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Federal Reserve Bank of Dallas
2200 N. PEARL ST.
DALLAS, TX 75201-2272

March 20, 2003

Notice 03-18

TO:

The Chief Executive Officer of each
financial institution and others concerned
in the Eleventh Federal Reserve District
SUBJECT
Proposed Amendments to Regulation Y
(Bank Holding Companies and Change in Bank Control)
DETAILS

The Board of Governors of the Federal Reserve System has requested comments on
proposed amendments to Regulation Y (Bank Holding Companies and Change in Bank Control) that
would permit bank holding companies to take and make delivery of title to commodities underlying
derivative contracts on an instantaneous, pass-through basis.
The Board must receive comments by April 14, 2003. Please address comments to Jennifer J.
Johnson, Secretary, Board of Governors of the Federal Reserve System, 20th Street and Constitution
Avenue, N.W., Washington, DC 20551. Also, you may mail comments electronically to
regs.comments@federalreserve.gov. All comments should refer to Docket No. R-1146.
ATTACHMENT
A copy of the Board’s notice as it appears on pages 12316–18, Vol. 68, No. 50 of the Federal
Register dated March 14, 2003, is attached.
MORE INFORMATION
For more information, please contact Gayle Teague, Banking Supervision Department,
(214) 922-6151. Paper copies of this notice or previous Federal Reserve Bank notices can be printed from
our web site at http://www.dallasfed.org/banking/notices/index.html.

For additional copies, bankers and others are encouraged to use one of the following toll-free numbers in contacting the Federal
Reserve Bank of Dallas: Dallas Office (800) 333-4460; El Paso Branch Intrastate (800) 592-1631, Interstate (800) 351-1012;
Houston Branch Intrastate (800) 392-4162, Interstate (800) 221-0363; San Antonio Branch Intrastate (800) 292-5810.

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Federal Register / Vol. 68, No. 50 / Friday, March 14, 2003 / Proposed Rules

FEDERAL RESERVE SYSTEM
12 CFR Part 225
[Regulation Y; Docket No. R–1146]

Bank Holding Companies and Change
in Bank Control
AGENCY: Board of Governors of the
Federal Reserve System.
ACTION: Proposed rule with request for
public comments.
SUMMARY: The Board of Governors of the
Federal Reserve System is proposing an
amendment to Regulation Y that would
permit bank holding companies to take
and make delivery of title to
commodities underlying derivative
contracts on an instantaneous, passthrough basis.
DATES: Comments on the proposed rule
must be received not later than April 14,
2003.
ADDRESSES: Comments should refer to
Docket No. R–1146, and should be
mailed to Ms. Jennifer J. Johnson,
Secretary, Board of Governors of the
Federal Reserve System, 20th Street and
Constitution Avenue, NW., Washington,
DC 20551, or mailed electronically to
regs.comments@federalreserve.gov.
Comments addressed to Ms. Johnson
also may be delivered between 8:45 a.m.
and 5:15 p.m. to the Board’s mail
facility in the West Courtyard of the
Eccles Building, located on 21st Street
between Constitution Avenue and C
Street, NW. Members of the public may
inspect comments in Room MP–500 of
the Martin Building between 9 a.m. and
5 p.m. on weekdays pursuant to
§ 261.12, except as provided in § 261.14,
of the Board’s Rules Regarding
Availability of Information, 12 CFR
261.12 and 261.14.
FOR FURTHER INFORMATION CONTACT:
Scott G. Alvarez, Associate General
Counsel (202/452–3583), Mark E. Van
Der Weide, Counsel (202/452–2263), or
Andrew S. Baer, Counsel (202/452–
2246), Legal Division. For users of
Telecommunications Device for the Deaf
(TDD) only, contact 202/263–4869.
SUPPLEMENTARY INFORMATION:

Background
The Board’s Regulation Y currently
authorizes bank holding companies
(‘‘BHCs’’) to engage as principal in
forward contracts, options, futures,
options on futures, swaps, and similar
contracts, whether traded on exchanges
or not, based on a rate, price, financial
asset, nonfinancial asset, or group of
assets (other than a bank-ineligible
security) (‘‘Commodity Contracts’’). A
BHC’s authority to enter into

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Commodity Contracts is subject to
certain restrictions that are designed to
limit the BHC’s activity to trading and
investing in financial instruments rather
than dealing directly in commodities. In
particular, Regulation Y provides that a
BHC may enter into a Commodity
Contract only if (i) the commodity
underlying the contract is eligible for
investment by a state member bank; or
(ii) the contract requires cash
settlement; or (iii) the contract allows
for assignment, termination, or offset
prior to delivery or expiration (the
‘‘Contractual Offset Requirement’’), and
the BHC makes every reasonable effort
to avoid taking or making delivery of the
underlying commodity (the ‘‘Delivery
Avoidance Requirement’’).1
The effect of these restrictions is to
allow a BHC to engage as principal in
derivative contracts involving any type
of commodity (other than bankineligible securities) but to limit the
authority of a BHC to physically settle
derivative contracts. Under these
restrictions, a BHC may take or make
delivery on derivative contracts based
on commodities that a state member
bank is permitted to own.2 For all other
types of physically settled commodity
derivatives,3 a BHC must make
reasonable efforts to avoid delivery, and
the contract must have assignment,
termination, or offset provisions.
The Bank Holding Company Act
(‘‘BHC Act’’), as amended by the
Gramm-Leach-Bliley Act (Pub. L. No.
106–102, 113 Stat. 1338 (1999)) (‘‘GLB
Act’’), permits a BHC to engage in
activities that the Board had determined
were closely related to banking, by
regulation or order, prior to November
12, 1999. A BHC must conduct these
activities in accordance with the terms
and conditions contained in such
regulations and orders, unless modified
by the Board.
Citigroup Inc., New York, New York
(‘‘Citigroup’’), and UBS AG, Zurich,
Switzerland (‘‘UBS’’), have asked the
Board to modify the restrictions in
Regulation Y to allow BHCs to enter into
derivative contracts that typically result
in taking and making delivery of title to,
but not physical possession of,
commodities on an instantaneous, passthrough basis (regardless of whether the
CFR 225.28(b)(8)(ii)(B).
member banks may own, for example,
investment grade corporate debt securities, U.S.
government and municipal securities, foreign
exchange, and certain precious metals.
3 These would include derivative contracts based
on, for example, energy-related commodities and
agricultural commodities.

contracts contain specific assignment,
termination, or offset provisions).4
In response to these requests, the
Board has determined to seek public
comment on the proposed rule
described below.
Proposed Rule
As noted, Citigroup and UBS have
urged the Board to permit BHCs to enter
into Commodity Contracts that are
settled by the BHC receiving and
transferring title to the underlying
commodity instantaneously, by
operation of contract, and without
taking physical possession of the
commodity. Citigroup and UBS also
have urged the Board to remove its
regulatory requirement that BHCs only
enter into Commodity Contracts that
require cash settlement or specifically
provide for assignment, termination, or
offset prior to delivery.
These requests arise in large part
because, in certain over-the-counter
forward markets (U.S. energy markets,
for example), the physically settled
derivative contracts traded by market
participants do not specifically provide
for assignment, termination, or offset
prior to delivery and, thus, do not
conform to the Contractual Offset
Requirement of Regulation Y. Moreover,
participants in these markets generally
settle the derivative contracts by
temporarily taking and making delivery
of title to the underlying commodities
and, thus, do not comply with the
Delivery Avoidance Requirement of
Regulation Y.
Financial intermediary participants in
these markets generally enter into backto-back derivative contracts with third
parties that effectively offset each other.
That is, financial intermediaries in these
markets that enter into a contract to buy,
for example, a certain number of barrels
of oil from a certain counterparty in a
certain future month generally also will
enter into another contract, prior to the
expiration of the original contract, to
sell the same number of barrels of oil to
another counterparty in the same future
month on substantially identical
delivery terms. These market practices
typically result in the creation of a chain
of contractual relationships that begins
with a commodity producer, passes
through a number of intermediaries who
have entered into matched contracts
both to buy and sell the same
commodity at the same future time, and

1 12

2 State

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

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Federal Register / Vol. 68, No. 50 / Friday, March 14, 2003 / Proposed Rules
ends with a purchaser that intends to
take physical delivery of the
commodity. On the maturity date of the
derivative contracts, the producer will
be responsible for making physical
delivery and the ultimate buyer will be
responsible for accepting physical
delivery, while each intermediate
participant in the chain will be deemed,
by operation of contract, to have
instantaneously received and
transferred legal title to the commodity.
The Board adopted the restrictions in
Regulation Y on the types of Commodity
Contracts that a BHC may enter into as
principal to reduce the potential that
BHCs would become involved in and
bear the risks of physical possession,
transport, storage, delivery, and sale of
bank-ineligible commodities. The
restrictions ensure that the commodity
derivatives business of a BHC is largely
limited to acting as a financial
intermediary that facilitates transactions
for customers who use or produce
commodities or are otherwise exposed
to commodity price risk as part of their
regular business.
Citigroup and UBS contend that a
BHC that takes title to a commodity on
an instantaneous, pass-through basis
takes no risk that is greater than or
different in kind from the risk that it has
as a holder of a commodity derivative
contract that meets the current
requirements of Regulation Y.
Instantaneous receipt and transfer of
title to (but not physical possession of)
commodities does not appear to involve
the usual activities relating to, or risks
attendant on, commodity ownership.
Instead, such transactions involve the
routine operations functions of passing
notices, documents, and payments—
functions that BHCs regularly perform
in their role as financial intermediaries
in other markets. Moreover, although
BHCs that receive and transfer title to
commodities on an instantaneous, passthrough basis face default risks, they are
not significantly different than the
default risks associated with cashsettled derivative contracts or derivative
contracts that include the assignment,
termination, or offset provisions
required by Regulation Y.
In this light, the Board proposes to
modify Regulation Y by changing the
Delivery Avoidance Requirement to
allow BHCs to take or make delivery of
title to commodities underlying
commodity derivative transactions on
an instantaneous, pass-through basis.
In addition, the Board proposes to
modify Regulation Y by changing the
Contractual Offset Requirement to
permit BHCs to participate in physically
settled derivative markets where the
standard industry documentation does

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not allow for assignment, termination,
or offset. In particular, the proposal
would allow BHCs to enter into
Commodity Contracts that do not
require cash settlement or specifically
provide for assignment, termination, or
offset prior to delivery so long as the
contracts involve commodities for
which futures contracts have been
approved for trading on a U.S. futures
exchange by the Commodity Futures
Trading Commission (‘‘CFTC’’) (and the
BHC complies with the revised Delivery
Avoidance Requirement). Limiting this
relief from the Contractual Offset
Requirement to derivative contracts
based on commodities approved for
exchange trading (which are more likely
to have reasonably liquid markets) is
intended to provide some assurance that
a BHC’s reasonable efforts to avoid
delivery would be successful. This
requirement would, therefore, serve the
same purpose as the current Contractual
Offset Requirement, which facilitates
the financial settlement of Commodity
Contracts by requiring BHCs to have
contractual rights to avoid taking or
making delivery of the underlying
commodities.
The proposed modifications of the
derivatives provisions in Regulation Y
would apply to all BHCs. Although the
GLB Act prohibited the Board from
adding to the list of activities
permissible for all BHCs after November
11, 1999, the Act preserved the Board’s
authority to modify the terms and
conditions that applied to such
activities before that date.5 The Board
had authorized BHCs to engage as
principal in commodity derivative
transactions prior to November 11,
1999. The proposed rule would
represent a relaxation of the current
limitations that apply to a BHC’s
commodity derivative activities under
Regulation Y and would not create a
new permissible activity for BHCs.
The Board invites comment on all
aspects of the proposed rule and
particularly seeks comment on whether
the proposed modifications to
Regulation Y would expand the ability
of BHCs to participate in commodity
derivative markets without exposing
them to significant additional risks.
Plain Language
Section 722 of the GLB Act requires
the Board to use ‘‘plain language’’ in all
proposed and final rules published after
January 1, 2000. In light of this
requirement, the Board has sought to
present the proposed rule in a simple
and straightforward manner. The Board
invites comment on whether the Board
5 See

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12 U.S.C. 1843(c)(8).

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12317

could take additional steps to make the
proposed rule easier to understand.
Regulatory Flexibility Act
In accordance with section 3(a) of the
Regulatory Flexibility Act (5 U.S.C.
603(a)), the Board must publish an
initial regulatory flexibility analysis
with this proposed rule. The proposed
rule, if adopted, would expand the
scope of permissible commodity
derivatives activities for a bank holding
company. A description of the reasons
for the Board’s decision to issue the
proposed rule and a statement of the
objectives of, and legal basis for, the
proposed rule are contained in the
supplementary material provided above.
The proposed rule would apply to
bank holding companies regardless of
their size and should enhance the
ability of all bank holding companies,
including small ones, to compete with
other providers of financial services in
the United States and to respond to
changes in the marketplace in which
banking organizations compete. The
Board specifically seeks comment on
the likely burden the proposed rule
would have on bank holding companies,
especially small bank holding
companies.
Paperwork Reduction Act
In accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C. 3506;
5 CFR 1320 Appendix A.1), the Board
has reviewed the proposed rule under
authority delegated to the Board by the
Office of Management and Budget. The
proposed rule contains no collections of
information pursuant to the Paperwork
Reduction Act.
List of Subjects in 12 CFR Part 225
Administrative practice and
procedures, Banks, Banking, Federal
Reserve System, Holding companies,
Reporting and recordkeeping
requirements, Securities.
Authority and Issuance
For the reasons set forth in the
preamble, the Board proposes to amend
12 CFR part 225 as follows:
PART 225—BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)
1. The authority citation for part 225
continues to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818,
1828(o), 1831i, 1831p–1, 1843(c)(8), 1843(k),
1844(b), 1972(1), 3106, 3108, 3310, 3331–
3351, 3907, and 3909.

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

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Federal Register / Vol. 68, No. 50 / Friday, March 14, 2003 / Proposed Rules

§ 225.28 List of permissible nonbanking
activities.

*

*
*
*
*
(b) * * *
(8) * * *
(ii) * * *
(B) Forward contracts, options,
futures, options on futures, swaps, and
similar contracts, whether traded on
exchanges or not, based on any rate,
price, financial asset (including gold,
silver, platinum, palladium, copper, or
any other metal approved by the Board),
nonfinancial asset, or group of assets,
other than a bank-ineligible security,6 if:
(1) A state member bank is authorized
to invest in the asset underlying the
contract;
(2) The contract requires cash
settlement;
(3) The contract allows for
assignment, termination, or offset prior
to delivery or expiration, and the
company—
(i) makes every reasonable effort to
avoid taking or making delivery of the
asset underlying the contract; or
(ii) engages in the instantaneous
receipt and transfer of title to the
underlying asset, by operation of
contract and without taking or making
physical delivery of the underlying
asset; or
(4) The contract is based on an asset
for which futures contracts or options
on futures contracts have been approved
for trading on a U.S. contract market by
the Commodity Futures Trading
Commission, and the company—
(i) makes every reasonable effort to
avoid taking or making delivery of the
asset underlying the contract; or
(ii) engages in the instantaneous
receipt and transfer of title to the
underlying asset, by operation of
contract and without taking or making
physical delivery of the underlying
asset.
*
*
*
*
*
By order of the Board of Governors of the
Federal Reserve System, March 10, 2003.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 03–6155 Filed 3–13–03; 8:45 am]
BILLING CODE 6210–01–P

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


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102