# O

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| ## Comptroller of the Currency                                        |
|                                                                       |
| > Administrator of National Banks                                     |
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Washington, DC 20219

######## Interpretive Letter #962

April 21, 2003 **May 2003**

**12 U.S.C. 24(7)**

John H. Huffstutler

Associate General Counsel

Bank of America Corporation

NC1-002-29-01

101 South Tryon Street

Charlotte, NC 28255

Re: Authority to Expand Customer-Driven Financial Intermediation

[Transactions in Electricity Derivatives to Include Transitory Title
Transfers]{.underline}

Dear Mr. Huffstutler:

This letter responds to your request for approval from the Office of the
Comptroller of the

Currency ("OCC") for Bank of America, N.A. ("Bank") to expand its
financial intermediation

business to include customer-driven, electricity derivative transactions
that involve transfers of title to electricity.[^1] For the reasons
discussed below and subject to the limitations described herein, we
believe that the proposed transactions are permissible for the Bank.

I.  **Background**

The Bank engages in a variety of cash-settled, customer-driven financial
intermediation transactions involving exchanges of payments based on
interest rates, and the value of equities and commodities. The Bank's
cash-settled financial intermediation derivative transactions involve a
wide range of energy-related commodities, including electricity. The
Bank received authority to engage in customer-driven, cash-settled
electricity derivative transactions and hedges in OCC Interpretive
Letter No. 937 to assist customers in meeting their financial and risk
management needs.[^2] The Bank now proposes to settle and hedge
electricity derivative transactions by accepting and immediately
relinquishing title to electricity, as a party in a "chain of title"
transfers ("transitory title transfers").[^3] The Bank represents that
it does not intend to ever be in a situation where it is required to
receive or deliver actual power as a result of an electricity derivative
transaction. And, the Bank represents that it will engage in transitory
title transfers solely for the accommodation of customers or for its own
risk management purposes.

The Bank has obtained an order from Federal Energy Regulatory Commission
("FERC") granting it general authority to act as a power marketer, thus
enabling the Bank to engage in transitory title transfers in electricity
in interstate commerce at market-based rates.[^4] As part of the FERC
Order, the Bank received a number of waivers and authorizations granted
to other power marketers (including a waiver of certain FERC filing and
accounting requirements, and a blanket authorization to issue securities
and assume obligations and liabilities without prior FERC approval).[^5]

Under the Bank's proposal, it will settle all of its customer-driven
electricity derivative transactions in cash or by transitory title
transfers. Currently the Bank acts as a financial intermediary under
electricity derivative contracts that provide for cash settlement.[^6]
In certain electricity derivatives markets, contracts do not
specifically provide for assignment, termination, or offset prior to a
transitory title transfer. Instead, participants in these markets settle
electricity derivative contracts through title transfers. Financial
intermediaries in these markets enter into back-to-back-contracts
providing for the receipt and immediate transfer of title to
electricity. In order to participate in these markets, the Bank seeks to
engage in transitory title transfers where the Bank takes title to
electricity in a "chain of title" and relinquishes title
instantaneously.[^7]

The Bank states that it will engage only in wholesale electricity
transitory title transfers. "Wholesale" electricity transitory title
transfers are principally to and from other market intermediaries, some
of which may, in turn, affect retail delivery. "Retail" delivery
involves the transmission of power to an end-user customer and involves
a more extensive scheduling function than wholesale delivery.

The Bank represents that transitory title transfer transactions pose
risks[^8] similar in nature to those inherent in cash-settled
electricity derivative transactions and it has a demonstrated ability to
successfully manage and control such risks. And, because transitory
title transfer transactions typically do not entail the physical
possession of commodities, these transactions do not appear to involve
the customary activities relating to, or risks attendant on, commodity
ownership, *e.g.,* production, transportation, transmission,
distribution. While transitory title transfer transactions will require
the introduction of some new operational processes (*e.g.*, scheduling
of power flows), the majority of operational functions, such as passing
notices, document transfers, and payments, are similar to those
regularly performed by national banks in their role as financial
intermediaries. Moreover, national banks that engage in transitory title
transfer transactions face risks such as counterparty credit risk that
are not significantly different than the risks associated with
cash-settled electricity derivative transactions.

The Bank will manage the market risks in its electricity derivative
transactions on a "portfolio basis," and will hedge the resulting net
risk exposures. Because the market risk exposures arising from
transactions with customers may offset each other, the Bank will not
need to hedge each transaction individually. The Bank will use both
cash-settled hedges and those that involve transitory title transfers.
There will normally be some market risk that will not be hedged and this
residual exposure will be subject to risk management limits as discussed
below. The Bank represents that residual market risk arising from this
activity at all times will be *de minimis* relative to the Bank's
earnings and capital and will be consistent with a customer-driven
business strategy.

The Bank believes that electricity transitory title transfers are a
natural extension of the Bank's existing financial intermediation
activities in electricity that will benefit customers as well as the
Bank. The Bank represents that its ability to engage in transitory title
transfers will enable the Bank to offer customers a broader range of
intermediation services that more fully accommodate customers'
financial, risk management, and liquidity needs. In many areas of the
United States, contracts reflecting the market convention provide for
settlement through transitory title transfers. If the Bank cannot engage
in transitory title transfers it will not be able to provide customers
with the option of participating in these markets to address financial
and risk management needs. For the Bank to provide effective liquidity
and risk management solutions for its electricity derivatives customers,
the settlement terms in the electricity derivative transactions it
intermediates need to satisfy each customer's particular needs.
Accordingly, the Bank believes that its ability to settle electricity
derivative transactions by transitory title transfer is vital to its
ability to assist customers with their particular financial, risk
management, and liquidity needs.

The Bank states that its ability to participate in a broader range of
markets, and offer a broader range of products, also enables the Bank to
compete more effectively with other intermediaries, diversify its
business risks and operate more efficiently and profitably. The Bank's
proposed expansion of its existing electricity derivatives business will
enable the Bank to compete more effectively with other market
intermediaries that offer customers the option of selecting electricity
derivative contracts that settle in cash or by transitory title
transfer. By offering customers a broader range of risk management
products that more effectively address their individual financial needs,
the Bank has the ability to attract a broader customer base. Also, as a
participant in more than one type of electricity derivative settlement
market, the Bank will have greater access to relevant price and other
related information. And, with greater access to market information, the
Bank can provide more extensive services to current and prospective
customers. In addition, by participating in a broader range of markets
and expanding its customer base, the Bank may diversify and reduce
credit and other risks arising from its electricity derivatives
business. Consequently, transitory title transfers enable the Bank to
operate its electricity derivatives business more competitively,
efficiently, and profitably.

The Bank represents that the ability to engage in electricity transitory
title transfers can reduce the risk that it will be subject to a
"market" or "liquidity" squeeze. The Bank contends that being limited to
electricity derivative transactions that require cash settlement may be
disadvantageous because market participants know that the Bank is
constrained in its ability to cover and exit electricity derivative
transactions. In addition, the Bank believes if there is limited
liquidity or substantial volatility in the electricity derivatives
market, the Bank's inability to enter into electricity derivative
transactions settled by transitory title transfer, constrains its
ability to choose among various risk management tools to guard against a
possible "market" or "liquidity" squeeze.

The Bank also represents that the ability to engage in transitory title
transfers will increase the Bank's hedging options and its ability to
control risks in its electricity derivatives business. The Bank asserts
that this capability will enable the Bank to broaden its ability to
hedge, on a portfolio basis, its electricity derivative business.

The Bank has expertise in conducting energy derivative transactions.
Consistent with this expertise, the Bank has well-established policies,
procedures and controls that it applies to its customer-driven,
cash-settled oil, gas, and electricity derivatives businesses. For
example, the Bank: (i) hedges the price risk arising from commodity
derivatives on a portfolio basis and values transactions using data sets
and models implemented in accordance with Bank standards; (ii) records
credit exposure against customer credit limits; (iii) documents
cash-settled customer transactions using the ISDA Master Agreement, with
appropriate confirmations;[^9] and (iv) uses operations systems that
permit booking and settlement of commodity derivatives transactions. The
Bank represents that it will continue to conduct its activities in
customer-driven electricity derivatives consistent with the same
policies, procedures and controls it applies to its existing energy
commodity derivatives business (the "Commodity Derivative Product
Controls").

The Bank commits that before engaging in transitory title transfers it
will adopt and implement all necessary policies, procedures and controls
to assure that (i) its electricity derivative business is
customer-driven and meets all required regulatory standards for
conducting a customer-driven derivative business, and (ii) the Bank has
in place all appropriate mechanisms to identify, monitor, limit and
control the risks inherent in conducting this business so that it
complies with all applicable OCC guidance and requirements.[^10]

To manage the risks in its expanded electricity derivatives business,
the Bank represents it will implement those policies, procedures and
controls set forth in OCC guidance, *e.g., OCC Derivatives Handbook* and
BC-277, to assure the ongoing function and maintenance of an effective
risk management process. The Bank specifically acknowledges that, as
contemplated by the *OCC Derivatives Handbook* and BC-277, an effective
risk management process includes appropriate oversight and supervision,
managerial and staff expertise, comprehensive policies and operating
procedures, risk identification, measurement and management information
systems, and effective risk control functions that oversee and ensure
the continuing appropriateness of the risk management process.

In implementing those policies, procedures, and controls, the Bank
commits to conducting a full evaluation of (i) pricing, hedging
(including portfolio hedging), processing, recordkeeping, documentation,
accounting, "back office" and risk management; (ii) the development of
adequate knowledge, staff, oversight management and technology
(including contingency planning) to accommodate the activity; (iii) the
implementation of appropriate controls (including the Commodity
Derivative Product Controls discussed above); (iv) the establishment,
implementation and monitoring of appropriate risk management limits with
respect to various types of risks\--such as market risk, credit risk,
and liquidity risk\--associated with transitory title transfers;[^11]
and (v) Compliance Department training of personnel and development of a
supervisory framework designed to ensure compliance with policies and
procedures, including trading practices. Such a framework will strictly
prohibit manipulative practices of any kind, including patterns of
trading related to so-called "round tripping" of electricity derivatives
transactions and will promote compliance with FERC and other relevant
regulatory requirements.[^12] Risk Control, Operations, Accounting,
Legal, Compliance, Audit and Senior and Line Management will all be
involved in assuring that the risks undertaken by the Bank are
comparable to, and are addressed in ways comparable to those applicable
to, the Bank's existing energy-based derivative products and business.

The Bank further commits that: (i) it will not run a proprietary book in
electricity/electricity derivatives, (ii) any trading in derivatives
will be done exclusively to hedge residual open positions related to
customer transactions (or incurred in anticipation of customer
transactions), and (iii) its electricity derivatives business will be
conducted in a safe and sound manner and consistent with prudential risk
management practices as prescribed in the *OCC Derivatives Handbook* and
BC-277.

Furthermore, the Bank commits that complex structured transactions
involving electricity derivatives will be subject to appropriate review
and oversight of the Bank's risk management approval process to ensure
that such transactions conform to the Bank's standards of
appropriateness and integrity. In this risk management approval process,
committees that are independent of the sponsoring business will review
complex structured transactions. These committees will review the
transactions for risks presented by the transactions, including credit
risk, market risk, operations risk, legal risk and reputation risk.
Furthermore, in the normal course of risk management, the Bank will
typically evaluate the purpose of transactions to assess whether the
client has attempted to achieve a financial statement objective that
could be construed as materially misrepresenting its financial
condition, even if in conformance with generally accepted accounting
principles ("GAAP"). In any instance where it is determined that a
proposed transaction may result in materially misleading financial
statements, the Bank will decline the transaction, condition approval
upon the counterparty making express disclosures regarding the nature
and financial impact of the transaction on the counterparty's financial
position or take other steps to assure that the Bank's role is
appropriate. The Bank will also have an appropriate process for
verifying customers have satisfied any conditions the Bank establishes
concerning disclosures. As part of the process to determine the
appropriateness of a transaction, the Bank may seek representations and
warranties from the counterparty to the complex structured transaction
stating the purpose of the transaction, how the counterparty will
account for the transaction, and that the counterparty will account for
the transaction in accordance with GAAP, consistently applied.

##### **II. Discussion**

In our opinion, the proposed title transfer transactions may be
permissible under 12 U.S.C. § 24(Seventh) as an activity incidental or
"convenient and useful" to its electricity derivatives business,
provided the Bank has established an appropriate risk measurement and
management process for the activity that is satisfactory to the Bank's
EIC.[^13]

National Banks May Engage in Electricity Title Transfers to Settle and
Hedge Customer-Driven Electricity Derivative Transactions as Activities
Incidental to the Business of Banking

The OCC previously determined that the Bank may engage in electricity
derivative transactions and hedges that are cash-settled.[^14] The Bank
proposes to settle and hedge electricity derivative transactions by
transitory title transfers where the Bank takes title to electricity in
a "chain of title" and relinquishes title instantaneously. The proposed
transitory title transfers will enable the Bank to participate in
markets using this form of settlement and provide customers with a
broader range of sophisticated risk management tools to address their
financial, risk management, and liquidity needs. Further, the proposed
transitory title transfers will enable the Bank to compete more
effectively and operate more efficiently and profitably. Transitory
title transfer capability also will increase the Bank's hedging options
and its ability to control risks in its electricity derivatives
business.

Engaging in transitory title transfers will subject the Bank to risks
similar in nature to those inherent in cash-settled electricity
derivatives where the Bank has demonstrated risk management procedures,
systems and controls to appropriately manage and controls such risks.
Transitory title transfer transactions typically do not involve taking
physical possession of commodities, and thus do not appear to involve
the customary activities relating to commodity ownership. While
transitory title transfer transactions will require the introduction of
some new operational processes (*e.g*., scheduling of power flows), the
majority of operational functions, such as passing notices, document
transfers, and payments, are similar to those regularly performed by
national banks in their role as financial intermediaries.

The OCC has previously concluded in a variety of contexts that national
banks may engage in instantaneous title transfers as an activity
permissible under 12 U.S.C. § 24(Seventh). In OCC Interpretive Letter
No. 684, for example, the OCC determined that it was permissible for a
national bank to engage in instantaneous warehouse receipt transfers in
furtherance of managing the risks in financial intermediation
transactions with customers, involving the exchange of payments based on
the value of commodities.[^15] The instantaneous warehouse receipt
transfers, entailed the bank taking possession of a warehouse receipt
and instantaneously passing it on to a third party under an offsetting
transaction. In OCC Interpretive Letter No. 684, as here, the Bank did
not propose to take actual delivery by receipt of physical quantities of
commodities on Bank premises. Rather, transitory title transfers
preclude actual delivery by passing title down the chain from the
initial seller to the ultimate buyer in a series of instantaneous
back-to-back transactions. Each party in the chain has title for an
instant but does not take actual physical delivery (other than the
ultimate buyer which, in no case, will be the Bank). The OCC determined
that the warehouse receipt transfers were permissible, where consistent
with safe and sound banking principles, and with prior written
authorization from OCC supervisory staff.

Analogously, the OCC has previously determined that a national bank may
instantaneously acquire and transfer equity and debt securities in the
secondary market under 12 U.S.C.

§ 24(Seventh), in financial intermediary transactions with
customers.[^16] The bank purchased the equities and debt securities only
for immediate resale to an ultimate purchaser as a riskless principal.
The OCC approved the transactions because the bank did not assume any of
the customer's risk of loss, did not assume any liability as guarantor
or endorser of the value of the securities, and did not have any
beneficial ownership of the securities. The purchases and sales of
equity and debt securities were in furtherance of bank permissible
brokerage activities.

In sum, the ability of the Bank to engage in transitory title transfers
in connection with its customer-driven electricity derivative
transactions will allow the Bank to provide customers with a broader
range of tools to address their financial, risk management, and
liquidity needs. Transitory title transfer capability also will permit
the Bank to conduct its electricity derivatives business more
competitively, efficiently, and profitably and increase its hedging
options. The risks to which the Bank is exposed are similar in nature to
cash-settled electricity derivative transactions where the Bank has a
demonstrated ability to manage and control such risks. The Bank's
proposed transitory title transfers are functionally comparable to other
title transfers that the OCC has permitted under 12 U.S.C.
§ 24(Seventh). Accordingly, subject to satisfying the safety and
soundness factors discussed below, the Bank's proposed transitory title
transfers are incidental or "convenient and useful" to the Bank's
financial intermediation activities in electricity derivative
transactions.

***Safety and Soundness Requirements and EIC Approval***

For the Bank to permissibly engage in transitory title transfers, the
Bank's risk measurement and management capabilities must be of
appropriate sophistication to ensure that the activity can be conducted
in a safe and sound manner. Consequently, in order for the OCC to
conclude that this activity is permissible for the Bank because it is
convenient or useful to conducting authorized banking activities, the
Bank must demonstrate to the satisfaction of the OCC that the Bank has
established an appropriate risk measurement and management process for
its transitory title transfers. As detailed further in the *OCC
Derivatives Handbook* and BC-277, an effective risk measurement and
management process includes board supervision, managerial and staff
expertise, comprehensive policies and operating procedures, risk
identification and measurement, and management information systems, as
well as an effective risk control function that oversees and ensures the
appropriateness of the risk management process. Risk control processes
will need to become increasingly sophisticated as this business activity
grows in size and complexity.

Additionally, the Bank's risk management approval process must subject
complex structured electricity derivative transactions to appropriate
review and oversight to ensure that these transactions conform to the
Bank's standards of appropriateness and integrity. This should include
review and approval of these transactions by independent and qualified
individuals. The structured transaction approval process should consider
all relevant risks, should require review of transaction
appropriateness, and should include evaluation of the purpose of these
transactions to determine whether the Bank's customer is attempting to
achieve a financial statement objective that materially misrepresents
its financial condition, regardless of being in conformance with GAAP.

In addition to a satisfactory risk management program, the Bank's
process must include an independent compliance monitoring program to
ensure ongoing compliance with the specific commitments made by the Bank
in its proposal, including the commitment to continue to conduct its
financial intermediation activities in electricity as a customer-driven
and non-proprietary trading business. The compliance monitoring program
should also ensure that the Bank has a supervisory framework that
protects against manipulative practices of any kind, including "round
tripping," and promotes compliance with FERC and other regulatory
requirements. An adequate and effective compliance monitoring program
will include policies, training, independent surveillance and
well-defined exception approval and reporting procedures.

The OCC will make these determinations though the Bank's EIC and the
Bank may not commence the proposed activities unless and until its EIC
has concluded that the foregoing standards are met.

####### III. Conclusion

The Bank may settle and hedge its customer-driven bank permissible
electricity derivative transactions by transitory title transfers as an
activity incidental to its existing electricity

derivatives business, provided the Bank has established, to the
satisfaction of its EIC, an appropriate risk measurement and management
process for its transitory title transfers.

Sincerely,

/s/ Julie L. Williams

Julie L. Williams

First Senior Deputy Comptroller

and Chief Counsel

[^1]: For the purposes of this letter, the term "electricity derivative
    transactions" encompasses electricity linked transactions of every
    type \-- including derivative products such as futures, forwards,
    options, swaps, caps, floors and collars, and options thereon \--
    where a portion of the return (including interest, principal or
    payment streams) is linked to electricity or the price of
    electricity.

[^2]: OCC Interpretive Letter No. 937 (June 27, 2002) *reprinted in*
    \[Current Transfer Binder\] Fed. Banking L. Rep. (CCH) ¶ 81-462.

[^3]: Examples of a cash-settled electricity swap, forward and option
    transaction are contained in OCC Interpretive Letter No. 937,
    *supra.* The swap, forward, and option transactions at issue are
    similar, except that the transactions will provide for transitory
    title transfer to settle the contracts. The Bank expects that less
    than 20% of the total volume (in megawatt hours) associated with the
    Bank's electricity derivative transactions (electricity derivative
    contracts and hedges) will involve transitory title transfers. The
    Bank will consult with its OCC examiner-in-charge ("EIC") and
    address any supervisory concerns raised before exceeding the 20% of
    total volume limit.

[^4]: FERC asserts jurisdiction over entities such as the Bank that
    engage in transitory title transfers. *See* *Bank of America, N.A.,*
    101 FERC ¶ 61,098 (Oct. 30, 2002) (the "FERC Order"). Other
    financial institutions that participate in electricity derivatives
    markets \-- including affiliates of Credit Suisse First Boston,
    Goldman Sachs & Co., Merrill Lynch & Co., Morgan Stanley & Co. and
    UBS \-- have also received FERC approval to operate as power
    marketers authorized to sell electricity in interstate commerce at
    market-based rates.

[^5]: By Declaratory Order, dated Dec. 19, 2002 (Docket Nos.
    EL02-130-000 and EC02-120-000), FERC granted in part the Bank's
    request for a blanket authorization to acquire "securities" of
    public utilities without prior FERC approval, subject to certain
    conditions. Because such Declaratory Order did not grant all aspects
    of the Bank's request in this regard, the Bank has petitioned FERC
    for a reconsideration of certain of the conditions set out in the
    Order. Any such acquisitions would have to be permissible under
    Federal banking law.

[^6]: OCC Interpretive Letter No. 937, *supra.* The term \"cash-settled
    electricity derivative transactions\" includes any electricity
    derivative contract that is cash-settled or that can be assigned,
    terminated or offset prior to any transitory title transfer.

[^7]: Accordingly, as noted above, the Bank will not enter into
    transactions where it will hold title to electricity for more than a
    legal instant. The Bank expects that only a small volume of
    electricity derivative transactions that it enters into (in general,
    less than 20%) will involve transitory title transfers. (*See* note
    3 above.)

[^8]: Risks that are similar in nature include credit, compliance,
    market, transaction and reputation.

[^9]: We would expect the Bank to document all electricity transitory
    title transfer transactions with appropriately comparable
    confirmations.

[^10]: *See, e.g.*, OCC Handbook: *Risk Management of Financial
    Derivatives* (January 1997) ("*OCC Derivatives Handbook*"); OCC
    Banking Circular No. 277 (October 27, 1993), *reprinted in* 5 Fed.
    Banking L. Rep. (CCH)

    ¶ 62-152 ("BC-277"); OCC Bulletin 94-31 (May 10, 1994), *reprinted
    in* 5 Fed. Banking L. Rep. (CCH) ¶ 62-152.

[^11]: For example, in the context of market and related risks of
    electricity derivatives, the Bank will specifically address such
    matters as price volatility and concentration of market participants
    on a geographic and power exchange/power pool/individual customer
    basis. In the context of options, it will specifically address all
    of those characteristics identified in the *OCC Derivatives
    Handbook* (*e.g.,* at 20-21 and Appendix B) as primary component
    measures of option sensitivity.

[^12]: To illustrate, the head of the electricity derivatives desk will
    be provided with a "best practices" policy that describes the
    responsibilities of the position in monitoring transactions for
    market manipulation, including round-tripping. This individual will
    receive daily position and activity reports to review and monitor
    consistent with the best practices policy. The Bank's Compliance
    Division will also receive and review position and activity reports
    on a daily basis, test for proprietary trading, test the
    appropriateness of derivative transactions and hedges, and review
    documentary support on a quarterly basis. Bank employees involved in
    this business will be subject to applicable "Standards of
    Professional Conduct" and will be required to attend compliance
    training. Furthermore, the Bank's Legal Department will provide
    guidance to the Compliance Department to ensure FERC rules and
    regulations as prescribed by the National Power Act are understood
    with appropriate compliance policies and procedures developed and
    implemented.

[^13]: This process is necessary for the Bank to achieve its customer
    risk management objectives in a safe and sound manner and, thus,
    must be established before the OCC can conclude that activities are
    permissible for the Bank.

[^14]: OCC Interpretive Letter No. 937, *supra.*

[^15]: OCC Interpretive Letter No. 684 (August 4, 1995), *reprinted in*
    \[1994-1995 Transfer Binder\] Fed. Banking L. Rep. (CCH) ¶ 83,632.
    Warehouse receipts evidence title to commodities. While OCC
    Interpretive Letter No. 684 characterized the transactions in that
    letter as involving the "physical delivery" of commodities, included
    within that characterization were instantaneous warehouse receipt
    transfers.

[^16]: OCC Interpretive Letter No. 626 (July 7, 1993) *reprinted in*
    \[1993-1994 Transfer Binder\] Fed. Banking L. Rep. (CCH) ¶ 83,508.