalized and wellmanaged both before and immediately after theproposed investment. The investments are sub-ject to the limitations discussed below.

3550.0.3.1 Individual Limit forInvestment in a Subsidiary

The Board grants its general consent for invest-ments by well-capitalized and well-managedinvestors, subject to certain investment limita-tions. For an investment in a subsidiary, the totalamount that may be invested directly or indi-rectly (in one transaction or a series of transac-

2. For this purpose, a direct subsidiary of a member bank isdeemed to be an investor.

Section 4(c)(13) of the BHC Act (International Activities of BHCs) 3550.0


tions) may not exceed 10 percent of the inves-tor’s tier 1 capital, where the investor is a bankholding company; 2 percent of the investor’stier 1 capital, where the investor is a memberbank; or the lesser of 2 percent of the tier 1capital of any parent-insured bank or 10 percentof the investor’s tier 1 capital, for any otherinvestor.

3550.0.3.2 Individual Limit forInvestments in a Joint Venture

For individual investments in a joint venture,the total amount invested directly or indirectly(in one transaction or a series of transactions)may not exceed 5 percent of the investor’s tier 1capital, where the investor is a bank holdingcompany; 1 percent of the investor’s tier 1 capi-tal, where the investor is a member bank; or thelesser of 1 percent of the tier 1 capital of anyparent-insured bank or 5 percent of investor’stier 1 capital, for any other investor.

3550.0.3.3 Individual Limit for PortfolioInvestment

For a portfolio investment, the total amountinvested directly or indirectly (in one transac-tion or a series of transactions) in such com-pany, general partnership, or unlimited-liabilitycompany cannot exceed the lesser of $25 mil-lion or—

1. 5 percent of the investor’s tier 1 capital, inthe case of a bank holding company or itssubsidiary or an Edge corporation engaged inbanking; or

2. 25 percent of the investor’s tier 1 capital, inthe case of an Edge corporation not engagedin banking.

3550.0.3.4 Aggregate Investment Limits

The amount of all investments made, directly orindirectly, during the previous 12-month periodunder section 211.9, when aggregated with theproposed investment, shall not exceed 20 per-cent of the investor’s tier 1 capital, where theinvestor is a bank holding company; 10 percentof the investor’s tier 1 capital, where the inves-tor is a member bank; or the lesser of 10 percentof the tier 1 capital of any parent-insured bankor 50 percent of the tier 1 capital of the investor,for any other investor.

3550.0.4 LIMITED GENERALCONSENT FOR AN INVESTOR THATIS NOT WELL CAPITALIZED ORWELL MANAGED

3550.0.4.1 Individual Limit

For investors that are not well capitalized andwell managed, the Board has granted limitedgeneral consent for an investor to make aninvestment in a subsidiary or joint venture, or tomake a portfolio investment. The total amountinvested, directly or indirectly (in one transac-tion or a series of transactions), cannot exceedthe lesser of $25 million or 5 percent of theinvestor’s tier 1 capital, where the investor is abank holding company; 1 percent of the inves-tor’s tier 1 capital, where the investor is a mem-ber bank; or the lesser of 1 percent of any parentinsured bank’s tier 1 capital or 5 percent of theinvestor’s tier 1 capital, for any other investor.

3550.0.4.2 Aggregate Limit

The amount of limited-general-consent invest-ments made by such an investor directly orindirectly during the previous 12-month period,when aggregated with the proposed investment,cannot exceed 10 percent of the investor’s tier 1capital, where the investor is a bank holdingcompany; 5 percent of the investor’s tier 1 capi-tal, where the investor is a member bank; andthe lesser of 5 percent of any parent insuredbank’s tier 1 capital or 25 percent of the inves-tor’s tier 1 capital, for any other investor.

3550.0.5 CALCULATINGCOMPLIANCE WITH THEINDIVIDUAL AND AGGREGATEGENERAL-CONSENT LIMITS

When determining compliance with the indi-vidual and aggregate general-consent limits, aninvestment by an investor in a subsidiary canonly be counted once, notwithstanding that thesubsidiary may, within 12 months of making theinvestment, downstream all or any part of theinvestment to another subsidiary. Also, whendetermining compliance with these limits, aninvestor is not required to combine the value ofall shares of an organization held in trading ordealing accounts under section 211.10(a)(15) of



Regulation K with investments in the sameorganization.

3550.0.6 OTHER ELIGIBLEINVESTMENTS UNDER GENERALCONSENT

In addition to the general-consent authorityalready discussed, the Board has granted itsgeneral consent for any investor to make thefollowing investments: any investment in anorganization in an amount equal to cash divi-dends received from that organization duringthe preceding 12 calendar months, and anyinvestment that is acquired from an affiliate atnet asset value or though a contribution ofshares.

3550.0.7 INVESTMENT INELIGIBLEFOR GENERAL CONSENT

An investment in a foreign bank is ineligible forgeneral consent if (1) after the investment, theforeign bank would be an affiliate of a memberbank, and (2) the foreign bank is located in acountry in which the member bank and its affili-ates have no existing banking presence.

3550.0.8 INVESTMENTS MADE WITHPRIOR NOTICE TO OR THE SPECIFICCONSENT OF THE BOARD

An investment that does not qualify for generalconsent under section 211.9(b), (c), or (d) ofRegulation K may be made after the investorhas provided the Board with 30 days’ priorwritten notice. The notice period commences atthe time the notice is received. However—

1. the Board may waive the 30-day period if itfinds the full period is not required for con-sideration of the proposed investment, or thatthe circumstances presented require immedi-ate action, and

2. the Board may suspend the 30-day period oract on the investment under its specific-consent procedures.

Any investment that does not qualify for eitherthe general-consent or the prior-notice proce-dure cannot be consummated without the spe-cific consent (that is, express approval) of theBoard.

3550.0.9 EXAMINATION OF FOREIGNSUBSIDIARIES OF BHCs

The procedures involved in examining foreignsubsidiaries of domestic bank holding compa-nies are generally the same as those used inexamining domestic subsidiaries engaged in simi-lar activities. The on-site examination of foreignsubsidiaries is, however, necessarily limited. Inmost cases, examiners should try to implementasset-appraisal procedures by using records atthe location of the U.S. parent or bank. Overseasexaminations are intended primarily to appraisethe firm’s internal-control systems and the suffi-ciency of the firm’s reporting to its parent com-pany. For examination objectives and proce-dures for foreign subsidiaries, see the instructionsfor similar section 4(c)(8) investments in othersections of this manual.

3550.0.10 INVESTMENTS BY BANKHOLDING COMPANIES, EDGECORPORATIONS, AND MEMBERBANKS IN FOREIGN COMPANIES

Subject to the limitations within subpart A ofRegulation K, the Board allows, with its specificconsent, banking organizations to acquire andhold investments in foreign companies that dobusiness in the United States subject to thefollowing conditions:

1. The activities abroad, whether conducteddirectly or indirectly, must be confined toactivities of a banking or financial nature andthose that are necessary to carry out suchactivities. When engaging in these activities,the investors are to act in accordance withhigh standards of banking and financial pru-dence, having due regard for diversificationof risks, suitable liquidity, and adequacy ofcapital.

2. The activities are either those that the Boardhas determined to be usual in connectionwith the transaction of banking or otherfinancial operations abroad as listed in sec-tion 211.10 of Regulation K, including thoseactivities authorized with the Board’s spe-cific approval, and those that have been deter-mined to be usual in connection with thetransaction of the business of banking orother financial operations abroad, consistentwith the Federal Reserve Act or the BHCAct.





Investment and activities abroad 211.8

Investment procedures 211.9

Use of foreign subsidiaries to selllong-term debt obligations inforeign markets

3–706

Investment by U.S. banking organi-zations in foreign companies thattransact business in the United States

211.602 3–715

Investment by U.S. banking organi-zations in futures commissionmerchant activities overseas

1982 FRB 671

Investment by U.S. banking organi-zation in general life insuranceunderwriting overseas

1984 FRB 1681985 FRB 269

Investment by U.S. banking organi-zation in property and casualtyinsurance underwriting overseas

1985 FRB 2671985 FRB 808

Investment by U.S. banking organi-zation in physical commoditiesbrokered overseas

1981 FRB 369

Investment in Edge Act corporation 611–632

Investment in foreign bankingcorporation

601–604/611–618





Section 4(c)(14) of the BHC Act(Export Trading Companies) Section 3560.0

In 1982 the Bank Holding Company Act of1956 was amended by the Bank Export ServicesAct (BESA). The Bank Export Services Actprovided an exemption to the prohibitions ofSection 4 of the BHC Act for a bank holdingcompany’s investment in the shares of any com-pany that is an export trading company. The(BESA) was designed to increase U.S. exportsby encouraging investments and participation inexport trading companies by bank holding com-panies and the specified investors.

An export trading company is a company thatis exclusively engaged in activities related tointernational trade and, by engaging in one ormore export trade services:

1. derives at least one-third of its revenues ineach consecutive four-year period (excluding atwo-year start up period) from the export ofgoods and services produced in the United Statesby persons other than the export trading com-pany or its subsidiaries; and

2. derives revenues from the export, or facil-itating the export, of goods or services producedin the United States and those revenues exceedrevenues from the import, or facilitating theimport into the United States, of goods or ser-vices produced outside the United States.

A bank holding company’s direct and indirectinvestment in export trading companies may notexceed 5 percent of the bank holding company’sconsolidatedcapitalandsurplus.The totalamountof extensions of credit by a bank holding com-pany and its subsidiaries to its affiliated exporttrading company may not exceed 10 percent ofthe bank holding company’s consolidated capi-tal and surplus.

A bank holding company may not invest inan export trading company, unless the Board hasbeen given sixty days prior written notice of theproposed investment. The Board may disap-prove any proposed investment only if:

1. Such disapproval is necessary to preventunsafe or unsound banking practices, undueconcentration of resources, decreased or unfaircompetition, or conflicts of interest; or

2. It finds that such investment would affectthe financial or managerial resources of a bankholding company to an extent that is likely tohave a materially adverse effect on the safetyand soundness of any subsidiary bank of suchbank holding company; or

3. The bank holding company fails to furnishthe information required by the Board.

An Edge Act or agreement corporation that isa subsidiary of a bank holding company mayinvest directly or indirectly in the aggregate up

to 5 percent (25 percent in the case of a corpora-tion not engaged in banking) of the voting stockor other evidences of ownership in one or moreexport trading companies.

Sections 23A and 23B of the Federal ReserveAct applies to transactions between an exporttrading company and its affiliated banks. Regu-lation K, however, grants relief from section23A’s collateral requirements where a bank issuesa letter of credit or advances funds to an affili-ated export trading company solely to financethe purchase of goods for which: (1) the exporttrading company has a bona fide contract for thesubsequent sale of the goods; and (2) the bankhas a security interest in the goods or in theproceeds from their sale at least equal in valueto the letter of credit or the advance. All other‘‘covered transactions’’ between a bank and anaffiliated export trading company should con-form to sections 23A and 23B of the FederalReserve Act.


Export Trading Companies are generally subsid-iaries of bank holding companies. Regulationsapplicable to them are contained in Section211.31–4 of Regulation K. Inspections of ExportTrading Companies will usually be conductedby international examiners or examiners havingspecialized training. Examiners conducting in-spections of Export Trading Companies shouldbe familiar with these sections as well as Sec-tion 4(c)(14) of the BHC Act.

There is no standardized inspection reportform for inspections of Export Trading Compa-nies. However, as a minimum, the report is toinclude the following items:


Page Description

— Cover

Name of organizationLocationName of parentLocation of parentDate inspection commencedDate of financial statements

i Table of Contents

Same information as cover

1 Examiner’s comments

Scope of inspectionSummary of conditionViolationsOperating resultsAdequacy of accounting records,internal controls, and audit

2 Comparative balance sheets

3 Comparative income statements

4 Classified Assets

CONFIDENTIAL

A Officers 1

B Directors 1

C Confidential comments

Assessment of management

1. Same information in tabular form as in Edge report.

Inspection procedures should follow the ExportTrading Company Questionnaire, illustratedherein. The questionnaire will be part of aspecial inspection report, prepared separately,or in conjunction with, a holding companyinspection.

A copy of the Export Trading Company reportas well as a copy of the Export Trading Com-pany Questionnaire will be retained and in-cluded in the workpapers for the BHC inspec-tion. Significant findings will be incorporatedinto the ‘‘ Examiner’s Comments’’ page, or theAnalysis of Financial Factors page, whenappropriate.

Section 4(c)(14) of the BHC Act (Export Trading Companies) 3560.0


3560.0.1.1 Export Trading Company Questionnaire

Yes No NA Comments

( )1. Is the Bank Holding Company (BHC) orbanking Edge Corporation investment in theExport Trading Company (ETC) limited to5% of its consolidated capital and surplus?

Reference: BESA, Section 203; BHC Act,Section 4(c); Regulation K, Section211.33(a)

( )2. Is the investment in the ETC by an EdgeCorporation not engaged in banking limited to25% of its consolidated capital and surplus?

Reference: Same as question 1.

( )3. Did the BHC or Edge Corporation furnish theFederal Reserve Board through the local FRBwritten notice of its proposed investmentin the ETC at least 60 days prior to itsinvestment in the ETC?

Reference: BESA, Section 203; BHC Act,Section 4(c); Regulation K, Section 211.34

( )4. Do the direct and indirect outstanding creditextensions to the ETC by the investor and itssubsidiaries exceed 10% of the investor’sconsolidated capital and surplus?

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(B); Regulation K,Section 211.33(b)

5. If the BHC or its subsidiary has extendedcredit to an affiliated ETC or to any of theETC’s customers:

( )a. are the terms of the credit any more fa-vorable than those afforded to similar bor-rowers in similar circumstances;

( )b. does the credit involve more than normalrisk of repayment; and

( )c. does the credit present any unfavorablefeatures?

Reference: Regulation K, Section 211.33(b)(2)

6. If the BHC or its subsidiary has extended creditto another investor with at least 10% interest inthe ETC, or to an affiliate of the investor:

( )a. are the terms of the credit any more favorablethan those afforded to similar borrowers insimilar circumstances;



Yes No NA Comments

( )b. does the credit involve more than normalrisk of repayment; and,

( )c. does the credit present any unfavorablefeatures?


( )7. Do covered transactions (under Sections 23Aand 23B of the Federal Reserve Act) betweena bank and an affiliated ETC meet the collateralrequirements of Section 23A unless exemptedbecause the bank has extended a letter of creditor advance to the affiliated ETC solely for thepurchase of goods for which:

a. the ETC has a bona fide sales contract; and

b. the bank has a security interest in the goods,or in the proceeds from their sale at leastequal in value to the letter of credit oradvance?

Reference: Regulation K, Section 211.33(b)(3)

( )8. Has the ETC received an export tradeCertificate of Review which exempts it fromantitrust laws?

Reference: BESA, Section 301

( )9. Has the ETC Certificate holder submitted anannual report to the Secretary of Commerceas required?


( )10. Is the ETC exclusively engaged in activitiesrelated to international trade?

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(F) Regulation K, Section211.32(a)

( )11. Is the ETC operated principally for thepurposes of exporting goods or servicesproduced in the U.S., or for purposes offacilitating the exportation of goods or ser-vices produced in the U.S. by unaffiliatedpersons by providing one or more exporttrade services?



Yes No NA Comments

The term ‘‘export trade services’’ includes,but is not limited to, consulting, internationalmarket research, advertising, marketing,insurance other than acting as principal,agent or broker in the sale of insurance onrisks resident or located, or activities per-formed, in the United States, except forinsurance covering transportation of cargofrom any point of origin in the U.S. to pointof origin in the U.S. to a point of final desti-nation outside the U.S., product research anddesign, legal assistance, transportation,including trade documentation and freightforwarding, communication and processingof foreign orders to and for exporters andforeign purchasers, warehousing, foreignexchange, financing, and taking title togoods in order to facilitate U.S. exports. AnETC may engage in importing, barter, andthird-party trades only if these activities fur-ther U.S. exports and only if the preponder-ance of ETC activities do not involveimporting and the revenues from exportactivities exceed revenues from importactivities.


( )12. If the ETC has expanded its activities signifi-cantly beyond those in the original notice tothe Board, such as to taking title to goods,product research and design, product modifi-cation, or activities not specifically coveredin the BHC Act, has the investor given a 60day notice in advance to the Board?

Reference: Regulation K, Section 211.34

( )13. If the ETC has been in operation more thansix years, is more than one-third of theETC’s revenue in the last consecutive four-year period derived from exports orfacilitating exports of U.S. goods and ser-vices produced in the U.S. by persons otherthan the ETC or its subsidiaries?

Revenue includes net sales revenue from thetrading of goods by the ETC for its ownaccount and gross revenue from all otheractivities of the ETC.

Reference: Regulation K, Section 211.32(a)



Yes No NA Comments

( )14. Does the ETC engage in agricultural produc-tion, manufacturing or product modificationof goods, e.g., repackaging, reassembly, orextracting by-products other than incidentalproduct modification as necessary to con-form to the requirements of foreign countriesfor sale of the goods in the foreigncountries?

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(c)

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(c)

( )15. Does the ETC take title to goods for which ithas received no firm purchase order orcommitment?

Reference: BESA, Section 103(a)(3)

16. What period of time do the goods on whichthe ETC has taken title remain in the inven-tory of the ETC?

( )Does this activity appear unduly speculative?


( )17. Do the nature and terms of sale of goodsretained by the ETC appear to be in line withproper ETC business operations, i.e., notunduly speculative and related to authorizedactivities?


( )18. If the ETC acts as a principal, agent, orbroker in the sale of insurance, does suchactivity exclude the sale of insurance onrisks or activities located or performedin the U.S.

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(F)

( )19. If the ETC engages in, or holds shares of acompany engaged in underwriting, selling ordistributing securities in the U.S., are suchactivities limited to the same extent as forBHC’s under applicable Federal and Statebanking laws and regulations?

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(C), 12 USC, Section1843(c)(14)(C)(i)



Yes No NA Comments

( )20. Does the ETC take positions in commodities,commodity contracts, securities or foreignexchange other than as may be necessary inthe course of the ETC’s authorized businesstransactions?

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(D)

( )21. Are activities of the ETC Certificate holderin compliance with the Certificate ofReview? (If not, the ETC could be subject toantitrust laws.)


( )22. Does the ETC capital base appear to ade-quately support the strength of the ETC andits ability to withstand unexpected adversedevelopments so as not to affect the financialresources of the parent or the safety andsoundness of affiliated banks?

Reference: 43Federal Register,26,448(1983).

( )23. Is there any evidence of adverse effect of theinvestment in the ETC on the investment inthe ETC on the financial or managerialresources of the BHC or Edge Corporationinvestor, or on the safety and soundness ofany subsidiary bank of a BHC investor?

Reference: BESA, Section 203; BHC Act,Section 4(c)(14)(A)(iv)(11)

( )24. Has the ETC’s capital to asset ratio remainedat all times at or above the minimum estab-lished in the original notice to the Board?

( )25. Is the ETC in compliance with operationalpolicies, including maximum financial lever-age per transaction, as established in theoriginal notice to the Board?

( )=Exception

Export Trading Company

Bank Holding Company Investor

Examination Date

Prepared by:

Date:



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