R E ^ '*

BOAR D O F GOVERNOR S

OF THE

FEDERAL RESERVE SYSTEM

WASHINGTON, D. C. 2055 1

ADDRESS OFFICIAL CORRESPONDENCE

TO THE BOARD

February 17, 2011

Andrew S. Baer, Esq.

Sullivan & Cromwell LLP

1701 Pennsylvania Avenue, NW

Washington, D.C. 20006

Dear Mr. Baer:

This letter concerns the notice that the Bank of Nova Scotia

("Scotiabank"), Toronto, Canada, filed on September 1, 2010, under section 4 of

the Bank Holding Company Act ("BHC Act") to engage, on a limited basis, in

physical commodity trading activities.1

Scotiabank stated in the notice that it currently engages in

commodity derivative activities that are permissible for bank holding companies

under the BHC Act ("Commodity Derivatives Activities"). These activities

include trading in cash-settled swaps, forwards, options, and other derivatives

based on commodities.2Scotiabank has requested approval to expand its current

trading activities to include engaging in physically settled commodity

derivatives, taking or making delivery of commodities in settlement of those

derivatives, taking inventory positions in physical commodities, and trading

activities in the spot market in physical commodities ("Physical Commodity

Trading"). Scotiabank has represented that its Physical Commodity Trading

1

Scotiabank would engage in the proposed activities through its wholly owned

subsidiary, Scotia Capital Energy Inc., also of Toronto.

2

12 CFR 225.28(b)(8)(ii).
2

will encompass a variety of commodities, including natural gas, crude oil, and

emissions allowances.3

The Board has previously determined pursuant to Regulation Y that

taking and making delivery of a physical commodity complements the financial

activity of engaging regularly as principal in Commodity Derivatives Activities

based on that commodity.4 The Board has delegated to the Director of the

Division of Banking Supervision and Regulation ("Director"), with the

concurrence of the General Counsel, authority to approve requests by financial

holding companies to engage in Physical Commodity Trading as an activity that

is complementary to Commodity Derivatives Activities, if the proposal meets

the conditions imposed by the Board when it has approved previous requests to

engage in Physical Commodity Trading and if it does not raise significant legal,

policy, or supervisory issues.5

For purposes of this letter, an "emission allowance" is an intangible right to

emit certain pollutants during a given year or any year thereafter that is granted

by the U.S. Environmental Protection Agency or comparable foreign regulatory

authority to an entity, such as a power plant or other industrial concern, affected

by environmental regulation aimed at reducing emission of pollutants.

4 Royal Bank of Scotland Group pic, 94 Federal Reserve Bulletin C45 (2008);

Societe Generale, 92 Federal Reserve Bulletin CI 13 (2006); Deutsche Bank AG,

91 Federal Reserve Bulletin C54 (2005); JPMorgan Chase & Co., 91 Federal

Reserve Bulletin C57 (2005); Barclays Bank PLC, 90 Federal Reserve

Bulletin 511 (2004); UBS AG, 90 Federal Reserve Bulletin 215 (2004); and

Citigroup Inc.. 89 Federal Reserve Bulletin 508 (2003).

5

Scotiabank has indicated that the transactions in which it intends to engage

after approval of this notice include, among other things, volumetric production

payment transactions ("VPPs") on oil and natural gas. VPPs are considered

permissible credit transactions under 12 CFR 225.28(b)(1) if a bank holding

company immediately sells any commodities it receives under the VPP to third

parties. See Letter from Scott G. Alvarez, Esq., to Elizabeth T. Davy, Esq.,

dated May 15, 2006, regarding UBS AG. Scotiabank would rely on approval of

this notice to permit it to retain ownership of commodities delivered to it under a

VPP. The market value of any such commodities retained by Scotiabank would

be included in the 5 percent of tier 1 capital limit on the value of its physical

commodity inventory to which Scotiabank has committed in connection with

this notice, as detailed in the appendix to this letter.
3

In evaluating the risks posed by the proposal, the Director and the

General Counsel have considered that Scotiabank already incurs the price risk of

commodities through its Commodity Derivatives Activities. Permitting

Scotiabank to engage in the limited amount and types of Physical Commodity

Trading described above, within the limits described in the appendix, would not

appear to increase significantly its potential exposure to commodity price risk.

To minimize the potential for increased risks associated with Physical

Commodity Trading (including, but not limited to, storage, transportation, legal,

and environmental risks), Scotiabank has committed to the Board that it will not

(i) own, operate, or invest in facilities for the extraction, transportation, storage,

or distribution of commodities; or (ii) process, refine, store, or otherwise alter a

physical commodity itself. Scotiabank has further committed to the Board that

it will limit the aggregate market value of physical commodities that it and any

of its subsidiaries hold at any one time to 5 percent of Scotiabank's

tier 1 capital.6Scotiabank also has established and maintained policies and

systems for monitoring and controlling the risks associated with Physical

Commodity Trading. Going forward, Scotiabank is expected to continue to

maintain effective risk-management policies and systems pertaining to its

Physical Commodity Trading. Approval of the proposal would likely benefit

Scotiabank's customers by enhancing the bank's ability to provide efficiently a

full range of commodity-related services and improving its understanding of the

commodity markets.

Based on all the facts of the record, including the commitments

made to the Board in connection with the notice and the conditions imposed by

the Board in previous cases, the Director, with the concurrence of the General

Counsel, has determined that the proposed activities for Physical Commodity

Trading are complementary to the Commodities Derivatives Activities

conducted by Scotiabank; that the proposal would not appear to pose a

substantial risk to Scotiabank, depository institutions operated by Scotiabank, or

the financial system generally; and that the proposal can reasonably be expected

to produce benefits to the public that outweigh any potential adverse effects.

In making these determinations, the Director and the General

Counsel have relied on all the information, representations, and commitments

that Scotiabank provided to the Board in connection with the notice and, in

particular, the commitments set forth in the appendix and the conditions

contained in the previous decisions noted above regarding these activities.

These commitments and conditions are critical to the determination that Physical

6

See the appendix for a list of Scotiabank's commitments.
4

Commodity Trading would not pose a substantial risk to the safety and

soundness of Scotiabank, other financial institutions, or the financial system

generally. These commitments and conditions are deemed to be conditions

imposed in writing in connection with this action and, as such, may be enforced

in proceedings under applicable law.

This determination is also subject to all the conditions set forth in

V • • Regulation Y, including those in section 225.7, to the conditions contained in

the Board's previous decisions regarding these activities, and to the Board's

authority to require modification or termination of the activities of a bank

holding company or any of its subsidiaries as the Board finds necessary to

ensure compliance with, or to prevent evasion of, the provisions and purposes of

the BHC Act and the Board's regulations and orders issued thereunder.

Sincerely yours,

flMJtlORobert deV. Frierson

Deputy Secretary of the Board

Appendix

cc: Ivan J. Hurwitz, Vice President

Federal Reserve Bank of New York

7

12 CFR 225.7.
5

Appendix

Commitments by Scotiabank

General

1. Scotiabank will conduct its Physical Commodity Trading exclusively

pursuant to the authority of section 4 of the BHC Act and in accordance

with the limitations that the Board has placed on the conduct of such

activities, and will not conduct such activities in the United States in

reliance on section 2(h)(2) of the BHC Act or section 211.23(f)(5) of the

Board's Regulation K.

Physical Commodity Trading Activities

2. Scotiabank will limit the aggregate market value of physical

commodities that it holds at any one time as a result of Physical

Commodity Trading to 5 percent of its tier 1 capital. Scotiabank will

include in this 5 percent limit the market value of any physical

commodities it holds as a result of a failure of reasonable efforts to avoid

taking delivery in commodities transactions conducted pursuant to

section 225.28(b)(8)(ii)(B) of Regulation Y. In addition, Scotiabank

agrees to notify the Federal Reserve Bank of New York if the aggregate

market value of commodities held under this approval exceeds 4 percent

of Scotiabank's tier 1 capital.

3. Scotiabank will take and make physical delivery only of physical

commodities (i) for which derivative contracts have been authorized for

trading on a U.S. futures exchange by the Commodity Futures Trading

Commission, (ii) as to which the Board has specifically determined that

all financial holding companies with Physical Commodity Trading

authority may take or make physical delivery, or (iii) as to which the

Board has specifically authorized Scotiabank to take and make physical

delivery (collectively, "Approved Commodities").

4. Scotiabank will not use this authority to own, invest in, or operate

facilities for the extraction, transportation, storage, or distribution of

commodities but will only use storage and transportation facilities

owned and operated by third parties. Scotiabank will enter into service

agreements only with reputable independent third-party facilities.
6

5. Scotiabank will act solely as an intermediary in the physical

commodities market and will not process, refine, or otherwise alter a

physical commodity itself. Scotiabank will contract with a third party for

any services it needs in connection with the handling of any commodity.

Scotiabank further commits that it will not contract for the exclusive

right to use a facility to alter commodities for any period of time.

Consistent with the Physical Commodity Trading authority, Scotiabank

will contract with third parties (i) to alter only an Approved Commodity

and (ii) to alter the commodity only into another Approved Commodity.

Volumetric Production Payment Transactions

6. Scotiabank will include any commodities that Scotiabank receives

under a volumetric production payment transaction and does not

immediately sell to a third party in calculating its compliance with

the limit of 5 percent of tier 1 capital on the aggregate market value

of the physical commodities that it and any of its subsidiaries hold at

any one time as a result of Physical Commodity Trading.