OFFICIAL SEAL OF THE 

BOARD OF GOVERNORS 

OF THE FEDERAL RESERVE 

SYSTEM 

OFFICIAL LETTERHEAD 

STATIONERY FOR 

SCOTT G. ALVAREZ 

GENERAL COUNSEL 

May 15, 2006 

Isaac Lustgarten, Esq. 

McDermott Will & Emery LLP 

50 Rockefeller Plaza 

New York, New York 10020 

Dear Mr. Lustgarten: 

This responds to your request on behalf of [BANK HOLDING 

COMPANY (“BHC”)], a bank holding company that has elected to be a 

financial holding company within the meaning of the Bank Holding Company 

Act of 1956 (12 U.S.C. section 1841 et seq.) (“BHC Act”). You have inquired 

as to whether it would be permissible under the BHC Act and the Board’s 

Regulation Y (12 C.F.R. part 225) for [BHC] to engage in “commodity 

purchase and forward sale” (“CPFS”) transactions as a method of financing 

the commodity inventories of its customers. [Footnote 1. Begin text of 

Footnote 1. You have indicated that the commodities involved in these 

transactions would include agricultural commodities (such as corn, wheat, 

soybeans and other legumes, cotton, cocoa, coffee, sugar, various oilseeds 

and oils, and dairy products), live cattle, timber, and exchange-traded metals. 

[BHC]’s CPFS transactions would in all cases involve commodities (i) for 

which contracts have been approved for trading on a U.S. futures exchange 

by the Commodity Futures Trading Commission, or (ii) which [BHC] can 

show, to Board staffs satisfaction, have readily-available price quotes and 

are traded regularly in global commodity markets. End Footnote 1.] 

You have described two alternative structures for the CPFS 

transactions. In the first structure, [BHC] would purchase a commodity from its 

customer and simultaneously enter into a forward sale agreement under which 
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the customer would be obligated to repurchase the commodity from [BHC] at a 

predetermined price and on a predetermined future date. The second structure is 

similar to the first structure, except that it would involve a third party, either as 

the initial seller of the commodity to [BHC] or as the ultimate purchaser of the 

commodity from [BHC]. For example, under this second structure, [BHC] 

might purchase a commodity from a supplier identified by [BHC]’s customer 

and simultaneously execute a forward sale agreement under which [BHC]’s 

customer would be obligated to purchase the commodity from the bank at a 

predetermined price and on a predetermined future date. During the term of a 

CPFS transaction, [BHC] would hold title to the underlying commodity, would 

mark the commodity to market on a daily basis, and would call for additional 

margin if the market value of the commodity falls below a specific collateral 

threshold. 

The BHC Act permits bank holding companies to engage in 

any activity that the Board had determined by regulation or order as of 

November 11, 1999, “to be so closely related to banking as to be a proper 

incident thereto.” [Footnote 2. Begin text of Footnote 2. 12 U.S.C. section 

1843(c)(8). End Footnote 2.] The Board had determined by regulation 

issued prior to November 11, 1999, that “[m]aking, acquiring, brokering, 

or servicing loans or other extensions of credit (including factoring, issuing 

letters of credit and accepting drafts) for the company’s account or for the 

account of others” is an activity so closely related to banking as to be a proper 

incident thereto and, therefore, is a permissible activity for bank holding 

companies. [Footnote 3. Begin text of Footnote 3. See 12 C.F.R. 225.28(b)(1). 

End Footnote 3.] You argue that the proposed CPFS transactions are the 

functional equivalent of extensions of credit, and therefore permissible under 

this authority. 

[BHC] would earn a fixed return on a CPFS transaction, just as 

it would on an ordinary secured loan, and its risk exposure would effectively 

be limited to counterparty credit risk. You have indicated that [BHC] would 

subject any prospective CPFS counterparty to the same credit review process 

used for loan applicants, and that [BHC]’s internal credit review personnel 

would also review outstanding CPFS arrangements. You have indicated that 

[BHC] would never enter into an agreement to purchase a commodity unless 

the bank simultaneously enters into an agreement to sell the commodity to a 

creditworthy counterparty on a fixed future date at a fixed price. You have 

indicated that the fixed future sale price would be equal to the initial purchase 
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price plus a fixed interest component (and thus would not vary based on 

movements in the price of the commodity). In other words, unless the 

ultimate purchaser defaults, [BHC] would be repaid its principal plus a 

fixed amount of interest at maturity of the transaction. Accordingly, unless 

the ultimate purchaser defaults, [BHC] would not bear any commodity price 

risk from a CPFS transaction – the price the bank would receive for the 

commodities on the maturity date of the transaction would be fixed on the 

date the bank enters into the transaction. If the ultimate purchaser were to 

default in its obligation to purchase the underlying commodity at the maturity 

of the CPFS transaction, [BHC] would have a claim against the ultimate 

purchaser to recover the equivalent of principal and interest and could sell 

the commodity into the market to mitigate credit losses in the same manner 

as the bank would liquidate any collateral supporting a loan in default. Any 

commodities acquired by [BHC] as a result of counterparty default would be 

held in accordance with the limits applicable to assets acquired by a bank 

holding company in the course of collecting a debt previously contracted. 

[Footnote 4. Begin text of Footnote 4. 12 C.F.R. 225.22(d)(1). End 

Footnote 4.] 

Moreover, you have represented that all non-price risks and costs 

of owning the commodity during the term of the CPFS transaction would be 

borne by the ultimate purchaser. For example, [BHC] would not be exposed to 

the storage risk of the commodity because the terms of the CPFS transaction 

would require the ultimate purchaser to purchase the commodity “as is, where 

is,” (in the absence of willful misconduct by [BHC]). The ultimate purchaser 

must also obtain insurance that covers the risks of damage, deterioration, and 

typically theft or fraud of the commodity, and [BHC] would be added as a 

named beneficiary to the insurance policy. During the term of the transaction, 

the ultimate purchaser (not [BHC]) would be responsible for paying the costs 

of storing and insuring the commodity. In all cases, although [BHC] would 

take title to the underlying commodity at the inception of a CPFS transaction, it 

would take title in the form of a warehouse receipt only; that is, the commodity 

would continue to be stored in a licensed warehouse owned and operated by an 

entity other than [BHC]. The commodity would not be moved physically as a 

result of the transaction. 

You have stated that [BHC] acquires title to the underlying 

commodity in a CPFS transaction as an incident to the financing the bank 

provides to its customers and not for speculative purposes. You have 
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represented that [BHC] does not and will not hold itself out as making a market 

in the commodity. In addition, you have indicated that [BHC] does not and will 

not (i) own, operate, or invest in facilities for the extraction, transportation, 

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

commodities. 

To support your view that the transaction is the functional 

equivalent of an extension of credit, you have indicated that [BHC] would 

account for a CPFS transaction as an “asset purchased under an agreement to 

resell” and would recognize profit and loss on a CPFS transaction on an accrual 

basis, in a manner similar to a traditional loan. You also have stated that the 

ultimate purchaser counterparty in a CPFS transaction would generally record 

the underlying commodity as an asset on its balance sheet, and would record its 

obligation to purchase the commodity as a short-term debt liability on its 

balance sheet, during the term of the transaction. 

The Board has previously found a three-party commodity financing 

arrangement similar to [BHC]’s proposed three-party CPFS transactions to be an 

extension of credit permissible for bank holding companies under Regulation Y. 

In a 1973 order issued to Chemical New York Corporation (“Chemical”), the 

Board approved as a permissible lending activity for bank holding companies an 

arrangement under which Chemical would finance a utility’s coal purchases by 

purchasing from a third party, and taking title to, a quantity of coal on a monthly 

basis at the direction of the utility customer. [Footnote 5. Begin text of 

Footnote 5. Chemical New York Corporation/CNA Nuclear Leasing, Inc., 

59 Federal Reserve Bulletin 698 (1973). End Footnote 5.] Chemical would store 

the coal on the premises of the utility under a lease arrangement with the utility. 

The utility would use the coal continuously throughout the following month and 

would pay Chemical monthly for the amount of coal used, at a price equal to 

Chemical’s acquisition cost for the coal plus a fixed amount of interest. The 

utility explicitly bore the risk of loss or damage to the coal during storage. If 

the utility defaulted, Chemical had the right to sell the coal to cover its losses 

and the right to sue the utility for any shortfall in the liquidation proceeds. As 

with the proposed CPFS transactions, the utility’s motive for the transaction 

was to obtain financing for its commodities inventory. 

Based on the information you have provided and the Board’s 

precedents in this area, it is my opinion that the proposed CPFS transactions are 
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within the scope of permissible lending activities for bank holding companies 

under section 225.28(b)(1) of Regulation Y. [BHC] should have in place 

policies and procedures to identify whether a CPFS transaction would create 

heightened legal or reputational risk to [BHC], and to manage any such risk. 

In particular, [BHC] should have policies and procedures to identify whether 

a particular CPFS transaction lacks economic substance or business purpose; 

may be designed by the counterparty for questionable accounting, regulatory, 

or tax purposes; or may be accounted for or disclosed by the counterparty in a 

way that is misleading or inconsistent with the substance of the transaction or 

applicable regulatory or accounting requirements. 

This opinion is limited solely to the permissibility of the proposed 

CPFS activities described above under Regulation Y and does not address the 

permissibility of any other activities or authorize [BHC] to engage in any other 

activities in the United States. Any material change in the manner in which 

[BHC] conducts the proposed CPFS transactions could result in a different 

conclusion and should be reported promptly to Board staff. If you have 

any questions about this matter, please contact Mark E. Van Der Weide 

(202/452-2263) or Andrew S. Baer (202/452-2246) of the Board’s Legal 

Division. 

Sincerely, 

(signed) 

Scott G. Alvarez 

cc: Federal Reserve Bank of New York 

New York State Banking Department