Sin

unsecured exposure to Affiliated Broker-Dealers in securities-borrowing
transactions plus (ii) an estimate of Bank’s potential future exposure (“PFE”) to
Affiliated Broker-Dealers in the transactions.'' Bank’s current unsecured exposure
to Affiliated Broker-Dealers in securities-borrowing transactions would equal the
difference between the cash amount (or current market value of securities) posted
as collateral by Bank and the current market value of the Borrowed Securities.
Bank’s PFE to Affiliated Broker-Dealers in securities-borrowing transactions
initially would be fixed at 6 percent of the current market value of the Borrowed
Securities,'” but Bank may ultimately use an internal model to measure PFE or
overall exposure for these transactions with the approval of Federal Reserve
System and OCC staff.

To address the possibility that this exemption could facilitate Bank’s
structuring loans to affiliates in the form of securities-borrowing transactions, the
exemption would be available only if the Affiliated Broker-Dealer executes a
securities-borrowing transaction with an unaffiliated counterparty that is
substantially contemporaneous with and on the same basic terms as the Bank’s
securities-borrowing transaction with the Affiliated Broker-Dealer. The purpose of
this requirement is to ensure that exempt securities-borrowing transactions are
bank-driven rather than affiliate-driven; that is, that securities-borrowing
transactions are not used to finance the securities inventory of an Affiliated
Broker-Dealer.

To enhance the ability of Bank to close out securities-borrowing
transactions if an Affiliated Broker-Dealer becomes insolvent, Bank must
document the transactions as securities contracts for purposes of section 555 of the
Bankruptcy Code.'? This practice should facilitate the ability of Bank to liquidate

"’ Bank’s potential future exposure in a securities-borrowing transaction is the
potential additional unsecured exposure Bank may have to the Affiliated Broker-
Dealer counterparty if the Borrowed Securities were to fall in value.

2 This approach resembles the approach taken by the federal banking agencies’
risk-based capital guidelines for measuring the credit risk of equity derivative
transactions. See, e.g., 12 CFR part 225, Appendix A, § III.E.2.c.

3 11 U.S.C. § 555.


First, in order to ensure accurate monitoring of Bank’s exposure to
affiliates and to limit Bank’s unsecured exposure to affiliates, Bank must mark to
market on a daily basis its securities-borrowing transactions with Affiliated
Broker-Dealers, and the securities-borrowing transactions must be subject to daily
margin-maintenance requirements. These requirements would ensure that Bank’s
exposure on a securities-borrowing transaction with an Affiliated Broker-Dealer
would be limited to (i) the amount by which the value of the collateral must exceed
the value of the Borrowed Securities (usually 2 percent of the value of the
Borrowed Securities) plus (ii) the amount by which the value of the collateral
might further exceed the value of the Borrowed Securities between the last
remargining event and the time when Bank is able to liquidate Borrowed Securities
after a default by an Affiliated Broker-Dealer.”

Second, in order to enhance Bank’s ability to determine the mark-to-
market value of the Borrowed Securities and to facilitate efforts by Bank to
liquidate the Borrowed Securities if an Affiliated Broker-Dealer defaults, the
exemption would be available only for transactions involving Borrowed Securities
that have a “ready market,” as defined in the net capital rule of the Securities and
Exchange Commission (“SEC”).'° Under the SEC’s interpretations of the net
capital rule, U.S. equity securities have a “ready market” if they are traded on a
USS. securities exchange or are OTC securities quoted by independent market
makers in an interdealer network.

In addition, Bank would be required to treat a portion of each
securities-borrowing transaction with an affiliate as nonexempt. Specifically, the
nonexempt covered transaction amount would be equal to (i) Bank’s current

(assuming the Borrowed Securities were equities) or would otherwise have to
obtain additional collateral from an affiliate to comply with the collateral
requirements of section 23A and Regulation W.

° Bank marks to market its securities-borrowing portfolio on the morning of each
business day, based on closing prices for securities from the previous business day,
and makes requests for the return of excess collateral on a daily basis. The
securities-borrowing agreement between Bank and the Affiliated Broker-Dealers
will require the Affiliated Broker-Dealers to return excess collateral on the same
business day on which Bank makes the request.

' See 17 CFR 240.15c3-1(c)(11)(i).


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these transactions promptly after commencement of an insolvency proceeding with
respect to the Affiliated Broker-Dealer."

Bank would continue to be subject to the market-terms requirement of
section 23B of the Federal Reserve Act in its securities-borrowing transactions
with affiliates. Section 23B requires that these transactions be on terms that are
substantially the same, or at least as favorable to the bank, as those prevailing at
the time for comparable transactions with unaffiliated companies.'°

Granting the exemption would have public benefits. The exemption
would reduce the cost of securities-borrowing transactions for Bank and would,
therefore, make Bank more competitive when pricing equity derivative and other
transactions for customers.

Conclusion

In light of these considerations and all the facts presented, the request
appears to be consistent with safe and sound banking practices and the purposes of
section 23A. Accordingly, the Board hereby grants the requested exemption,
subject to the conditions and limits discussed above. This exemption also is
available to Wachovia’s other subsidiary banks, subject to the condition that those
transactions are on the same terms as those between Bank and the Affiliated
Broker-Dealers, including the terms and conditions outlined in this letter.

This determination is specifically conditioned on compliance by
Wachovia and Bank with all the commitments and representations made to the
Board in connection with the exemption request. These commitments and
representations are deemed to be conditions imposed in writing by the Board in
connection with granting the request and, as such, may be enforced in proceedings
under applicable law. This determination is based on the specific facts and

" Ifa securities-borrowing transaction between Bank and an Affiliated Broker-
Dealer qualifies as a securities contract under the Bankruptcy Code, Bank’s ability
to liquidate the transaction in the event of the bankruptcy of the Affiliated Broker-
Dealer generally cannot be stayed, avoided, or otherwise limited by operation of
any provision of the Bankruptcy Code. See, e.g., 11 U.S.C. § 555.

'S See 12 U.S.C. § 371c-1(a)(1).


BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM

WASHINGTON, D.C. 2055!

ADDRESS OFFICIAL CORRESPONDENCE
TO THE BOARD

June 12, 2007

Courtney D. Allison, Esq.

Senior Vice President and
Assistant General Counsel

Wachovia Corporation

Legal Division

NC0630

301 South College Street

Charlotte, North Carolina 28288

Dear Ms. Allison:

This is in response to the request by Wachovia Corporation
(“Wachovia”), Charlotte, North Carolina, for an exemption from section 23A of
the Federal Reserve Act and the Board’s Regulation W for transactions in which
Wachovia Bank, National Association (“Bank”) borrows securities from
US. broker-dealer subsidiaries of Wachovia (“Affiliated Broker-Dealers”).’

Background

Bank engages in a wide variety of transactions that result in Bank’s
having a synthetic long position in one or more underlying securities. In some
cases, Bank’s hedging methodology requires it to enter into short sales in the
underlying securities. Bank typically establishes these short sales by borrowing
the securities it sells short (the “Borrowed Securities”).

Bank has proposed to enter into these securities-borrowing
transactions with Affiliated Broker-Dealers. Bank has indicated that it has chosen
to borrow securities from Affiliated Broker-Dealers (rather than from an
unaffiliated securities lender) to help maintain the confidential and proprietary

' 12 US.C. § 371c; 12 CFR part 223. Wachovia has also requested that the Board
grant a broader exemption for securities-borrowing transactions between any
subsidiary bank of Wachovia and an Affiliated Broker-Dealer.


-9-

circumstances of the securities-borrowing transactions described in your
correspondence and in this letter. Any material change in those facts and
circumstances or any failure by Wachovia or Bank to observe any of its

commitments or representations may result in a different view or in a revocation of
the exemption.

Very truly yours,

Fit. tddZ Tp Bem

Robert deV. Frierson
Deputy Secretary of the Board

ce: Federal Reserve Bank of Richmond
Office of the Comptroller of the Currency


Din

nature of Bank’s hedging activities and to enable Bank to use the operational and
systems capabilities of Affiliated Broker-Dealers (instead of maintaining its own
securities-borrowing infrastructure).

Bank would borrow securities from Affiliated Broker-Dealers under a
written securities-borrowing agreement, which would require Bank to post
collateral to an Affiliated Broker-Dealer -- usually in the form of cash but
sometimes in the form of other securities or letters of credit -- to secure its
obligation to return the Borrowed Securities. The value of the collateral posted by
Bank would have to equal a certain minimum percentage (the “margin
percentage”) of the value of the Borrowed Securities. The margin percentage
would range from 100 to 105 percent, depending on the nature of the collateral and
the Borrowed Securities. In the vast majority of cases, including the typical case in
which Bank borrows a U.S. equity security secured by U.S. dollars or
US. Treasury securities, the margin percentage would be 102 percent. Bank has
represented that both the form and amount of collateral posted by Bank would be
customary for securities-borrowing transactions between unaffiliated
counterparties.

The cash collateral typically provided by Bank in a securities-
borrowing transaction would not be held by the Affiliated Broker-Dealer in a
segregated account during the term of the transaction. Instead, the Affiliated
Broker-Dealer would re-pledge the cash collateral to secure a contemporaneous
and parallel borrowing of the Borrowed Securities from a nonaffiliate.

During the term of the securities-borrowing transaction, Bank would
mark to market on a daily basis the Borrowed Securities and any collateral and
would call on a daily basis for the return of collateral to the extent that the value of
the collateral exceeds the agreed margin percentage of the value of the Borrowed
Securities.’ Bank would be able to terminate a securities-borrowing transaction on
any business day by returning the Borrowed Securities to the Affiliated Broker-
Dealer, and the Affiliated Broker-Dealer would be able to terminate a transaction
by giving Bank three business days’ prior notice.

> Bank also would have an obligation, upon request by an Affiliated Broker-
Dealer, to post additional collateral to the extent that the value of the collateral
drops below the margin percentage of the value of the Borrowed Securities.


Legal Analysis

Section 23A and Regulation W limit the aggregate amount of
“covered transactions” between a bank and any single affiliate to 10 percent of the
bank’s capital stock and surplus, and limit the aggregate amount of covered
transactions between a bank and all its affiliates to 20 percent of the bank’s capital
stock and surplus.? “Covered transactions” include the purchase of assets by a
bank from an affiliate, the extension of credit by a bank to an affiliate, the issuance
of a guarantee by a bank on behalf of an affiliate, and certain other transactions.’
In addition, the statute and rule require a bank to secure its extensions of credit to,
and guarantees on behalf of, affiliates with prescribed amounts of collateral.”
Section 23A and Regulation W also authorize the Board to exempt, at its
discretion, transactions or relationships from the requirements of the statute and
rule if the Board finds such exemptions to be in the public interest and consistent
with the purposes of section 23A.°

The Board has previously determined that a bank’s collateralized
borrowing of securities from an affiliate is an extension of credit by the bank to the
affiliate for purposes of section 23A and Regulation W.’

The Exemption

In light of the facts and circumstances of this proposal, the Board
believes that granting an exemption would be appropriate and consistent with
precedent, as long as Bank complies with the following conditions.*

3 12 U.S.C. § 371c(a)(1) and 12 CFR 223.11 and 223.12.
* 12 U.S.C. § 371¢(b)(7) and 12 CFR 223.3(h).

> 12 U.S.C. § 371o(c) and 12 CFR 223.14.

6 12 U.S.C. § 371c(£)(2) and 12 CFR 223.43.

7 See Board Letter dated June 7, 2005, to John H. Huffstutler, Esq. (Bank of
America Corporation).

* Id. In the absence of an exemption, Bank would be required to count the entire
amount of the collateral posted by Bank to an Affiliated Broker-Dealer toward the
quantitative limits of section 23A and Regulation W. In addition, Bank would
have to obtain Borrowed Securities from the Affiliated Broker-Dealer that had a
market value equal to at least 130 percent of the collateral posted by Bank