24186 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

1 12 U.S.C. 371c(f), 371c–1(e).

2Pub. L. No. 106–102, 113 Stat. 1338 (1999).

3See 63 FR 32766, June 16, 1998; 62 FR 37744,

July 15, 1997.

FEDERAL RESERVE SYSTEM

12 CFR Part 223

[Regulation W; Docket No. R–1103]

Transactions Between Banks and Their

Affiliates

AGENCY: Board of Governors of the

Federal Reserve System.

ACTION: Notice of proposed rulemaking.

SUMMARY: The Board of Governors of the

Federal Reserve System (Board) is

proposing a new rule (Regulation W) to

implement comprehensively sections

23A and 23B of the Federal Reserve Act.

The proposed rule would combine

statutory restrictions on transactions

between a bank and its affiliates with

numerous existing and proposed Board

interpretations and exemptions in an

effort to simplify compliance with

sections 23A and 23B.

DATES: Comments must be submitted on

or before August 15, 2001.

ADDRESSES: Comments should refer to

Docket No. R–1103 and should be sent

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 to the Board’s

mail room between the hours of 8:45

a.m. and 5:15 p.m. weekdays and,

outside of those hours, to the Board’s

security control room. Both the mail

room and the security control room are

accessible from the Eccles Building

courtyard entrance, located on 20th

Street, NW., 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. weekdays,

except as provided in section 261.14 of

the Board’s Rules Regarding Availability

of Information (12 CFR 261.14).

FOR FURTHER INFORMATION CONTACT:

Pamela G. Nardolilli, Senior Counsel

(202/452–3289), or Mark E. Van Der

Weide, Counsel (202/452–2263), Legal

Division; or Michael G. Martinson,

Associate Director (202/452–3640), or

Molly S. Wassom, Associate Director

(202/452–2305), Division of Banking

Supervision and Regulation; Board of

Governors of the Federal Reserve

System, 20th Street and Constitution

Avenue, NW., Washington, DC 20551.

SUPPLEMENTARY INFORMATION:

Introduction

Sections 23A and 23B of the Federal

Reserve Act are two of the most

important statutory protections against a

bank suffering losses because of its

transactions with affiliates and,

correspondingly, are two of the most

effective means of limiting the ability of

a bank to transfer to its affiliates the

subsidy arising from the bank’s access to

the Federal safety net. Although

sections 23A and 23B of the Federal

Reserve Act each explicitly grant the

Board broad authority to issue

regulations to administer the section,1

the Board has never issued a regulation

fully implementing either section.

Instead, banks seeking guidance on how

to comply with sections 23A and 23B

have relied on a series of Board

interpretations and informal staff

guidance. Banks have increasingly

sought guidance from the Board on

section 23A issues in recent years as a

result of the increasing scope of

activities conducted by modern

financial holding companies and the

growing complexities of the U.S.

financial markets.

The Board now believes that adoption

of a comprehensive regulation

implementing sections 23A and 23B

would be appropriate for several

reasons. First, the new regulatory

framework established by the GrammLeach-Bliley Act (‘‘GLB Act’’) 2

emphasizes the importance of sections

23A and 23B as a means to protect

banks from losses in connection with

the newly authorized affiliates under

the GLB Act. In addition, the GLB Act

amended section 23A in several

important respects and requires the

Board to address by rule under section

23A the credit exposure arising from

derivative transactions and intraday

credit extensions.

Moreover, the Board believes that

adoption of a comprehensive regulation

would simplify the interpretation and

application of sections 23A and 23B,

ensure that the statute is consistently

interpreted and applied, and minimize

burden to the extent consistent with the

statute’s goals. Finally, issuing a

proposed regulation would allow the

public an opportunity to comment on

Board and staff interpretations of

sections 23A and 23B, many of which

were adopted without the benefit of a

public comment process.

The proposed regulation would

supersede outdated Board and staff

interpretations concerning sections 23A

and 23B and would incorporate other

existing interpretations. In addition, the

regulation would incorporate the results

of the Board’s earlier proposals to clarify

the scope of the attribution rule, expand

the section 23A(d)(6) exemption for

purchases of readily marketable assets,

and, consistent with the GLB Act,

extend the coverage of section 23A to

subsidiaries of a bank engaged in

activities that the bank cannot conduct

directly.3 Finally, the proposed

regulation would answer questions that

have arisen frequently in the Board’s

administration of the statutory

provisions and in their enforcement by

each of the Federal banking agencies.

The Board emphasizes that Regulation

W is a proposed rule and expects to

make changes to the rule to reflect

public comments as appropriate. Until

Regulation W is finalized, all previously

issued valid Board interpretations and

staff opinions regarding sections 23A

and 23B will remain in full force and

effect. After the Board issues the

regulation in final form, any Board

interpretations or staff opinions on the

statute that are inconsistent with the

regulation will be deemed superseded

by the rule.

Background

As noted above, sections 23A and 23B

of the Federal Reserve Act are designed

to limit the risks to a bank (and the

Federal deposit insurance funds) from

transactions between the bank and its

affiliates and to limit the ability of a

bank to transfer to its affiliates the

subsidy arising from the bank’s access to

the Federal safety net. Section 23A

achieves these goals in three major

ways. First, it limits a bank’s ‘‘covered

transactions’’ with any single ‘‘affiliate’’

to no more than 10 percent of the bank’s

capital and surplus, and transactions

with all affiliates combined to no more

than 20 percent of capital and surplus.

‘‘Covered transactions’’ include

purchases of assets from an affiliate,

extensions of credit to an affiliate,

investments in securities issued by an

affiliate, guarantees on behalf of an

affiliate, and certain other transactions

that expose the bank to an affiliate’s

credit or investment risk. A bank’s

‘‘affiliates’’ include, among other

companies, any companies that control

the bank, any companies under common

control with the bank, and certain

investment funds that are advised by the

bank or an affiliate of the bank.

Second, the statute requires all

transactions between a bank and its

affiliates to be on terms and conditions

that are consistent with safe and sound

banking practices, and prohibits a bank

from purchasing low-quality assets from

its affiliates. Finally, the statute requires

that a bank’s extensions of credit to

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24187

4 Garn-St Germain Depository Institutions Act of

1982, Pub. L. No. 97–320, § 410, 96 Stat. 1515

(1982) (codified at 12 U.S.C. 371c).

5Pub. L. No. 89–485, § 12(c), 80 Stat. 242 (1966)

(codified at 12 U.S.C. 1828(j)).

6Financial Institutions Reform, Recovery, and

Enforcement Act of 1989, Pub. L. No. 101–73, § 301,

103 Stat. 342 (1989) (codified at 12 U.S.C. 1468)

(‘‘FIRREA’’).

7Pub. L. No. 100–86, § 102, 101 Stat. 552, 564

(1987) (codified at 12 U.S.C. 371c–1).

8Section 23A excludes from the definition of

‘‘affiliate’’ most subsidiaries of a bank. See 12

U.S.C. 371c(b)(2)(A).

9See 12 U.S.C. 24a, 1464(c)(4)(B), and 1831a; 12

CFR 5.39 and 362.4.

10 62 FR 37744, July 15, 1997.

11See 12 U.S.C. 24a.

12Covered transactions between a bank and any

of its financial subsidiaries would count toward the

bank’s 20 percent limit for covered transactions

with all affiliates in the aggregate.

13 GLB Act section 121(e)(3) (codified at 12 U.S.C.

371c(f)(3)).

affiliates and guarantees on behalf of

affiliates be appropriately secured by a

statutorily defined amount of collateral.

Section 23B protects a bank by

requiring that certain transactions

between the bank and its affiliates occur

on market terms; that is, on terms and

under circumstances 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. Section 23B applies this

restriction to any covered transaction (as

defined in section 23A) with an affiliate

as well as certain other transactions,

such as the sale of securities or other

assets to an affiliate and the payment of

money or furnishing of services to an

affiliate.

Section 23A originally was enacted as

part of the Banking Act of 1933 and

applied only to banks that were

members of the Federal Reserve System

(‘‘member banks’’). Since 1933,

Congress has amended the statute

several times, including a

comprehensive revision in 1982.4

Congress also amended the Federal

Deposit Insurance Act in 1966 to extend

section 23A to cover insured

nonmember banks.5 In 1989, Congress

further extended the coverage of section

23A to insured savings associations.6

Congress enacted section 23B of the

Federal Reserve Act as part of the

Competitive Equality Banking Act of

1987,7 and has subsequently expanded

its scope to cover the same set of

depository institutions as are covered by

section 23A. Consequently, sections

23A and 23B now apply to all insured

depository institutions and uninsured

member banks.

As part of its comprehensive revision

of section 23A in 1982, Congress

amended the statute to exempt

transactions between a bank and its

subsidiaries.8 In 1982, a subsidiary of a

bank generally was permitted to engage

only in activities that its parent bank

could conduct. Since 1982, however,

some subsidiaries of banks have begun

to engage in activities impermissible to

the banks themselves.9 In 1997, to

address these subsidiaries, the Board

issued for comment a proposal to extend

sections 23A and 23B to transactions

between a bank and a subsidiary of the

bank engaged in activities not

permissible for the bank to engage in

directly.10 Consistent with this

proposal, the GLB Act recently amended

the Federal Reserve Act so that sections

23A and 23B would apply to

transactions between a bank and its

‘‘financial subsidiaries.’’ Section 23A, as

amended by the GLB Act, defines a

financial subsidiary as any subsidiary of

a bank that would be a financial

subsidiary of a national bank under

section 5136A of the Revised Statutes of

the United States.11 This statutory

provision defines a financial subsidiary

of a national bank as a subsidiary of an

insured depository institution that

engages in activities that are not

permissible for a national bank to

engage in directly (unless a national

bank is authorized by the express terms

of a Federal statute (other than the GLB

Act) to own or control the subsidiary).

The GLB Act provides that a financial

subsidiary of a bank is considered an

‘‘affiliate’’ of the bank for purposes of

sections 23A and 23B and requires, with

certain limited exceptions, that any

covered transactions between a bank

and its financial subsidiaries comply

with the same quantitative, collateral,

and other restrictions imposed by

sections 23A and 23B on other affiliates.

The GLB Act also establishes certain

special rules for financial subsidiaries.

For example, the GLB Act extends the

restrictions of sections 23A and 23B to

investments by a bank’s affiliate in

securities issued by any financial

subsidiary of the bank. The GLB Act

also authorizes the Board to extend

sections 23A and 23B to loans and other

extensions of credit made by a bank’s

other affiliates to any financial

subsidiary of the bank, if the Board

determines that such action is necessary

or appropriate to prevent evasions of the

Federal Reserve Act or the GLB Act.

Finally, the GLB Act provides that the

10 percent restriction on covered

transactions with any individual

affiliate does not apply to transactions

between a bank and any individual

financial subsidiary of the bank.12 The

proposed regulation addresses these

provisions of the GLB Act.

In addition, the GLB Act requires the

Board to adopt, by May 12, 2001, final

rules to address as a covered transaction

the credit exposure arising out of

derivative transactions between banks

and their affiliates and intraday

extensions of credit by banks to their

affiliates.13 Concurrently with proposed

Regulation W, the Board is issuing

interim final rules that address these

credit exposures to affiliates as covered

transactions under section 23A, in

accordance with this statutory

requirement, by requiring banks to

adopt policies and procedures to

manage the credit exposures. The

interim final rules also require banks to

ensure that their intraday extensions of

credit to an affiliate and their derivative

transactions with affiliates comply with

the market terms requirement of section

23B.

The proposed Regulation W sets forth

a more comprehensive proposal on the

treatment of intraday extensions of

credit under section 23A than is

contained in the interim final rules and

includes a detailed request for comment

on the appropriate treatment of credit

exposure arising from bank-affiliate

derivative transactions under section

23A. If, after further analysis and review

of the comments received on this

regulation and the interim final rule on

derivatives, the Board believes that

additional measures are needed to

address credit exposure on derivative

transactions under section 23A, the

Board will develop a specific proposal

and seek comment on that proposal.

Explanation of Proposed Rule

I. Format of Regulation

The proposed Regulation W seeks to

provide users with a single,

comprehensive reference tool for

complying with and analyzing issues

arising under sections 23A and 23B.

Accordingly, the regulation includes

Board interpretations of the sections and

also restates the statutory definitions,

restrictions, and exemptions. Although

including the statutory language

lengthens the text of the regulation, the

Board believes that eliminating the need

to cross-reference the statute should

make understanding and using the

regulation easier.

The regulation first sets forth, in

subpart B, the principal restrictions and

requirements imposed by section 23A.

Next, in subpart C, the regulation

discusses the appropriate valuation and

timing principles for covered

24188 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

14The regulation implements sections 23A and

23B of the Federal Reserve Act. The regulation does

not contain or implement statutory or regulatory

restrictions on transactions between banks and their

affiliates that may be applicable under other

provisions of law, including that may apply to

banks subject to prompt corrective action under

section 38 of the Federal Deposit Insurance act (12

U.S.C. 1831o).

15HOLA prohibits an insured savings association

from (i) making loans or extending credit to any

affiliate unless that affiliate is engaged solely in

activities that the Board has determined to be

permissible under section 4(c) of the Bank Holding

Company Act (12 U.S.C. 1843(c)); and (ii)

purchasing or investing in shares issued by an

affilate other than a subsidiary of the savings

association.

16 12 U.S.C. 1468(a)(4). 17 12 U.S.C. 371c(a)(1).

transactions. Subpart D discusses the

appropriate treatment under section

23A for transactions with financial

subsidiaries, bank-affiliate derivative

transactions, and certain bank-affiliate

merger and acquisition transactions.

Subpart E sets forth available

exemptions from certain of the

restrictions and requirements of section

23A. Subpart F lays out the operative

provisions of section 23B. Subpart G

discusses the application of the

statutory provisions and rule to U.S.

branches and agencies of foreign banks.

Subpart H provides a comprehensive

glossary of the terms used in the

regulation and sections 23A and 23B.

The proposed regulation also includes

examples illustrating how several of the

rule’s provisions would apply in

particular circumstances. The examples

included in the rule are considered part

of the rule and compliance with an

example, to the extent applicable,

would constitute compliance with the

rule. Each example included in the rule

illustrates only the scope and

application of the particular topic

addressed by the example and does not

illustrate any other topic or issue that

may arise under the rule.

The Board requests comment on the

proposed format of the regulation,

including the Board’s decision to restate

and reorganize the statutory provisions

and include examples in the rule. The

Board also requests comment on

whether additional examples should be

added to the rule and, if so, in what

areas. In addition, the Board requests

comment on whether there are

additional methods for making the

regulation more user-friendly or for

reducing unnecessary regulatory

burden.

II. Scope of Regulation

As proposed, Regulation W applies to

all ‘‘banks.’’ As noted above, although

sections 23A and 23B apply by their

terms only to member banks, the

Federal Deposit Insurance Act subjects

insured nonmember banks to the

restrictions of sections 23A and 23B as

if they were member banks. Referring to

banks (rather than member banks)

should clarify the scope of the

regulation for the reader. By using the

defined term ‘‘bank,’’ the Board does not

intend to expand the scope of sections

23A and 23B beyond member banks and

insured nonmember banks. 14

The Home Owners’ Loan Act

(‘‘HOLA’’) also subjects insured savings

associations to sections 23A and 23B as

if they were member banks. HOLA

imposes several restrictions on

transactions between an insured savings

association and certain of its affiliates

that are not contained in section 23A 15

and provides the Office of Thrift

Supervision (‘‘OTS’’) with authority to

impose additional restrictions on

transactions between an insured savings

association and its affiliates.16 In light of

the stricter regulatory regime governing

transactions between an insured savings

association and its affiliates and in light

of a request by the OTS that the

proposed Regulation W not specifically

cover such institutions, the proposed

rule does not apply by its terms to

savings associations. The Board notes,

however, that because insured savings

associations are subject to sections 23A

and 23B as if they were member banks,

any parallel regulation adopted by the

OTS to govern transactions with

affiliates must be at least as strict on

insured savings associations as

Regulation W is on banks.

III. General Provisions of Section 23A—

Subpart B

Subpart B of the proposed regulation

sets forth the principal restrictions of

section 23A. These restrictions include:

(i) the quantitative limits on covered

transactions by a bank with any

individual affiliate and all affiliates in

the aggregate;

(ii) the requirement that all

transactions with an affiliate be on

terms and conditions that are consistent

with safe and sound banking practices;

(iii) the collateral requirements for

extensions of credit and similar

transactions with an affiliate;

(iv) the prohibition on the purchase of

low-quality assets from an affiliate; and

(v) the attribution rule, which

provides that any transaction with any

person that is not an affiliate will be

considered a transaction with an

affiliate to the extent that the proceeds

of the transaction are used for the

benefit of, or transferred to, that affiliate.

Subpart B also incorporates previous

Board and staff interpretations of these

provisions. In addition, the subpart

includes a few new interpretations of

the statute’s quantitative limits,

collateral requirements, and attribution

rule. These clarifications of the statute

are discussed below.

A. Quantitative Limits—223.2 and 223.3

Section 23A(a)(1) provides that a bank

may engage in a covered transaction

with an affiliate only if, upon

consummation of the proposed

transaction, the aggregate amount of the

bank’s covered transactions (i) with any

single affiliate would not exceed 10

percent of the bank’s capital stock and

surplus and (ii) with all affiliates would

not exceed 20 percent of the bank’s

capital stock and surplus.17 Sections

223.2 and 223.3 of the proposed

regulation set forth these quantitative

limits. The quantitative limits of

Regulation W (consistent with section

23A) only prohibit a bank from engaging

in a new covered transaction if the bank

would be in excess of the 10 or 20

percent thresholds after consummation

of the new transaction. The regulation

(consistent with section 23A) generally

does not require a bank to unwind

existing covered transactions if the bank

exceeds the 10 or 20 percent limits

because its capital declined or a preexisting covered transaction increased

in value.

Section 23A(a)(1)(A) states that a bank

‘‘may engage in a covered transaction

with an affiliate only if * * * in the

case of any affiliate,’’ the aggregate

amount of covered transactions of the

bank will not exceed 10 percent of the

capital stock and surplus of the bank.

Regulation W makes clear that this

limitation prevents a bank from

engaging in a new covered transaction

with an affiliate if the aggregate amount

of covered transactions between the

bank and any affiliate (not only the

particular affiliate with which the bank

proposes to engage in the new covered

transaction) would be in excess of 10

percent of the bank’s capital stock and

surplus after consummation of the new

transaction. This interpretation of the

section is consistent with the statutory

language and would have the salutary

effect of encouraging banks with

covered transactions in excess of the 10

percent threshold with any affiliate to

reduce those transactions before

expanding the scope or extent of the

bank’s relationships with other

affiliates.

B. Collateral Requirements—223.5

Section 223.5 of the proposed

regulation sets forth the collateral

requirements established by section

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24189

18 12 U.S.C. 371c(c)(1).

19 12 U.S.C. 371c(c)(3) and (4).

20See Letter dated Aug. 31, 1987, from Michael

Bradfield, General Counsel of the Board, to Gail

Runnfeldt.

21See Fitzpatrick v. FDIC, 765 F.2d 569 (6th Cir.

1985).

22This proposed treatment would not apply to

guarantees, acceptances, and letters of credit issued

on behalf of an affiliate, which must be fully

collateralized at inception.

23A(c) for loans and extensions of credit

to an affiliate, and guarantees,

acceptances, and letters of credit issued

on behalf of an affiliate (collectively,

‘‘credit transactions’’). As a general

matter, section 23A requires any credit

transaction by a bank with an affiliate to

be secured with a statutorily prescribed

amount of collateral. The required

collateral varies from 100 percent of the

value of the credit extended (when the

collateral is a deposit account or U.S.

government securities) to 130 percent of

the credit extended (when the collateral

is stock, leases, or certain other ‘‘real or

personal property’’).18

1. Deposit account as collateral—

223.5(b)(1)(iv). Under section

23A(c)(1)(A)(iv), a bank may satisfy the

collateral requirements of the statute by

securing a credit transaction with an

affiliate with a segregated, earmarked

deposit account maintained with the

bank in an amount equal to 100 percent

of the credit extended. The proposed

regulation clarifies that to satisfy the

statute’s ‘‘earmarked’’ requirement, the

account must exist for the sole purpose

of securing the credit extended and be

so identified.

2. Ineligible collateral—223.5(c). The

purpose of section 23A’s collateral

requirements is to ensure that banks that

engage in credit transactions with an

affiliate have legal recourse, in the event

of affiliate default, to tangible assets

with a value at least equal to the amount

of the credit extended. The statute

recognizes that certain types of assets

are not appropriate to serve as collateral

for credit transactions with an affiliate.

In particular, the statute provides that

low-quality assets and securities issued

by an affiliate are not eligible collateral

for such covered transactions.19

In light of the purposes of section

23A, the Board believes that intangible

assets (as defined by generally accepted

accounting principles (‘‘GAAP’’))—

including mortgage servicing assets and

other servicing assets—are not

acceptable collateral to secure credit

transactions with an affiliate. Intangible

assets are particularly hard to value, and

a bank may have significant difficulty in

collecting and selling such assets in a

reasonable period of time. For these

reasons, Board staff opined in 1987 that

mortgage servicing rights may not be

used to satisfy the collateral

requirements of section 23A.20 The

Board believes that these reasons

continue to justify the exclusion of

mortgage servicing assets, as well as

other intangible assets, from the types of

collateral eligible to satisfy the

requirements of section 23A. The Board

seeks comment on whether banks

should be permitted to use any

particular types of intangible assets to

meet section 23A’s collateral

requirements.

In addition, the Board does not

consider guarantees and letters of credit

to be eligible collateral for section 23A

purposes. These agreements are not

balance sheet assets under GAAP and,

accordingly, would not constitute ‘‘real

or personal property’’ under section

23A. Moreover, section 23A(c) requires

that credit transactions be ‘‘secured’’ by

collateral. A credit transaction between

a bank and an affiliate supported only

by a guarantee or letter of credit from a

third party would not appear to meet

the statutory requirement that the credit

transaction be secured by collateral.

As noted above, section 23A prohibits

a bank from accepting securities issued

by an affiliate as collateral for an

extension of credit to an affiliate. The

Board also proposes to clarify that

securities issued by the bank itself are

not eligible collateral to secure a credit

transaction with an affiliate. If the bank

were forced to foreclose on such a credit

transaction, the bank may be unwilling

to liquidate its own securities promptly

to recover on the credit transaction

because the sale might depress the price

of the bank’s outstanding securities or

result in a change in control of the bank.

In addition, to the extent that a bank is

unable or unwilling to sell its own

securities acquired through foreclosure,

the transaction may result in a reduction

in the bank’s capital, thereby offsetting

any potential benefit provided by the

collateral. The Board seeks comment on

whether this exclusion should apply to

debt and equity securities issued by the

bank or whether the exclusion should

apply only to bank-issued equity

securities.

3. Perfection and priority required—

223.5(d). To ensure that the bank has

good access to the assets serving as

collateral for its transactions with

affiliates, the proposed regulation also

provides that a bank’s security interest

in any collateral required by section

23A must be perfected in accordance

with applicable law. This requirement is

consistent with court decisions on the

issue 21 and ensures that the bank has

the legal right to realize on the collateral

in case of default, including one

resulting from the affiliate’s insolvency,

liquidation, or similar circumstances.

For similar reasons, the proposed

regulation requires that a bank either

must obtain a first priority security

interest in the required collateral or

must deduct from the amount of

collateral obtained by the bank the

lesser of (i) the amount of any security

interests in the collateral that are senior

to that obtained by the bank or (ii) the

amount of any credits secured by the

collateral that are senior to that of the

bank. For example, if a bank lends $100

to an affiliate and takes as collateral a

second lien on a parcel of real estate

worth $200, the arrangement would

only satisfy the collateral requirements

of section 23A if the affiliate owed the

holder of the first lien $70 or less (a

credit transaction secured by real estate

must be secured at 130 percent of the

amount of the transaction).

4. Undrawn portion of an extension of

credit—223.5(g). Section 23A requires

that the ‘‘amount’’ of an extension of

credit be secured by the statutorily

prescribed levels of collateral. Board

staff traditionally has advised that a

bank that provides a line of credit to an

affiliate must secure the full amount of

the line of credit throughout the life of

the credit. That is, staff has not viewed

section 23A as permitting a bank to

satisfy the collateral requirements of

section 23A by securing only the

portion of a credit line that has been

drawn down by the affiliate. The Board

acknowledges that this treatment may

be too strict for some lines of credit.

Accordingly, the regulation provides

that the collateral requirements of

section 23A do not apply to the

undrawn portion of an extension of

credit to an affiliate so long as the bank

does not have any legal obligation to

advance additional funds under the

credit facility until the affiliate has

posted the amount of collateral required

by the statute with respect to the entire

drawn portion of the extension of

credit.22 In such credit arrangements,

securing the undrawn portion of the

credit line is unnecessary from a safety

and soundness perspective because the

affiliate can never require the bank to

advance additional funds without

posting the additional collateral

required by section 23A. If a bank

voluntarily advanced additional funds

under such a credit arrangement

without obtaining the additional

collateral required under section 23A to

secure the entire drawn amount (despite

24190 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

23 12 U.S.C. 371c(a)(3). Section 23A does not

prohibit an affiliate from donating a low-quality

asset to a bank, so long as a bank provides no

consideration for the asset.

24See Letter dated Aug. 10, 1984, from Michael

Bradfield, General Counsel of the Board, to Margie

Goris.

25 12 U.S.C. 371c(a)(2).

26 63 FR 32766, June 11, 1998, and 63 FR 32768,

June 11, 1998.

its lack of legal obligation to make such

an advance), the Board would view this

action as a violation of the collateral

requirements of the statute.

C. Prohibition on the Purchase of LowQuality Assets—223.6

Section 223.6 of the proposed

regulation restates the statute’s general

prohibition on a bank purchasing lowquality assets from an affiliate.23 This

section also provides an exception to

the general prohibition, which is based

on a long-standing staff interpretation.24

The exception allows a bank that

purchased a loan participation from an

affiliate to renew its participation in the

loan, or provide additional funding

under the existing participation, even if

the underlying loan has become a lowquality asset, so long as certain criteria

are met. These renewals or additional

credit extensions may enable both the

affiliate and the participating bank to

avoid or minimize potential losses. It

would be inconsistent with the

purposes of section 23A to bar a

participating bank from using sound

banking judgment to take the necessary

steps (consistent with the criteria

established in the rule) to protect itself

from harm in such a situation.

The exception is available only if the

underlying loan was not a low-quality

asset at the time the bank purchased its

participation, and the proposed

transaction does not increase the bank’s

proportional share of the credit facility.

The transaction also must be approved

by the bank’s board of directors, and the

bank must provide its appropriate

Federal banking agency with 20 days’

prior notice of the transaction. The

notice requirement represents an

additional condition to the exception

that is not contained in the staff’s

outstanding interpretive letter on the

exception. The Board proposes to add

this condition at the request of a Federal

banking agency that expressed an

interest in monitoring these

transactions.

The Board believes that this exception

allows banks appropriate flexibility to

resolve problems associated with a

troubled loan participation.

D. Attribution Rule—223.7

Section 23A(a)(2) provides that any

transaction between a bank and a third

party is deemed to be a transaction with

an affiliate to the extent that the

proceeds of the transaction are used for

the benefit of, or transferred to, that

affiliate.25 For example, a bank’s loan to

a customer for the purpose of

purchasing securities from the inventory

of a broker-dealer affiliate of the bank

would be a covered transaction under

section 23A. This ‘‘attribution rule’’ was

included in section 23A to prevent a

bank from evading the restrictions in the

section by using intermediaries and to

limit the exposure that a bank has to

customers of affiliates of the bank.

Section 223.7 of the proposed regulation

restates this provision and provides

interpretive guidance and exemptions

on the following topics.

1. Agency and riskless principal

transactions—223.7(b)(1) and (2). In

June 1998, the Board proposed several

exemptions for covered transactions

between a bank and its securities

affiliates (the ‘‘1998 Proposal’’).26 In the

1998 Proposal, the Board proposed to

exempt from section 23A loans by a

bank to an unaffiliated customer who

uses the proceeds to purchase securities

through a broker-dealer affiliate of the

bank that is acting solely in an agency

or riskless-principal capacity. The Board

is adopting an expanded form of this

exemption in a separate final rule issued

concurrently with Regulation W. The

exemptive aspects of the final rule also

are contained in Regulation W, and the

Board asks for further comment on the

exemption. In particular, the Board asks

whether the riskless principal

exemption should be expanded to cover

purchases of assets other than securities.

2. Preexisting Lines of Credit—

223.7(b)(3). In the 1998 Proposal, the

Board also proposed an exemption from

section 23A for extensions of credit by

a bank to an unaffiliated customer that

uses the credit to purchase securities

underwritten by or held in the inventory

of a broker-dealer affiliate of the bank

when that extension of credit was made

pursuant to a preexisting line of credit

(the ‘‘Preexisting Line of Credit

Exemption’’). The Board is adopting this

exemption substantially as proposed in

another separate final rule issued

concurrently with Regulation W. The

exemption is also included in

Regulation W, thus allowing an

opportunity for further comment on the

exemption.

3. General Purpose Credit Cards—

223.7(b)(4). Section 23A’s attribution

rule, by its terms, would cover an

extension of credit by a bank to a

nonaffiliate where the proceeds of the

extension of credit are used by the

nonaffiliate to purchase products or

services from an affiliate of the bank.

Regulation W would exempt such an

extension of credit from the attribution

rule if the extension is made pursuant

to a general purpose credit card issued

by the bank to the nonaffiliate. The

regulation defines a general purpose

credit card as a credit card issued by a

bank, if (i) the card may be used to buy

products or services from a nonaffiliate

of the bank, (ii) the card is widely

accepted by merchants that are not

affiliates of the bank, and (iii) less than

25 percent of the aggregate amount of

products and services purchased with

the card by all cardholders are products

or services purchased from affiliates of

the bank (see § 223.26(n)). In these

circumstances, the funding benefit

received by the affiliate from the

unaffiliated borrower’s use of the

general purpose credit card is likely to

be minimal, and a bank’s decision to

issue a general purpose credit card (and

make loans pursuant to such credit

card) to an unaffiliated borrower likely

would be based on independent credit

standards unrelated to any possible

affiliate transaction. Extensions of credit

to unaffiliated borrowers pursuant to

special purpose credit cards (that is,

credit cards that may only be used or are

substantially used to buy goods or

services from affiliates of the bank),

however, would continue to be subject

to the attribution rule because the

affiliate would be a significant and

intended beneficiary of the bank’s credit

extensions pursuant to the cards.

IV. Valuation and Timing Principles

Under Section 23A—Subpart C

Subpart C of the proposed regulation

sets forth the rules that banks must use

to calculate the value of covered

transactions for purposes of determining

compliance with the quantitative limits

and collateral requirements of section

23A. This subpart also sets forth several

rules that banks must employ to

determine when a transaction becomes

or ceases to be a covered transaction.

Although most of these valuation and

timing rules are consistent with

previous advice given by Board staff on

these issues, certain of the principles

represent new positions. The rules are

discussed below.

A. Credit Transactions—223.8

The regulation provides generally that

a credit transaction initially must be

valued at the amount of funds provided

by the bank to, or on behalf of, the

affiliate plus any additional amount that

the bank could be required to provide

to, or on behalf of, the affiliate. For

example, a $100 term loan is a $100

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24191

27The purchase by a bank of a security issued by

an affiliate is addressed in Part IV.C. below, and the

purchase by a bank of any other note or obligation

of an affiliate is addressed in Part IV.A. above.

28The Board also has determined to treat certain

bank-affiliate merger and acquisition transactions as

constructive asset purchases. These transactions are

discussed in Part V.A. below.

29The valuation rule for investments in securities

issued by a financial subsidiary is discussed in Part

V.B.2. below.

30Carrying value refers to the amount at which

the securities are carried on the GAAP financial

statements of the bank.

covered transaction, a $300 revolving

credit facility is a $300 covered

transaction (regardless of how much of

the facility the affiliate has drawn

down), and a guarantee backstopping a

$500 debt issuance of the affiliate is a

$500 covered transaction.

The regulation also would make clear

that a bank has entered into a credit

transaction with an affiliate at the time

during the day that the bank becomes

legally obligated to make the extension

of credit to, or issue the guarantee,

acceptance, or letter of credit on behalf

of, an affiliate. This timing rule

represents a departure from the industry

practice of complying with section 23A

only with respect to overnight positions.

The rule is consistent, however, with

the regulation’s proposal to incorporate

intraday credit extensions into section

23A, as described below. This timing

rule also clarifies that a covered

transaction occurs at the moment that

the bank executes a legally valid,

binding, and enforceable credit

agreement or guarantee document, and

does not occur only when a bank funds

a credit facility or makes payment on a

guarantee.

Under section 23A and the proposed

regulation, a bank has made an

extension of credit to an affiliate if the

bank purchases from a third party a loan

previously made to an affiliate of the

bank. The regulation refers to this type

of transaction as an ‘‘indirect’’ credit

transaction. In these circumstances, the

bank must value the credit transaction

at the price paid by the bank for the loan

plus any additional amount that the

bank could be required to provide to, or

on behalf of, the affiliate under the

terms of the credit agreement.

For example, if a bank pays a third

party $90 for a $100 term loan that the

third party previously made to an

affiliate of the bank (because, for

example, the loan was at a fixed rate

and has declined in value due to a rise

in the general level of interest rates), the

covered transaction amount is $90

rather than $100. The lower covered

transaction amount reflects the fact that

the bank’s maximum loss on the

transaction is $90 rather than the

original principal amount of the loan. If

a bank pays a third party $70 for a $100

line of credit to an affiliate of which $70

had been drawn down by the affiliate,

the covered transaction amount would

be $100 (the $70 purchase price paid by

the bank for the credit plus the

remaining $30 that the bank could be

required to lend under the credit line).

For these indirect credit transactions,

the regulation deems a bank to engage

in a covered transaction at the moment

during the day that the bank acquires

the credit transaction from the third

party.

Although a bank’s purchase of, or

investment in, a debt security issued by

an affiliate is considered an ‘‘extension

of credit’’ under the regulation, these

transactions are not valued like other

extensions of credit. The valuation rules

for purchases of, and investments in, the

debt securities of an affiliate are set

forth in section 223.10 of the rule,

which is discussed in Part IV.C. below.

Banks sometimes lend money to, or

issue guarantees on behalf of,

unaffiliated companies that later

become affiliates of the bank. The

regulation provides that credit

transactions with a nonaffiliate become

covered transactions at the time that the

nonaffiliate becomes an affiliate of the

bank. The Board does not believe that

section 23A should be read to prevent

the affiliation or to require that the

indebtedness be reduced to meet the

applicable section 23A quantitative

limits before the affiliation occurs or

thereafter. The bank must ensure,

however, that any such credit

transaction satisfies the collateral

requirements of section 23A promptly

after the nonaffiliate becomes an

affiliate. The bank also must include the

amount of any such transaction in the

aggregate amount of its covered

transactions for purposes of determining

whether any future covered transactions

would comply with the quantitative

limits of section 23A.

In cases where the bank entered into

the credit transaction with the

nonaffiliate in contemplation of the

nonaffiliate becoming an affiliate of the

bank, however, there is an additional

requirement. In such cases, the bank

must, at or prior to the time the

nonaffiliate becomes an affiliate, reduce

the aggregate amount of its covered

transactions with affiliates if necessary

so as not to exceed the quantitative

limits of section 23A. The regulation

provides an example of how section

23A applies in these circumstances.

B. Asset Purchases—223.9

Regulation W provides that a

purchase of assets by a bank from an

affiliate initially must be valued at the

total amount of consideration given by

the bank in exchange for the asset. This

consideration can take any form, and

the regulation makes clear that it would

include an assumption of liabilities by

the bank.27 The regulation also indicates

that an asset purchase remains a

covered transaction for a bank for as

long as the bank holds the asset, and

that the value of the covered transaction

after the purchase may be reduced to

reflect amortization or depreciation of

the asset, to the extent that such

reductions are consistent with GAAP

and are reflected on the bank’s financial

statements.28

In contrast with credit transactions,

an asset purchase from a nonaffiliate

that later becomes an affiliate generally

does not become a covered transaction

for the purchasing bank. However, as set

forth in the proposed rule, if a bank

purchases assets from a nonaffiliate in

contemplation of the nonaffiliate

becoming an affiliate of the bank, the

asset purchase becomes a covered

transaction at the time the nonaffiliate

becomes an affiliate. In addition, the

bank must ensure that the aggregate

amount of the bank’s covered

transactions (including any such asset

purchase from the nonaffiliate) would

not exceed the quantitative limits of

section 23A at the time that the

nonaffiliate becomes an affiliate.

The regulation provides several

examples designed to assist banks in

valuing purchases of assets from an

affiliate.

C. Purchases of and Investments in

Securities Issued by an Affiliate—223.10

Section 23A includes as a covered

transaction a bank’s purchase of, or

investment in, securities issued by an

affiliate. Regulation W would require a

bank to value a purchase of, or

investment in, securities issued by an

affiliate (other than a financial

subsidiary, which is subject to special

rules under the GLB Act) at the greater

of the bank’s purchase price or carrying

value of the securities.29 Under the rule,

a bank that pays no consideration in

exchange for affiliate securities must

nevertheless value the covered

transaction at no less than the bank’s

carrying value for the securities.30 In

addition, under the rule, if the bank’s

carrying value of the affiliate securities

increased or decreased after the bank’s

initial investment (due to profits or

losses at the affiliate), the amount of the

bank’s covered transaction would

increase or decrease to reflect the bank’s

changing financial exposure to the

24192 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

31 12 U.S.C. 371c(b)(7)(D). This covered

transaction only arises when the bank’s loan is to

a nonaffiliate. Under section 23A, the securities

issued by an affiliate are not acceptable collateral

for a loan or extension of credit to any affiliate. See

12 U.S.C. 371c(c)(4). Moreover, if the proceeds of

a loan that is secured by an affiliate’s securities are

transferred to an affiliate by the third party

borrower (for example, to purchase assets or

securities from the inventory of an affiliate), the

loan should be treated as a loan to the affiliate. The

loan must then be secured with collateral in an

amount and of a type that meets the requirements

of section 23A for loans by a bank to an affiliate.

32 In either case, the transaction must comply

with section 23B; that is, the bank must obtain the

same amount of affiliate securities as collateral on

the credit extension that the bank would obtain if

the collateral were not affiliate securities. 33See Letter dated January 21, 1999, from J. Virgil

Mattingly, General Counsel of the Board, to Bruce

Moland. This letter set forth an opinion of Board

staff that, for purposes of applying the quantitative

limits in section 23A, such mixed-collateral loans

should be valued at the lesser of (1) the total

amount of the loan less the fair market value of

nonaffiliate collateral (if any), or (2) the fair market

value of the affiliate’s securities that are used as

collateral.

affiliate, but could not decline below the

amount paid by the bank for the

securities.

The Board believes several

considerations support the approach

contained in the proposed regulation.

First, the approach is generally

consistent with GAAP, which would

require the bank to reflect its investment

in securities issued by an affiliate at

carrying value throughout the life of the

investment, even if the bank paid no

consideration for the securities.

Second, the definition of covered

transaction in section 23A includes both

a ‘‘purchase of’’ and an ‘‘investment in’’

securities issued by an affiliate.

Accordingly, the statute by its terms

appears to cover situations where a bank

purchases securities of an affiliate and

situations where a bank receives affiliate

securities and pays no consideration. If

the rule permitted banks to value these

transactions only at purchase price, the

‘‘investment in’’ language of the statute

would be rendered superfluous. The

Board believes, moreover, that the

statute’s ‘‘investment in’’ language

indicates that Congress was concerned

with a bank’s continuing exposure to an

affiliate through an ongoing investment

in securities issued by the affiliate. The

best way to give effect to this concern

and the ‘‘investments in’’ prong of the

statutory definition is to base the value

of a bank’s investment in the securities

of an affiliate on the bank’s actual

financial exposure to the investment (as

reflected on the bank’s GAAP financial

statements), even if the bank paid

nothing to acquire the securities.

Third, amendments to section 23A

made by the GLB Act indicate that the

value of an investment in the securities

of an affiliate under section 23A should

reflect increases (or decreases) in the

value of the securities caused by

earnings (or losses) at the affiliate. In

particular, the GLB Act defines a

financial subsidiary of a bank as an

affiliate of the bank, but specifically

provides that the section 23A value of

a bank’s investment in the securities of

a financial subsidiary does not include

retained earnings of the subsidiary. The

negative implication from this provision

is that the section 23A value of a bank’s

investment in other affiliates includes

the affiliates’ retained earnings, which

would be reflected in the bank’s

carrying value of the investment under

the proposed valuation rule.

Finally, this valuation rule is

consistent with the purposes of section

23A—limiting the financial exposure of

banks to their affiliates and promoting

safety and soundness. The proposed

rule would require a bank to revalue

upwards the amount of an investment in

affiliate securities only when the bank’s

exposure to the financial condition of

the affiliate has increased (as reflected

on the bank’s financial statements) and

the bank’s capital has increased to

reflect the higher value of the

investment. In these circumstances, the

valuation rule merely reflects the bank’s

greater financial exposure to the affiliate

and promotes safety and soundness by

reducing the bank’s ability to engage in

additional transactions with an affiliate

as the bank’s exposure to that affiliate

increases.

As noted above, the proposed rule

provides that the section 23A value of

a bank’s investment in affiliate

securities can be no less than the

amount paid by the bank for the

securities, even if the carrying value of

the securities declines below that

amount. The Board believes that this

approach, although not consistent with

GAAP, is reasonable because it

establishes as a floor the amount of

funds actually paid by the bank for the

affiliate securities. Using the bank’s

purchase price for the securities as a

floor for valuing the covered transaction

also limits the ability of a bank to

provide additional funding to an

affiliate as the affiliate approaches

insolvency. If the regulation were to

value investments in securities issued

by an affiliate strictly at carrying value,

then the bank could lend more funds to

the affiliate as the affiliate’s financial

condition worsened, because the

carrying value of the affiliate’s securities

also would decline and thereby increase

the bank’s ability to provide additional

funding under section 23A. This type of

increasing support for an affiliate in

distress is precisely what section 23A

was intended to restrict.

The regulation provides several

examples designed to assist banks in

valuing purchases of and investments in

the securities of an affiliate.

D. Posting Securities Issued by an

Affiliate as Collateral—223.11

Section 23A defines as a covered

transaction a bank’s acceptance of

securities issued by an affiliate as

collateral for a loan or extension of

credit to any person or company.31 This

type of covered transaction has two

classes: one in which the only collateral

for the loan is affiliate securities; and

another in which the loan is secured by

a combination of affiliate securities and

other collateral. Section 23A does not

explain how these different types of

covered transactions should be valued

for purposes of determining compliance

with the quantitative limits of the

statute.

As a general rule, Regulation W

would value covered transactions of the

first class, where the credit extension is

secured exclusively by affiliate

securities, at the full amount of the

extension of credit. This approach

reflects the difficulty of measuring the

actual value of typically untraded and

illiquid affiliate securities, and

conservatively assumes that the value of

the securities is equal to the full value

of the loan that the securities

collateralize. This position also reflects

the traditional advice given by Board

staff on this issue. Regulation W

proposes an exception to the general

rule where the affiliate securities held as

collateral have a ready market. In that

case, the transaction may be valued at

the fair market value of the affiliate

securities. The exception grants relief

from staff’s traditional position in those

circumstances where the value of the

affiliate securities is independently

verifiable by reference to transactions

occurring in a liquid market.32

Regulation W would value covered

transactions of the second class, where

the credit extension is secured by

affiliate securities and other collateral,

at the lesser of (i) the total value of the

extension of credit minus the fair

market value of the other collateral and

(ii) the fair market value of the affiliate

securities (if the securities have a ready

market). Until 1999, staff advised banks

to value this class of covered

transactions at the total amount of the

extension of credit. In January 1999, the

staff modified its position on mixed

collateral loans to permit banks to value

these transactions in a manner similar to

the proposed rule.33

The Board believes that in situations

in which a loan is secured by securities

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24193

34 12 U.S.C. 371c(a)(4).

35See, e.g., Letter dated June 11, 1999, from

Robert deV. Frierson, Associate Secretary of the

Board, to Mr. Robert L. Anderson. Some institutions

have argued that this treatment is too strict and that

a covered transaction should be deemed to occur in

connection with a share contribution only if there

is a net transfer of value from the bank to the

affiliate (that is, if the liabilities of the transferred

company exceed the value of the assets of the

company). In many internal reorganizations, the

Board has found that the value of the assets of the

transferred company was uncertain. In addition, the

transactions often were motivated by funding

problems at the transferred affiliate and by a desire

to use the bank’s resources to alleviate those

funding needs. Soon after consummating such

reorganizations, bank funds typically were used to

pay down liabilities that the transferred company

had to the parent holding company of the bank.

of an affiliate and other collateral, it is

reasonable to reflect the fair market

value of the other collateral in

determining whether, and to what

extent, the loan should count towards

the bank’s section 23A quantitative

limits. Under the proposed method of

calculation for mixed-collateral loans, if

a loan is fully secured by nonaffiliate

collateral with a fair market value that

equals or exceeds the loan amount, then

the loan would not be included in the

bank’s quantitative limits for purposes

of section 23A. If the loan is not fully

secured by other collateral, then the

maximum amount that the bank must

count against its quantitative limits is

the difference between the full amount

of the loan and the fair market value of

the nonaffiliate collateral. This

methodology takes account of the bank’s

reliance on the value of nonaffiliate

collateral in a loan transaction, while

also recognizing that a portion of the

loan may be supported by securities

issued by an affiliate.

The approach taken in Regulation W,

however, is different from that of the

1999 interpretation in two respects.

First, although the 1999 interpretation

allows banks to use the fair market

value of the affiliate securities as an

upper limit on the value of the

transaction regardless of the liquidity of

the affiliate securities, the regulation

only would allow banks to use the value

of the affiliate securities as an upper

limit if the affiliate securities have a

ready market. If the affiliate securities

do not have a ready market, a bank

could understate the market value of the

securities in order to shrink the size of

the covered transaction. Second, the

regulation’s ready market requirement

would replace an implicit condition of

the 1999 interpretation that only a small

amount of the total collateral could be

affiliate securities. The valuation rule in

Regulation W would apply regardless of

the amount of affiliate collateral.

The Board also notes that, under

section 23A, a loan that is secured with

any amount of an affiliate’s securities

must be consistent with safe and sound

banking practices.34

V. Other Considerations under Section

23A—Subpart D

Subpart D of the proposed rule would

provide guidance to banks on three

issues under section 23A: (i) merger and

acquisition transactions between a bank

and an affiliate; (ii) financial

subsidiaries of a bank; and (iii)

derivative transactions between a bank

and an affiliate.

A. Bank-affiliate Merger and Acquisition

Transactions—223.12

Section 23A includes a purchase of

assets from an affiliate and the purchase

of, or investment in, securities issued by

an affiliate within the definition of

covered transaction. In the past, the

Board has been required to apply these

provisions to transactions where a bank

directly or indirectly acquires an

affiliate. There are three principal

methods by which a bank acquires an

affiliate. The first method is where a

bank (or one of its subsidiaries that is

not treated as an affiliate of the bank

under section 23A (an ‘‘operations

subsidiary’’)) directly purchases or

otherwise acquires the affiliate’s assets

and assumes the affiliate’s liabilities. In

this case, the transaction is treated as a

purchase of assets, and the covered

transaction amount is equal to the

amount paid by the bank for the

affiliate’s assets plus the amount of any

liabilities assumed by the bank in the

transaction.

The second method is where a bank

(or its operations subsidiary) acquires an

affiliate by merger. Because a merger

with an affiliate generally results in the

bank acquiring all the assets of the

affiliate and assuming all the liabilities

of the affiliate, this transaction is

effectively equivalent to the purchase

and assumption transaction described in

the previous paragraph. Accordingly,

the merger transaction also is treated as

a purchase of assets, and the covered

transaction amount is again equal to the

amount paid by the bank for the

affiliate’s assets (if any) plus the amount

of any liabilities assumed by the bank in

the transaction.

The third method involves the

contribution or sale of an affiliate’s

shares by the affiliate’s parent to the

bank (or its operations subsidiary). The

Board previously has treated these

transactions as a purchase of assets

covered by section 23A where the bank

paid consideration for the shares or the

affiliate whose shares were contributed

to the bank had liabilities to any affiliate

of the bank.35

The proposed rule does not alter the

treatment of the first two types of

transaction described above. The

proposed rule does provide, however, a

new treatment, which is consistent with

the structure of section 23A, for the

third type of transaction. The rule

provides that the acquisition by a bank

of securities issued by a company that

was an affiliate of the bank before the

acquisition is treated as a purchase of

the assets of the company if (i) as a

result of the transaction, the company

becomes a subsidiary of the bank and

ceases to be an affiliate of the bank; and

(ii) the company has liabilities, or the

bank gives cash or any other

consideration in exchange for the

securities. The rule also provides that

such transactions must be valued

initially at the sum of (i) the total

amount of consideration given by the

bank in exchange for the securities; and

(ii) the total liabilities of the company

whose securities have been acquired by

the bank through the contribution or

purchase. In effect, the rule requires

banks to treat these sorts of share

donations and purchases in the same

manner as if the bank had purchased the

assets of the transferred company at a

purchase price equal to the liabilities of

the transferred company (plus any

separate consideration paid by the bank

for the shares).

This treatment for affiliate share

transfers would be consistent with the

approach that section 23A takes on

subsidiaries of banks and with

economic and marketplace realities.

Section 23A treats banks and their

operations subsidiaries as a single unit.

Transactions between a bank and its

operations subsidiaries are not treated

as covered transactions between a bank

and an affiliate under section 23A;

rather, they are treated as transactions

entirely inside the bank. Similarly, a

transaction between a bank’s operations

subsidiary and an affiliate of the bank is

treated as a covered transaction between

the bank itself and an affiliate under

section 23A. Ignoring the separate

corporate form of subsidiaries of banks

and treating the assets and liabilities of

subsidiaries of banks as assets and

liabilities of the bank itself is, therefore,

consistent with the structure of section

23A. Accordingly, under section 23A,

these share transfers in which an

affiliate of a bank becomes a subsidiary

of the bank are properly viewed as a

purchase of an affiliate’s assets and an

assumption of an affiliate’s liabilities by

the bank.

24194 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

36Affiliate share transfers to a bank often are

functionally equivalent to transactions in which a

bank directly acquires the assets and assumes the

liabilities of an affiliate, because a bank can usually

merge the newly acquired subsidiary into itself. As

noted above, in a direct acquisition of assets and

assumption of liabilities, the covered transaction

amount would be equal to the total amount of

liabilities assumed by the bank.

37See, e.g., Travelers Group Inc. and Citicorp, 84

Federal Reserve Bulletin 985, 1013–14 (1998) and

Letter dated November 14, 1996, from William W.

Wiles, Secretary of the Board, to John Byam.

The proposed treatment for affiliate

share transfers is also consistent with

the Board’s supervisory experience. The

Board has found that banks often

operate their consolidated

organizations—because of capital

requirements, financial reporting

requirements, and reputational risk

concerns—as if the assets and liabilities

of subsidiaries were actually assets and

liabilities of the bank itself. Banks often

attempt to shore up their subsidiaries in

times of financial stress, despite the

limited liability inhering in the

corporate form. Accordingly, the Board

proposes to treat the assets and

liabilities of a subsidiary of a bank as

assets and liabilities of the bank itself

for purposes of section 23A.36

The proposed rule only imposes asset

purchase treatment on affiliate share

transfers where the company whose

shares are being transferred to the bank

was an affiliate of the bank before the

transfer. If the transferred company

were not an affiliate prior to transfer, it

would not be appropriate to treat the

share transfer as a purchase of the assets

of an affiliate. Similarly, the rule only

requires asset purchase treatment for

share transfers where the transferred

company becomes a subsidiary and not

an affiliate of the bank through the

transfer. If the company were not a

subsidiary of the bank after the transfer

(because, for example, the bank

acquired less than 25 percent of a class

of voting securities of the company) or

if the company were an affiliate of the

bank after the transfer (because, for

example, the bank’s holding company

continued to own 25 percent or more of

a class of voting securities of the

company or because the company

became a financial subsidiary of the

bank after the transfer), the Board does

not believe it would be appropriate to

treat the liabilities of the company as

the liabilities of the bank for purposes

of section 23A. In those circumstances,

section 23A would not treat the bank

and the transferred company as a single

unit.

The Board solicits comment on

whether this method of treating affiliate

share transfers is appropriate.

The Board notes that it has granted

numerous section 23A exemptions, on a

case-by-case basis, for transactions

involving the transfer (by merger,

purchase and assumption transaction, or

otherwise) by a holding company of one

of its nonbank subsidiaries to a

subsidiary bank.37 The Board typically

has approved such exemptions only if

certain conditions are met, including (i)

the transfer of the affiliate must be the

result of a one-time corporate

reorganization, (ii) the entity

transferring the shares to the bank must

provide certain assurances concerning

the quality of the assets being

transferred, (iii) the disinterested

directors of the bank must approve the

transaction in advance, (iv) the transfer

must not include any low-quality assets,

and (v) the bank’s appropriate Federal

banking agency and the Federal Deposit

Insurance Corporation must inform the

Board that they have no objection to the

transaction. Banks may continue to

apply to the Board for such case-by-case

exemptions.

The proposed regulation also contains

a regulatory exemption for certain

merger and acquisition transactions that

result in the transfer of an affiliate to a

bank. Section 223.12(d) of the regulation

provides an exemption from the

requirements of section 23A (other than

the safety and soundness requirement)

for transactions in which, for example,

a bank holding company acquires the

stock of an unaffiliated company and,

immediately after consummation of the

acquisition, transfers the shares of the

acquired company to the holding

company’s subsidiary bank. Although

these transactions technically would be

subject to the asset purchase treatment

discussed in this section—and the bank

would be required to value the covered

transaction at the total amount of the

liabilities of the acquired company (plus

any consideration paid by the bank for

the company)—the Board believes that

it would be inappropriate to treat this

transaction as a covered transaction. If

the bank had acquired the unaffiliated

company directly, there would be no

covered transaction, and the mere fact

that the bank’s holding company owned

the target company for a moment in

time does not change the fundamental

nature of the transaction.

Accordingly, the regulation exempts

these ‘‘step’’ transactions as long as

certain conditions are met. First, the

bank must acquire the target company

immediately after the company becomes

an affiliate (by being acquired by the

bank’s holding company, for example).

To the extent that the bank acquires the

target company some time after the

company becomes an affiliate, the

transaction looks less like a single

transaction in which the bank acquires

the target company and more like two

separate transactions, the latter of which

involves the bank acquiring assets from

an affiliate. Second, the bank must

acquire the entire ownership position in

the target company that its holding

company acquired. If the bank were to

acquire less than all the shares or assets

of the target company that its holding

company acquired, the transaction again

would not, in effect, involve the

purchase of the company by the bank.

Finally, the entire transaction must

comply with the market terms

requirement of section 23B.

B. Financial Subsidiaries—223.13

As noted above, the GLB Act

amended section 23A to treat a financial

subsidiary of a bank as an affiliate of the

bank and to establish several special

rules that apply to transactions with

financial subsidiaries. The proposed

regulation combines all of the special

rules that apply to transactions with

financial subsidiaries in a single section.

1. Applicability of the 10 percent

quantitative limit to transactions with a

financial subsidiary—223.13(a). First,

consistent with the GLB Act, the

regulation provides that the 10 percent

quantitative limit in section 23A does

not apply with respect to covered

transactions between a bank and any

individual financial subsidiary of the

bank. Accordingly, a bank’s aggregate

amount of covered transactions with

any individual financial subsidiary may

exceed 10 percent of the bank’s capital

stock and surplus. A bank’s covered

transactions with its financial

subsidiaries, however, are subject to the

statutory and regulatory 20 percent

quantitative limit. Thus, a bank may not

engage in a covered transaction with

any affiliate (including a financial

subsidiary) if the bank’s aggregate

amount of covered transactions with all

affiliates (including financial

subsidiaries) would exceed 20 percent

of the bank’s capital stock and surplus.

2. Valuation of investments in the

securities of a financial subsidiary—

223.13(b). Because financial subsidiaries

of a bank are considered affiliates of the

bank for purposes of section 23A,

purchases of and investments in the

securities of a financial subsidiary are

covered transactions under the statute.

The GLB Act provides that a bank’s

investment in its financial subsidiary,

for purposes of section 23A, shall not

include the retained earnings of the

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24195

38 GLB Act section 121(b)(1) (codified at 12 U.S.C.

371c(e)(3)(B)).

39The regulation also makes clear that if a

financial subsidiary is consolidated with its parent

bank under GAAP, the carrying value of the bank’s

investment in the financial subsidiary shall be

determined based on parent-only financial

statements of the bank.

40 GLB Act section 121(b)(1) (codified at 12 U.S.C.

371c(e)(4)).

41The proposed regulation also provides an

exception to the anti-evasion rules for transactions

between a bank’s financial subsidiary and another

affiliate if the other affiliate is itself a bank or

savings association subject to section 23A. In that

event, the anti-evasion rules are not needed because

the transaction will count as a covered transaction

for the affiliated bank or savings association.

Without this exception, the same transaction would

double count as a covered transaction both for the

parent bank of the financial subsidiary and for the

other affiliated institution. 42 12 CFR part 225, appendix A.III.E.1.a–d.

financial subsidiary.38 In light of this

statutory provision, the regulation

contains a special valuation rule for

investments in the securities of a

financial subsidiary. Such investments

must be valued at the greater of (i) the

price paid by the bank for the securities;

and (ii) the carrying value of the

securities on the financial statements of

the bank (determined in accordance

with GAAP but without reflecting the

bank’s pro rata share of any earnings

retained or losses incurred by the

financial subsidiary after the bank’s

acquisition of the securities).39

This valuation rule differs from the

general ‘‘investment in the securities of

an affiliate’’ valuation rule only in that

the financial subsidiary rule requires,

consistent with the GLB Act, that the

carrying value of the investment be

computed without consideration of the

retained earnings or losses of the

financial subsidiary since the time of

the bank’s investment. As a result of this

rule, the covered transaction amount for

a bank’s investment in the securities of

its financial subsidiary would not

increase except in the event that the

bank made an additional capital

contribution to the subsidiary or

purchased additional securities of the

subsidiary.

The regulation provides several

examples designed to assist banks in

valuing purchases of and investments in

securities issued by a financial

subsidiary.

3. Anti-evasion rules—223.13(c).

Section 23A generally applies only to

transactions between a bank and an

affiliate of the bank and transactions

between a bank and a third party where

some benefit of the transactions accrues

to an affiliate of the bank. The statute

generally does not apply to transactions

between two affiliates. The GLB Act

establishes two special anti-evasion

rules, however, that govern transactions

between a financial subsidiary of a bank

and another affiliate of the bank.40 First,

the GLB Act provides that any purchase

of, or investment in, the securities of a

bank’s financial subsidiary by an

affiliate of the bank will be deemed to

be a purchase of, or investment in, such

securities by the bank itself. Second, the

GLB Act authorizes the Board to deem

a loan or other extension of credit made

by a bank’s affiliate to any financial

subsidiary of the bank to be an

extension of credit by the bank to the

financial subsidiary, if the Board

determines that such action is necessary

or appropriate to prevent evasions of the

Federal Reserve Act or the GLB Act.

The proposed regulation incorporates

both of these provisions.41 The

regulation also exercises the Board’s

authority under the second anti-evasion

rule by stating that an extension of

credit to a financial subsidiary of a bank

by an affiliate of the bank would be

treated as an extension of credit by the

bank itself to the financial subsidiary if

the extension of credit is treated as

regulatory capital of the financial

subsidiary. An example of the kind of

credit extension covered by this

provision would be a subordinated loan

to a financial subsidiary that is a

securities broker-dealer where the loan

is treated as capital of the subsidiary

under the SEC’s net capital rules. The

Board believes that such treatment is

appropriate in these circumstances

because the extension of credit by the

affiliate has a similar effect on the

subsidiary’s regulatory capital as an

equity investment by the affiliate, which

is treated as a covered transaction by the

terms of the GLB Act (as described

above).

The Board may find certain other

extensions of credit by an affiliate to a

financial subsidiary to be covered

transactions under section 23A on a

case-by-case basis. The Board seeks

comment on the appropriateness of

considering other classes of credit

extensions by an affiliate to a financial

subsidiary as extensions of credit by the

bank to the financial subsidiary.

C. Derivative Transactions—223.14

As noted above, the GLB Act requires

the Board to address as covered

transactions under section 23A credit

exposure arising out of derivative

transactions between banks and their

affiliates.

Determining the appropriate

treatment for derivative transactions

under section 23A is a complex and

important endeavor. In light of the

complexities of the subject matter and

in light of the May 12, 2001, statutory

schedule in the GLB Act, the Board is

taking two steps to address credit

exposure on bank-affiliate derivative

transactions under sections 23A and

23B. First, the Board is publishing an

interim rule, concurrently with

Regulation W, that (i) requires, under

section 23A as amended by the GLB

Act, that a bank establish and maintain

policies and procedures reasonably

designed to manage the credit exposure

arising from the bank’s derivative

transactions with affiliates and (ii)

clarifies that bank-affiliate derivative

transactions are subject to the market

terms requirement of section 23B. The

policies and procedures must at a

minimum provide for monitoring and

controlling the credit exposure arising

from the bank’s derivative transactions

with each affiliate, and all affiliates in

the aggregate, and ensuring that the

bank’s derivative transactions with

affiliates comply with section 23B.

The second step that the Board is

taking to address the credit exposure

arising from bank-affiliate derivative

transactions under section 23A is

contained in this section of the

preamble to Regulation W. This section

sets forth a set of questions regarding

the appropriate treatment of these

transactions under section 23A. In

connection with the interim rule and

proposed Regulation W, the Board

solicits public comment on the most

appropriate treatment under section

23A of the credit exposure arising from

bank-affiliate derivative transactions.

In deciding how to address under

section 23A credit exposure arising from

derivative transactions, the initial

question to be answered is how to

define the term ‘‘derivative transaction.’’

The Board’s interim rule on bankaffiliate derivatives defines the term by

reference to the definition of ‘‘derivative

contract’’ in the capital guidelines of the

Federal banking agencies (‘‘Capital

Guidelines’’).42 The definition

contained in the Capital Guidelines

covers swaps, forwards, options, and

other similar contracts on an interest

rate, currency, equity, or commodity.

The interim rule supplements the

definition contained in the Capital

Guidelines by also including ‘‘any

similar derivative contract, including

credit derivative contracts.’’ This

supplementation recognizes that

derivative instruments evolve in

response to the needs of the financial

marketplace.

Other options would include defining

derivative transaction by reference to

the definition of ‘‘qualified financial

contract’’ or ‘‘swap agreement’’ in the

24196 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

43See 12 U.S.C. 1821(e)(8)(D)(i) and (vi).

44 26 CFR 1.446–3.

Federal Deposit Insurance Act 43 or to

borrow from definitions contained in

the Bankruptcy Code. Another option

would involve taking a broad,

functional approach that defines a

derivative transaction as ‘‘a bilateral

contract the value of which derives from

the value of some underlying security,

financial instrument, rate, index, event,

commodity, or other asset or indicator.’’

Although such a broad definition may

be somewhat overinclusive and more

ambiguous in scope than a targeted

definition, it also may provide the Board

with more flexibility in responding to

market trends.

The remainder of this section seeks

comment on a set of questions regarding

how the Board should address bankaffiliate derivative transactions under

section 23A.

First, the Board notes that some

derivative transactions—like deep inthe-money options or swaps with an

exchange of principal on different

dates—are the functional equivalent of a

loan, which is an explicit type of

covered transaction under section 23A.

Although the Board is not aware that

banks and their affiliates are entering

into these types of derivative

transactions, the Board expects that it

may need to address these derivatives

separately from the other types of

derivatives because of their functional

equivalence to an existing type of

covered transaction under the statute. In

this regard, the Board solicits comment

on how to determine when a derivative

transaction is (or contains an aspect that

is) the functional equivalent of a loan by

a bank to an affiliate. The Board believes

that it may be appropriate to treat such

a derivative transaction (or the relevant

part of the transaction that functions as

a loan) as a loan from the bank to the

affiliate for purposes of section 23A.

The Board requests comment on

whether and how Regulation W should

provide additional guidance for banks

on identifying derivative transactions

that are, or have aspects that are, the

functional equivalent of a loan. The

Board understands that the Internal

Revenue Service has adopted a

regulation that requires financial

institutions, for tax purposes, to

recharacterize as loans portions of

certain swap and other derivative

transactions based on the significance of

any nonperiodic payments provided for

under the terms of the transaction.44

The Board requests comment on

whether the standards used by the

Internal Revenue Service to determine

the inherent loan elements of a swap

transaction also would be appropriate

for the Board to use for section 23A

purposes. The Board also solicits

comment on whether the regulation

should treat the entirety of a bankaffiliate derivative transaction as a loan

under section 23A if any portion of the

transaction is the functional equivalent

of a loan or should impose loan

treatment only on that portion of the

transaction that functions as a loan.

The Board also asks for public

comment on whether Regulation W

should provide a separate treatment for

any other specific types of derivatives.

In particular, the Board seeks comment

on whether a credit derivative between

a bank and an affiliate in which the

bank provides credit protection to the

affiliate with respect to the affiliate’s

assets should be treated as a covered

transaction and made subject to all the

requirements of section 23A. Such a

credit derivative generates risks for the

bank that closely resemble the risks

incurred by a bank when it purchases

assets from an affiliate. The Board notes

that a credit derivative transaction

between a bank and an unaffiliated

company that references the obligations

of an affiliate of the bank and is the

functional equivalent of a guarantee by

the bank on behalf of the affiliate is a

guarantee by the bank on behalf of an

affiliate for purposes of section 23A.

Second, the Board asks whether banks

should be required to adopt any specific

policies and procedures with respect to

their derivative transactions with

affiliates. These policies and procedures

might include provisions that require a

bank to adopt the following ‘‘best

practices’’: (i) entering into a legally

enforceable bilateral netting agreement

with each of its affiliated derivatives

counterparties; (ii) revaluing its

derivative transactions with affiliates on

a daily basis; and (iii) collateralizing its

net mark-to-market credit exposure on

derivative transactions with affiliates.

The Board asks for comment on the

appropriateness of requiring these types

of policies and procedures and on

whether additional policies or

procedures should be required to ensure

that a bank’s derivative transactions

with affiliates are conducted safely and

soundly.

Third, the Board solicits comment on

whether banks should be required to

disclose to Federal bank supervisors or

the public, on a quarterly or other

periodic basis, their net credit exposure

to affiliates on derivative transactions.

The Board solicits comment on the

types of disclosures that banks

reasonably could be required to provide

with respect to their derivative

transactions with affiliates in order to

assist the Federal banking agencies in

monitoring and supervising such

transactions.

Fourth, the Board invites comment on

whether any final rule addressing bankaffiliate derivatives should impose a

quantitative limit on the aggregate

amount of a bank’s net credit exposure

on such transactions. The rule could

require that the aggregate amount of a

bank’s net credit exposure on derivative

transactions with affiliates not exceed

some percentage of the capital stock and

surplus of the bank, unless the bank

obtains the prior approval of its

appropriate Federal banking agency.

Such a separate limit for derivatives

would be in addition to the general 20

percent limit for covered transactions

with all affiliates under section 23A.

The Board asks for comment on whether

10 percent of the bank’s capital stock

and surplus would be an appropriate

size for a separate cap on net derivatives

credit exposure that a bank has to

affiliates. Instead of establishing a

separate limit, the rule could require

that a bank incorporate its net credit

exposure arising from derivative

transactions with affiliates into its

overall section 23A quantitative limits.

The Board seeks comment on the

appropriateness of either of these

alternatives.

Fifth, the Board asks whether banks

should be required to collateralize their

net derivatives credit exposure to

affiliates in accordance with the

collateral requirements of section 23A.

Finally, in the event that the Board

were to impose a quantitative limit on

bank-affiliate derivative transactions

(whether by establishing a separate limit

for derivatives or by requiring banks to

include derivatives in their overall

section 23A limits), the Board seeks

comment on how banks should be

required to determine the amount of

their derivative transactions with

affiliates. One valuation option would

be to require banks to value a derivative

transaction with an affiliate at the

current exposure of the bank to the

affiliate on the transaction. Under this

option, the amount of a bank’s section

23A exposure to an affiliate on a

derivative transaction would be based

on the mark-to-market value of the

transaction for the bank. If the mark-tomarket value of the transaction were

positive, then the current exposure

would be that mark-to-market value. If

the mark-to-market value were zero or

negative, the current exposure would be

zero. The Board specifically asks for

comment on whether these mark-tomarket values should be adjusted to

reflect counterparty credit quality.

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24197

45See, e.g., 12 CFR part 225, appendix A.III.E.2.

46See, e.g., 12 CFR part 225, appendix A.III.E.3.

47 12 U.S.C. 371c(d).

Another valuation option would

require banks to value a derivative

transaction with an affiliate at the

current exposure of the bank to the

affiliate on the transaction plus an

estimate of the bank’s potential future

exposure (‘‘PFE’’) to the affiliate on the

transaction. This is the approach to

measuring derivatives exposure that

most banks take with third parties and

that the Federal banking agencies have

taken in the Capital Guidelines.45 The

Board seeks comment on whether banks

should be required to include an

estimate of PFE when determining the

amount of their credit exposure on

bank-affiliate derivative transactions

and, if so, how banks should be required

to calculate PFE.

PFE could be measured in a wide

variety of ways. The Capital Guidelines

provide one possible methodology.

Under the Capital Guidelines, a bank

calculates its PFE by multiplying the

notional principal amount of the

derivative transaction times a

conversion factor specified in the

Guidelines that varies depending upon

the remaining maturity of the derivative

transaction and the nature of the asset

underlying the derivative transaction.

This methodology has the benefits of

being easy to calculate and of being a

method that is already employed by

banks for regulatory capital purposes

and, consequently, eliminates the

burden that would attend a requirement

for a different calculation method. The

methodology has the drawback of being

rather insensitive to gradations of risk

and rather conservative in its estimates

of PFE. Another possible PFE

computation methodology would be to

permit banks with sophisticated internal

models to use those models to calculate

their PFE on bank-affiliate derivative

transactions. The Board also seeks

comment on whether the appropriate

time horizon for estimating PFE on a

derivative transaction is the remaining

maturity of the transaction or some

shorter ‘‘close-out’’ period.

The Board also invites comment on

whether and how banks should be

allowed to take into account credit risk

mitigators such as collateral in

determining the amount of their

derivative transactions with affiliates.

Under section 23A, transactions fully

secured by cash on deposit or U.S.

government or agency securities are

generally exempt from the requirements

of the statute. Outside of this

exemption, the statute does not allow

banks to reduce the amount of a covered

transaction by securing the transaction

with collateral or obtaining a third-party

guarantee of the transaction.

Transactions secured by municipal

securities, corporate debt or equity

securities, or real estate, for example,

are treated the same as unsecured

transactions for purposes of the

quantitative limits of the statute.

The Board solicits comment on

whether Regulation W should provide

banks with partial credit for partially

securing derivative transactions with

affiliates. The Board also solicits

comment on what types of collateral the

regulation should recognize for the

purpose of reducing the section 23A

credit exposure of a bank to its affiliates

on derivative transactions. As noted, the

only types of collateral that have an

impact on a bank’s quantitative limits

under the terms of section 23A are cash

on deposit and U.S. government and

agency securities. The Board could use

this same limited list of collateral with

respect to bank-affiliate derivative

transactions. The Board seeks comment

on whether it should expand the list of

collateral acceptable for reducing the

section 23A amount of these

transactions and, if so, what kinds of

other collateral should be acceptable as

credit risk mitigators for the

transactions, and what haircuts should

apply to any added collateral types.

The Board also solicits the public’s

view on how, if the general 10 and 20

percent quantitative limits of section

23A are applied to bank-affiliate

derivative transactions, increased credit

exposure of the bank to an affiliate on

a pre-existing derivative transaction

should be treated. For example, a bank

could be required promptly to unwind

existing derivatives or other covered

transactions or otherwise promptly

reduce the amount of its exposure to

affiliates in order to restore itself to

compliance with the quantitative limits

of section 23A in the event that the

credit exposure on a derivative

transaction causes the bank to exceed

the limits. Alternatively, a bank could

be allowed to retain existing derivative

transactions and only be required to

cease engaging in new covered

transactions until the bank’s aggregate

amount of covered transactions falls

below the statute’s quantitative limits.

If the Board were to determine that

bank-affiliate derivative transactions are

subject to some sort of quantitative limit

under section 23A, the Board would

have to address the question of whether

and how to recognize netting

agreements. The Board solicits comment

on whether it should recognize bilateral

netting agreements when computing the

amount of a bank’s derivatives credit

exposure to an affiliate and, if so,

whether the principles set forth in the

Capital Guidelines are appropriate

minimum requirements for determining

what is a qualifying netting agreement.46

In addition, the Board solicits

comment on how often a bank should

mark to market its derivative

transactions with affiliates. The Board

requests information on how often

banks mark to market their derivative

transactions with third parties and on

the potential burden and benefits of

requiring banks to mark to market their

derivative transactions with affiliates on

a daily basis.

As a more general matter, the Board

invites comment on whether it is

necessary or appropriate to grandfather

existing derivative transactions between

banks and their affiliates. The Board

understands that, depending on the

approach ultimately taken on bankaffiliate derivatives, bringing existing

derivative transactions into compliance

with Regulation W may require

expensive and time-consuming

adjustments to positions or

renegotiation of agreements and, if

existing exposures are above any

quantitative limits established by

Regulation W, may prevent banks from

engaging in future derivative

transactions with affiliates.

The Board will analyze comments on

this proposal and the concurrently

issued interim final rule on derivative

transactions. If, based on that analysis,

the Board believes additional measures

are needed in this area, the Board will

issue a detailed proposed rule for public

comment.

VI. Exemptions—Subpart E

Section 23A specifies several types of

transaction that are exempt from the

statute’s quantitative and collateral

requirements and other types of

transaction that are exempt from the

statute’s quantitative, collateral, and

low-quality asset requirements.47 The

proposed regulation sets forth the

statutory exemptions, clarifies certain of

these exemptions, and exempts several

additional types of transactions. The

clarifications and additional exemptions

are discussed below.

A. Sister-Bank Exemption—223.15(a)

and (b)

Section 23A(d)(1) exempts any

transaction between a member bank and

a ‘‘bank’’ if the member bank controls 80

percent or more of the voting securities

of the bank, the bank controls 80

percent or more of the voting securities

of the member bank, or a company

controls 80 percent or more of the

24198 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

48The sister-bank exemption in section 23A does

not allow a bank to avoid any restrictions on sisterbank transactions that may apply to the bank under

the prompt corrective action framework set forth in

section 38 of the Federal Deposit Insurance Act (12

U.S.C. 1831o) and regulations adopted thereunder

by the bank’s appropriate Federal bankings agency.

49 12 U.S.C. 371c(b)(5), 1468(a)(2).

50 12 U.S.C. 371c(f)(1).

51See 12 U.S.C. 1815(e).

52As noted above, a bank and its operations

subsidiaries are considered a single unit for

purposes of section 23A. Accordingly, under the

statute and the proposed regulation, transactions

between a bank (or its operations subsidiary) and

the operations subsidiary of a sister insured

depository institution generally are exempt under

the sister-bank exemption.

53 12 U.S.C. 371c(d)(2).

54 12 U.S.C. 371c(d)(4).

55 12 U.S.C. 371c(d)(6).

56 63 FR 32768, June 11, 1998.

voting securities of both the member

bank and the bank.48 Section 23A states

that the term ‘‘bank’’ includes ‘‘any

State bank, national bank, banking

association, and trust company,’’ and

other federal law provides that an

insured savings association should be

treated as a ‘‘bank’’ for purposes of the

sister-bank exemption.49 Section 23A

also provides the Board with authority

to issue definitions consistent with the

section as may be necessary to carry out

the purposes of the section and to

prevent evasions thereof.50

Regulation W proposes to clarify that

the sister-bank exemption generally

applies only to transactions between a

bank (as defined in the regulation to

mean a member bank or an insured

nonmember bank), on the one hand, and

an insured depository institution, on the

other hand. Such an interpretation is

consistent with the legislative intent

behind the sister-bank exemption,

which was to permit the flow of funds

from one insured depository institution

to another insured depository

institution. In this regard, the Board

notes that, under the cross-guarantee

provisions of the Federal Deposit

Insurance Act, an insured depository

institution is generally liable for any

loss incurred by the FDIC in connection

with the default of a commonly

controlled insured depository

institution.51 Without such an

interpretation of the sister-bank

exemption, a bank would be able to

engage in unlimited covered

transactions with certain uninsured

depository affiliates. Permitting a bank

to provide an unlimited amount of

funding to an uninsured depository

affiliate would contravene one of the

principal purposes of the statuteprotecting the deposit insurance funds

from loss.52

B. Purchases of Loans on a Nonrecourse

Basis—223.15(c)

Under section 23A(d)(6), a bank may

purchase loans on a nonrecourse basis

from an affiliated ‘‘bank’’ exempt from

section 23A, even if the transaction does

not qualify for the sister-bank

exemption under section 23A(d)(1). The

proposed rule clarifies that the scope of

this exemption parallels that of the

sister-bank exemption by stating that

this exemption applies to a bank’s

purchase of a loan on a nonrecourse

basis from an affiliated insured

depository institution.

Section 23A(d)(6) also exempts the

purchase from an affiliate of assets that

have a readily identifiable market

quotation. This exemption is set forth

separately in the regulation for purposes

of clarity and is discussed in detail

below.

C. Correspondent Banking—223.16(a)

Section 23A exempts from its

quantitative limits and collateral

requirements any deposit by a bank in

an affiliated bank or affiliated foreign

bank that is made in the ordinary course

of correspondent business, subject to

any restrictions that the Board may

impose.53 The proposed rule provides

that such deposits must represent

ongoing, working balances maintained

by the bank in the ordinary course of

conducting the correspondent business.

An occasional deposit in an affiliated

institution would not be in the ordinary

course of correspondent business. The

proposed rule also indicates that

correspondent deposits in an affiliated

insured savings association are exempt

if they otherwise meet the requirements

of the exemption.

D. Fully Secured Credit Transactions—

223.16(c)

Section 23A exempts any credit

transaction by a bank with an affiliate

that is fully secured by obligations

issued or guaranteed by the United

States or its agencies or by a

‘‘segregated, earmarked’’ deposit

account.54 The proposed rule clarifies

that a deposit account meets the

‘‘segregated, earmarked’’ requirement

only if the account exists for the sole

purpose of securing the extension of

credit and is so identified. This

requirement would parallel the

provision in section 223.5(b)(1)(iv) of

the rule relating to which deposits count

toward the collateral requirements of

section 23A. Thus, if an earmarked

deposit is sufficient to fully secure the

transaction, then the transaction is

exempt under this section; if the deposit

represents less than full security, then

the amount of the deposit counts toward

the required collateral under section

223.5(b).

E. Purchases of Assets with Readily

Identifiable Market Quotes—

223.16(e)(1)

Section 23A(d)(6) exempts the

purchase of assets from an affiliate if the

assets have a ‘‘readily identifiable and

publicly available market quotation’’

and are purchased at their current

market quotation.55 The Board generally

has limited the availability of this

exemption (the ‘‘(d)(6) exemption’’) to

purchases of U.S. Treasury securities,

securities issued by a U.S. government

agency, and assets with market prices

that are recorded in widely

disseminated publications such as

newspapers with a national circulation.

Because only exchange-traded assets are

recorded in such publications, the test

ensures that the qualifying assets are

traded actively enough to have a true

‘‘market quotation’’ and that examiners

can verify that the assets are purchased

at their current market quotation.

Regulation W codifies this Board

interpretation of the (d)(6) exemption

and clarifies that the exemption applies

to a bank’s purchase of assets having a

readily identifiable and publicly

available market quotation if the assets

are purchased at or below the asset’s

current market quotation.

F. Purchases of Securities with a Ready

Market From a Securities Affiliate—

223.16(e)(2)

The Board proposed in its 1998

Proposal to exempt from section 23A

the purchase by a bank of certain types

of securities from a securities affiliate.56

The Board has determined to adopt a

somewhat revised form of this expanded

(d)(6) exemption in a separate final rule

being issued concurrently with

Regulation W. Regulation W also

contains this exemption, and the Board

seeks further comment on the scope and

conditions of the exemption. In

particular, the Board solicits the views

of the public on (i) whether the

exemption should be limited to

purchases from registered U.S.

securities broker-dealers; (ii) whether it

would be appropriate to use

independent dealer quotations to

establish a market price for a security

under the exemption; and (iii) whether

it would be appropriate to allow a bank

to use the exemption to purchase assetbacked securities issued by an affiliate

of the bank or to purchase securities

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24199

57The regulation defines municipal securities by

reference to section 3(a)(29) of the Securities

Exchange Act, which defines municipal securities

as direct obligations of, or obligations guaranteed as

to principal or interest by, a State or agency,

instrumentality, or political subdivision thereof,

and certain tax-exempt industrial development

bonds. 17 U.S.C. 78c(a)(29).

58Under the Municipal Securities Rulemaking

Board’s Rule G–11, the syndicate manager for a

municipal bond underwriting is required to send a

written summary to all members of the syndicate.

The summary discloses the aggregate par values and

prices of bonds sold from the syndicate account.

59The Board also would not consider such

transfers to be subject to the requirements of section

23B.

60 12 CFR 241.

61 12 U.S.C. 371c(b)(7)(C).

62 12 CFR 250.250. 63See Letter dated April 24, 1995, from J. Virgil

Mattingly, General Counsel of the Board, to William

F. Kroener, III; see also Letter dated January 21,

1987, from Michael Bradfield, General Counsel of

the Board, to Jeffrey C. Gerrish.

issued by a mutual fund advised by the

bank or an affiliate of the bank.

G. Purchasing Municipal Securities—

223.16(f)

The Board also proposes to exempt a

bank’s purchase of municipal securities

from an affiliate, if the purchase meets

a revised and somewhat shorter version

of the requirements applicable to the

expanded (d)(6) exemption contained in

section 223.16(e)(2) of the proposed

rule.57 First, as in the expanded (d)(6)

exemption, the bank must purchase the

municipal securities from a brokerdealer affiliate that is registered with the

SEC. Second, also as in the expanded

(d)(6) exemption, the municipal

securities must be eligible for purchase

by a State member bank and the bank

must report the transaction as a

securities purchase in its Call Report.

Third, the municipal securities must

either be rated by a nationally

recognized statistical rating organization

or must be part of an issue of securities

that does not exceed $25 million in size.

Finally, the price for the securities

purchased must be (i) quoted routinely

on an unaffiliated electronic service that

provides indicative data from real-time

financial networks, (ii) verified by

reference to two or more actual

independent dealer quotes on the

securities to be purchased or securities

that are comparable to the securities to

be purchased, or (iii) in the case of

securities purchased during the

underwriting period, verified by

reference to the price indicated in the

syndicate manager’s written summary of

the underwriting.58 Under any of the

three pricing options, the bank must

purchase the municipal securities at or

below the quoted or verified price.

The Board believes that this

streamlined set of requirements for

purchases of municipal securities is

appropriate because municipal

obligations generally have a lower

default risk than the other instruments

whose quotations would be difficult to

obtain, such as emerging market and

high yield debt. In addition, these

relaxed requirements are consistent

with the expressed desire of Congress to

support local communities’ use of

municipal securities to help meet their

financing needs.

H. Purchases of Assets by De Novo

Banks—223.16(h)

The proposed rule would exempt a

purchase of assets by a newly chartered

bank from an affiliate if the appropriate

Federal banking agency for the bank

approved the transfer. This exemption

would allow companies to charter a de

novo bank and to transfer assets to the

bank from its affiliates outside the

restrictions of section 23A.59 Currently,

if a company (usually a bank holding

company) establishes a credit card bank

or a trust company, the newly chartered

institution cannot acquire a critical

mass of assets from an affiliate because

of the quantitative limits and other

requirements of section 23A. The Board

has received many comments that these

restrictions are burdensome and

unnecessary because the chartering

authority for the new bank reviews the

transaction (and, in the case of a bank

holding company, the Board also

reviews the transaction) to ensure that

the transfer does not result in any safety

or soundness problems. For this reason,

the Board has proposed the exemption.

I. Transactions Approved Under the

Bank Merger Act—223.16(i)

The Board previously has exempted

from section 23A any merger or

consolidation transaction between

affiliated insured depository institutions

if the transaction has been approved by

the appropriate Federal banking agency

pursuant to the Bank Merger Act.60 The

proposed rule includes this exemption.

J. Purchases of Extensions of Credit—

223.16(j)

Section 23A includes as a covered

transaction a purchase of assets from an

affiliate, except such purchases of real

and personal property as may be

specifically exempted by the Board by

order or regulation.61 In 1979, the Board

issued a formal interpretation that

exempted a bank’s purchase of a

mortgage note or participation therein

from a mortgage banking affiliate,

provided that the bank’s commitment to

purchase is (i) obtained by the affiliate

within the context of each proposed

loan, (ii) obtained prior to the affiliate’s

commitment to make each loan, and (iii)

based upon the bank’s independent

evaluation of the creditworthiness of

each mortgagor (the ‘‘250.250

exemption’’).62 Although this

interpretation did not impose a strict

dollar limit on the amount of an

affiliate’s mortgage loans that a bank

could purchase under the exemption,

the interpretation cautioned that the

purpose of the exemption was to allow

a bank to take advantage of an

investment opportunity and not to

provide all the working capital needed

by an affiliate.

By 1995, some bank holding

companies were using the 250.250

exemption extensively to fund their

lending affiliates. In these cases, banks

were providing all or nearly all of their

affiliates’ funding needs. In response,

staff indicated in an interpretive letter

that the 250.250 exemption was not

available if the dollar amount of the

bank’s purchases from the affiliate

represented more than 50 percent of the

total dollar amount of loans originated

by the affiliate.63 Staff reasoned that, in

these circumstances, the asset purchases

look less like the bank taking advantage

of an investment opportunity brought to

it by the affiliate and more like the bank

providing an ongoing funding

mechanism for the affiliate. Staff

intended that this restriction would

require the affiliate to have alternative

funding sources and reduce the pressure

on the bank to purchase the affiliate’s

extensions of credit.

The proposed rule incorporates the

250.250 exemption and formally

expands the exemption to cover the

purchase of any type of loan or

extension of credit from an affiliate.

Regulation W also includes staff’s 50

percent test and another test designed to

ensure that the bank is not a principal

ongoing funding source for the affiliate.

In particular, the rule provides that the

250.250 exemption is unavailable if (i)

the amount of the bank’s total purchases

from the affiliate, when aggregated with

all other assets purchased from the

affiliate by affiliated banks and insured

savings associations, represents more

than 50 percent of the credit portfolio of

the affiliate; or (ii) the bank and its

affiliated banks and insured savings

associations provide substantial,

ongoing funding to the affiliate. The

Board recognizes that the ‘‘substantial,

ongoing funding’’ condition may create

some uncertainty for banks, but believes

that the condition would provide

examiners with additional flexibility to

stop arrangements in which a bank

provides a significant amount of

24200 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

64The text of section 23A in no way suggests that

a transaction must extend overnight to qualify as an

extension of credit.

65 If the Board were to take this approach, the

regulation may also have to require that a bank not

transfer any intraday credit extensions to other

jurisdictions. Such a requirement may be necessary

to prevent a bank from cycling its ‘‘intraday’’

transactions around the world to prevent them from

ever becoming ‘‘overnight’’ exposures.

funding to an affiliated lending

company but does not provide a

majority of the affiliate’s working

capital. The Board seeks comment on

whether the regulation should contain

staff’s 50 percent test or the

‘‘substantial, ongoing funding’’ test.

The Board also seeks comment on

whether the rule should limit the

amount of assets that a bank may

purchase from an affiliate pursuant to

the 250.250 exemption to some

percentage of the bank’s total assets.

The Board recently reviewed a case

where a nonbanking company proposed

to charter a bank for the sole purpose of

purchasing loans or leases from the

nonbanking company. In these

circumstances, a bank’s credit

underwriting process may be

compromised as a result of the complete

dependence of the bank on the affiliate

for asset growth. Prohibiting a bank

from using the 250.250 exemption to

accumulate a substantial percentage of

its assets may help prevent such

compromises. The Board notes that the 250.250

exemption only applies to the initial

purchase of assets by the bank and not

any covered transaction that may result

from the bank’s ongoing holding of the

asset purchased. For example, if a bank

purchases from the selling affiliate a

loan originated by the selling affiliate to

a second affiliate, the exemption may

exempt the bank’s purchase of the loan,

but it would not exempt the ongoing

extension of credit by the bank to the

second affiliate that results from the

purchase. To qualify for this exemption, a bank

must independently review the

creditworthiness of each obligor prior to

committing to purchase each loan. The

Board does not believe that a bank can

satisfy this requirement by simply

having its affiliates use the bank’s

underwriting standards or the

underwriting standards of the Federal

National Mortgage Association or any

other government agency or

government-sponsored enterprise. The

bank must itself review and approve

each loan prior to giving a purchase

commitment to its affiliate. Consistent

with the Board’s published

interpretation on this exemption, the

bank also must not make a legally

enforceable blanket advance

commitment to purchase a stipulated

amount of loans from the affiliate.

K. Intraday Extensions of Credit—

223.16(k)

As noted above, the GLB Act requires

the Board to ‘‘address as covered

transactions credit exposure arising out

of * * * intraday extensions of credit’’

by banks to their affiliates. Banks

regularly provide transaction accounts

to their affiliates in conjunction with

providing payment and securities

clearing services. As in the case of

unaffiliated commercial customers,

these accounts are subject to overdrafts

during the day that are repaid in the

ordinary course of business. The Board

has not to date ruled on whether these

or other types of intraday credit

extensions are covered transactions

under section 23A or are subject to the

market terms requirement of section

23B. Industry practice does not treat an

intraday credit extension as subject to

sections 23A or 23B unless the

extension remains outstanding at the

end of the day.64

Existing business practices indicate

that the potential risk reduction benefits

afforded by full application of the

requirements of section 23A to intraday

credit exposures may not justify the

costs to banking organizations of

implementing these requirements at this

time. Intraday overdrafts and other

forms of intraday credit extensions are

generally not used as a means of

funding or otherwise providing

financial support for an affiliate. Rather,

these credit extensions typically

facilitate the settlement of transactions

between an affiliate and its customers

when there are mismatches between the

timing of funds sent and received

during the business day. Although some

risk exists that such intraday credit

extensions could turn into overnight

funding of an affiliate, this risk may be

sufficiently remote that the strict

collateral and other requirements of

section 23A would not be warranted for

the intraday credit exposure. Moreover,

mandating that banks collateralize

intraday exposures could require banks

to measure exposures across multiple

accounts, offices, and systems on a

global basis and to adjust collateral

holdings in real time throughout the

day. The Board seeks comment on

whether banks currently have these

capabilities and, if not, whether they

would be costly to implement. Regulation W would provide that an

intraday extension of credit is not

subject to the quantitative limits or

collateral requirements of section 23A if

the credit extension arises in connection

with the performance by a bank, in the

ordinary course of business, of

securities clearing and settlement

transactions or payment transactions

(for example, wire transfers, check

clearing, and ACH transactions) on

behalf of an affiliate, and the bank (i)

has no reason to believe that the affiliate

will have difficulty repaying the

extension of credit in the ordinary

course of business; (ii) establishes limits

on the net amount of intraday credit that

the bank may extend to affiliates; and

(iii) establishes and maintains policies

and procedures for assessing affiliate

credit quality, monitoring each

affiliate’s compliance with the

established limits, reviewing intraday

credit extensions to an affiliate in the

event of the affiliate’s violation of the

limits, and ensuring that intraday credit

received by each affiliate complies with

section 23B. The bank also must

maintain records and supporting

information that are sufficient to enable

the appropriate Federal banking agency

for the bank to review the position

limits and required policies and

procedures.

Intraday extensions of credit by a

bank to an affiliate that do not meet the

conditions set forth above would be

subject to the quantitative, collateral,

and other requirements of section 23A.

All intraday extensions of credit by a

bank to an affiliate, including those that

meet the conditions set forth above,

would be subject to the market terms

requirement of section 23B.

Under Regulation W, all intraday

credit extensions (on a worldwide basis)

that exist at the end of the bank’s

business day in the United States would

become subject to section 23A at that

time. The Board requests comment on

whether the regulation should adopt a

different rule for determining when an

‘‘intraday’’ exposure become an

‘‘overnight’’ exposure. In particular, the

regulation could provide that an

‘‘intraday’’ exposure becomes an

‘‘overnight’’ exposure at the end of the

bank’s business day in the local

jurisdiction in which the credit was

extended.65

The Board may adopt a different

approach to intraday credit under

section 23A if it finds that banks are not

implementing satisfactory controls to

measure, monitor, and limit intraday

credit extensions to affiliates. The Board

requests comment on prudent risk

management measures for intraday

credit exposures.

The Board also requests comment on

whether the Board should find that

other types of intraday credit, not

related to payment transactions or

securities clearing and settlement

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24201

66Other credit card banks avoid section 23A by

securing their receivables with a segregated,

earmarked deposit account.

67Under section 23A and the proposed rule, an

extension of credit by a bank to a third party where

the proceeds of the transaction are used for the

benefit of, or transferred to, an affiliate of the bank

is a covered transaction between the bank and the

affiliate. 12 U.S.C. 371c(a)(2).

68 12 U.S.C. 371c–1(a)(2)(A).

69 12 U.S.C. 371c–1(b)(1)(B).

70Many smaller banking organizations had

difficulty meeting this standard because most or all

of their banks’ directors were officers or employees

of the banks or affiliates of the banks.

71 GLB Act section 738 (codified at 12 U.S.C.

371c–1(b)(2)). 72The Conference Report accompanying the

Competitive Equality Banking Act of 1987 stated

that the prior approval requirement of section

23B(b)(2) could be met ‘‘by the establishment in

advance of specific standards by the outside

directors for such acquisitions. If the outside

directors establish such standards, they must

regularly review acquisitions to assure that the

standards have been followed, and they must

periodically review the standards to assure that

they continue to be appropriate in light of market

and other conditions.’’ H.R. Conf. Rep. No. 100–

261, at 133 (1987).

transactions effected through an

affiliate’s transaction accounts at the

bank, should be exempt from the

quantitative limits and collateral

requirements of section 23A. In

particular, the Board understands that

some credit card banks issue special

purpose credit cards that customers may

use only at affiliates of the bank. These

banks extend credit on an intraday basis

to their credit card customers to enable

the customers to purchase goods or

services from the banks’ affiliates. At the

end of the day, however, many of these

banks sell their credit card receivables

to a third party or to another affiliate to

prevent the extensions of credit from

becoming overnight credits subject to

section 23A.66 These intraday credit

extensions would be covered

transactions subject to all the

requirements of section 23A under

Regulation W.67

Finally, the Board requests comment

on how long a transition period banks

need to put the necessary policies and

procedures in place in order to take

advantage of the exemption for intraday

credit extensions.

VII. General Provisions of Section 23B–

Subpart F

Subpart F of the proposed regulation

sets forth the principal restrictions of

section 23B. These include (i) the

requirement that certain transactions

between a bank and its affiliates be on

terms and circumstances that are

substantially the same as those

prevailing at the time for comparable

transactions with nonaffiliates; (ii) the

restriction on a bank’s purchase as

fiduciary of assets from an affiliate; (iii)

the restriction on a bank’s purchase,

during the existence of an underwriting

syndicate, of any security if a principal

underwriter of the security is an

affiliate; and (iv) the prohibition on a

bank’s or its affiliate’s publishing an

advertisement or entering into an

agreement stating that the bank will be

responsible for the obligation of its

affiliates. For the most part, subpart F

restates the operative provisions of

section 23B, and these provisions are

not discussed below. The remainder of

this section highlights four areas in

which Regulation W provides additional

guidance on section 23B.

A. Transactions Exempt from Section

23B–223.19(a)(1)

The market terms requirement of

section 23B applies to, among other

transactions, any ‘‘covered transaction’’

between a bank and an affiliate.68

Section 23B(d)(3) makes clear that the

term ‘‘covered transaction’’ in section

23B has the same meaning as the term

‘‘covered transaction’’ in section 23A,

but does not include any transaction

that is exempt under section 23A(d)-for

example, transactions between sister

banks, transactions fully secured by a

deposit account or U.S. government

securities, and purchases of assets from

an affiliate at a readily identifiable and

publicly available market quotation. The

regulation also excludes from section

23B any covered transaction that is

exempt from section 23A under section

223.17(h) or (i) of Regulation W (that is,

asset purchases by a de novo bank and

transactions approved as part of a bank

merger). The Board is proposing to

exclude from section 23B this additional

set of transactions because, in each case,

the appropriate Federal banking agency

for the bank involved in the transaction

would be expected to ensure that the

terms of the transaction are not

unfavorable to the bank.

B. Purchases of Securities for Which an

Affiliate is the Principal Underwriter–

223.20(b)

The GLB Act amended section 23B in

one respect. Since its passage in 1987,

section 23B(b)(1)(B) has prohibited a

bank, whether acting as principal or

fiduciary, from purchasing securities

during the existence of an underwriting

or selling syndicate if a principal

underwriter of the securities is an

affiliate of the bank.69 Prior to the GLB

Act, a bank could escape this

prohibition only if a majority of the

outside directors of the bank approved

the securities purchase before the

securities were initially offered to the

public.70 The GLB Act permits a bank to

purchase securities during an

underwriting conducted by an affiliate if

the following two conditions are met.

First, a majority of the directors of the

bank (with no distinction drawn

between inside and outside directors)

must approve the securities purchase

before the securities were initially

offered to the public. Second, such

approval must be based on a

determination that the purchase would

be a sound investment for the bank

irrespective of the fact that an affiliate

of the bank is a principal underwriter of

the securities.71 The proposed

regulation incorporates this new

standard and clarifies that if a bank

proposes to make such a securities

purchase in a fiduciary capacity, then

the directors of the bank must base their

approval on a determination that the

purchase is a sound investment for the

person on whose behalf the bank is

acting as fiduciary.

Obviously, a bank may satisfy this

director approval requirement by

obtaining specific prior director

approval of each securities acquisition

otherwise prohibited by section

23B(b)(1)(B). The regulation clarifies,

however, that a bank also may satisfy

this director approval requirement if a

majority of the directors of the bank

approve appropriate standards for the

bank’s acquisition of securities

otherwise prohibited by section

23B(b)(1)(B) and each such acquisition

meets the standards adopted by the

directors. In addition, a majority of the

bank’s directors must periodically

review such acquisitions to ensure that

they meet the standards and must

periodically review the standards to

ensure they meet the ‘‘sound

investment’’ criterion of section 23B.

The appropriate period of time between

reviews would vary depending on the

scope and nature of the bank’s program,

but such reviews should be conducted

by the directors at least annually. Prior

to the passage of the GLB Act, Board

staff informally allowed banks, based on

the legislative history of section 23B, to

meet the director approval requirement

in this fashion, and there is no

indication that Congress in the GLB Act

intended to alter the procedures that a

bank could use to obtain the requisite

director approval.72

For these reasons, the proposed

regulation would codify staff’s

preexisting approach to the director

approval requirement. The Board seeks

comment on whether this approach

remains appropriate in light of the

amendment made to section 23B by the

GLB Act.

24202 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

73 12 U.S.C. 371c–1(d)(1).

74 12 U.S.C. 1468(a)(2)(B).

75 12 U.S.C. 371c–1(c).

76The Board also believes that if a bank and its

affiliate enter into a joint undertaking with a third

party, the contract among the parties should make

clear that the bank is only responsible for its

obligations under the contract.

77The Board’s Operating Standards for section 20

affiliates require (i) any intraday extensions of

credit by a U.S. branch or agency of a foreign bank

to its section 20 affiliates to comply with the market

terms requirement of section 23B; (ii) any

extensions of credit by a U.S. branch or agency of

a foreign bank to its section 20 affiliates and any

purchase by such branch or agency of securities for

which a section 20 affiliate is the principal

underwriter to comply with sections 23A and 23B;

and (iii) a U.S. branch or agency of a foreign bank

to refrain from advertising or suggesting that it is

responsible for the obligations of a section 20

affiliate, consistent with section 23B(c). See 12 CFR

225.200; 62 FR 45295, Aug. 27, 1997.

78See 12 CFR 225.176(b)(6); 66 FR 8466, Jan. 21,

2001.

79See 12 U.S.C. 1843(k)(4)(B), (E), (H), and (I).

80The regulation covers subsidiaries of affiliates

directly engaged in the four activities in order to

prevent evasion. If these subsidiaries were not

covered, the U.S. branch of a foreign bank could

fund the foreign bank’s U.S. insurance underwriter

outside the scope of sections 23A and 23B by, for

example, lending money to a subsidiary of the

underwriter and having the subsidiary dividend or

on-lend the loan proceeds to the underwriter.

81Regulation W, consistent with the merchant

banking rule, would impose sections 23A and 23B

on a covered transaction between a U.S. branch or

agency of a foreign bank and its U.S. merchant

banking affiliate only to the extent the proceeds of

the covered transaction are used for the purpose of

funding the affiliate’s merchant banking activities.

C. The Definition of Affiliate Under

Section 23B–223.24(c)

Section 23B(d)(1) states that the term

‘‘affiliate’’ under section 23B has the

meaning given to such term in section

23A except that the term ‘‘affiliate’’

under section 23B does not include a

‘‘bank,’’ as defined in section 23A.73

Other federal law provides that an

insured savings association should be

treated as a ‘‘bank’’ for purposes of

section 23B.74 As in the case of the

sister-bank exemption, Regulation W

proposes to clarify that the only

companies that qualify for the ‘‘bank’’

exception to section 23B’s definition of

affiliate are insured banks and insured

savings associations. Without such an

interpretation, a bank would be able to

engage in transactions with certain

uninsured depository affiliates on terms

and conditions that were highly

unfavorable to the bank. Entering into

these kinds of transactions would not be

consistent with bank safety and

soundness and would contravene one of

the goals of section 23B—protecting the

deposit insurance funds.

D. The Advertising Restriction–223.21

Section 23B(c), the ‘‘advertising

restriction,’’ prohibits a bank from

publishing any advertisement or

entering into any agreement stating or

suggesting that the bank shall in any

way be responsible for the obligations of

its affiliates.75 Read literally, this

provision appears to prohibit a bank

from issuing a guarantee or letter of

credit on behalf of an affiliate. Because

section 23A includes as a covered

transaction the issuance by a bank of a

guarantee or letter of credit on behalf of

its affiliates, Board staff traditionally has

read the advertising restriction of

section 23B in light of section 23A. That

is, the Board does not believe that

section 23B(c) prohibits a bank from

issuing a guarantee, acceptance, or letter

of credit on behalf of an affiliate to the

extent permitted under section 23A.76

The regulation contains this

clarification.

VIII. Application of Sections 23A and

23B to U.S. Branches and Agencies of

Foreign Banks-Subpart G

Subpart G discusses the application of

sections 23A and 23B to U.S. branches

and agencies of foreign banks. As noted

above, sections 23A and 23B apply by

their terms only to member banks of the

Federal Reserve System, and other

federal banking laws have made insured

nonmember banks and insured savings

associations subject to the sections.

Federal banking law generally does not

subject the U.S. branches and agencies

of foreign banks to sections 23A and

23B.

Section 114(b)(4) of the GLB Act

grants the Board authority to impose

restrictions or requirements on

relationships or transactions between a

branch, agency, or commercial lending

company of a foreign bank in the United

States and any affiliate in the United

States of such foreign bank. The Board

may impose such prudential limits if

the Board finds that the limits are

appropriate to prevent an evasion of

certain Federal banking laws, avoid a

significant risk to the safety and

soundness of depository institutions or

any Federal deposit insurance fund, or

avoid other adverse effects, such as

undue concentration of resources,

decreased or unfair competition,

conflicts of interest, or unsound banking

practices.

The Board has for years imposed

certain of the requirements of sections

23A and 23B on transactions between a

U.S. branch or agency of a foreign bank

and its U.S. affiliates engaged in

underwriting and dealing in bankineligible securities (‘‘section 20

affiliates’’).77 The Board also recently

applied sections 23A and 23B to

transactions between a U.S. branch or

agency of a foreign bank and affiliates

conducting merchant banking activities

under the GLB Act and portfolio

companies held under that authority.78

The proposed regulation would fully

apply sections 23A and 23B to covered

transactions between a U.S. branch or

agency of a foreign bank and any

affiliate of such foreign bank directly

engaged in the United States in the

following financial activities newly

authorized under the GLB Act: (i)

insurance underwriting pursuant to

section 4(k)(4)(B) of the BHC Act; (ii)

securities underwriting and dealing

pursuant to section 4(k)(4)(E) of the BHC

Act; (iii) merchant banking investment

activities pursuant to section 4(k)(4)(H)

of the BHC Act; or (iv) insurance

company investment activities pursuant

to section 4(k)(4)(I) of the BHC Act.79

The regulation also would apply these

restrictions to transactions between a

U.S. branch or agency of a foreign bank

and any subsidiary of an affiliate

directly engaged in the four activities set

forth above (regardless of whether the

subsidiary itself engages in any of the

four activities).80 In addition, the

regulation would apply sections 23A

and 23B to transactions between a U.S.

branch or agency of a foreign bank and

any portfolio company controlled by the

foreign bank under the GLB Act’s

merchant banking or insurance

company investment authorities. The

regulation would not apply sections

23A or 23B to transactions between a

U.S. branch or agency and any other

type of affiliate (e.g., foreign affiliates or

U.S. affiliates engaged in nonbanking

activities under section 4(c)(8) of the

BHC Act), or to transactions between the

foreign bank’s non-U.S. offices and its

U.S. affiliates.

Applying the restrictions of sections

23A and 23B to transactions between

the U.S. branches and agencies of

foreign banks and the indicated U.S.

affiliates may help to ensure

maintenance of a competitive playing

field between U.S. banks and foreign

banks operating in the United States.

The issue of competitive equity arises

most strongly in connection with those

activities that a U.S. bank cannot engage

in directly or through an operations

subsidiary. A U.S. bank may affiliate

itself with a company engaged in the

newly authorized financial activities

listed above only if the company is a

holding company affiliate of the bank

or, in some cases, a financial subsidiary

of the bank.81 In either case, covered

transactions between the U.S. bank and

the company would be subject to

sections 23A and 23B. Without

Regulation W’s extension of the scope of

these statutory provisions, a foreign

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24203

82See 66 FR 8466, 8482, Jan. 31, 2001.

83The Board’s position on section 20 companies

requires U.S. branches and agencies of foreign

banks whose home country supervisor has not

adopted capital standards consistent with the Basle

Accord to calculate their section 23A capital stock

and surplus by reference to the capital of the foreign

bank parent as calculated under standards

applicable to U.S. banking organizations. See 62 FR

45304, Aug. 27, 1997.

84 12 U.S.C. 371c(b)(1)(D)(i).

85 12 U.S.C. 371c(b)(1)(D)(ii).

86Such a fund often is required to register under

the Commodity Exchange Act, and a bank affiliate

often registers as the fund’s commodity pool

operator (thereby sponsoring the fund) and

commodity trading advisor (thereby advising the

fund). See 7 U.S.C. 1a(4) (defining commodity pool

operator); 7 U.S.C. 1a(5)(B)(i) (defining commodity

trading advisor). Banks and trust companies are

excluded from the definition of commodity trading

advisor under the Commodity Exchange Act and, in

certain circumstances, may be excluded from the

definition of commodity pool operator. See 7 CFR

4.5.

87 12 U.S.C. 371c(b)(1)(E).

88 In fact, a bank may face greater risk from the

conflicts of interest arising from its relationships

with an investment fund that is not registered as an

investment company under the 1940 Act than with

a registered investment company because the 1940

Act restricts transactions between a registered

investment company and entities affiliated with the

company’s investment adviser.

89The term ‘‘investment company’’ in the 1940

Act does not include a company that is owned by

qualified persons or by no more than 100 persons,

provided that the company does not engage in a

public offering of its securities. See 15 U.S.C. 80a–

3(c)(1), (7). The term also generally does not include

investment funds that are engaged primarily in

investing in financial instruments other than

securities. See 15 U.S.C. 80a–3(a)(1).

90The Board also believes that investment funds

organized outside the United States for which a

bank or affiliate serves as investment advisor are

affiliates of the bank for purposes of section 23A.

See Letter dated July 24, 1990, from J. Virgil

Mattingly, General Counsel of the Board, to Anne

B. McMillen. The term ‘‘investment company’’ in

the 1940 Act does include investment funds

organized under the laws of a non-U.S. jurisdiction.

bank’s U.S. branch or agency could fund

and engage in transactions with these

types of affiliates more freely than could

a U.S. bank. To the extent that a foreign

bank’s U.S. branches and agencies are

able to fund these types of U.S. affiliates

outside of the restrictions of sections

23A and 23B, the affiliates are able to

compete for business in the United

States with a potential advantage not

available to the affiliates of U.S. banks.

The Board does not believe that it is

appropriate or necessary at this time to

impose the requirements of sections

23A and 23B on transactions between a

foreign bank’s U.S. branch or agency

and its U.S. affiliates that are engaged

only in activities that were permissible

for bank holding companies before the

passage of the GLB Act (other than

section 20 affiliates). The Board

recognizes the hardship this might

impose on foreign banks conducting

such activities in the United States

under previous law. Moreover, most of

these activities may be conducted by a

U.S. bank directly (or in an operations

subsidiary) and, hence, may be funded

by a U.S. bank in a manner that is not

subject to sections 23A and 23B.

The potential scope, nature, and risk

of transactions and relationships

between U.S. branches and agencies of

foreign banks and their affiliates

engaged in the United States in

insurance underwriting, full-scope

securities underwriting and dealing,

merchant banking, and insurance

company investment is unclear at this

time. At least until the Board acquires

more information and supervisory

experience regarding these transactions

and relationships, applying sections

23A and 23B may help ensure

competitive equity between foreign

banks and U.S. banking organizations in

the funding of certain of their U.S.

nonbank operations.

The regulation also provides that the

Board may add to the list of affiliates of

a foreign bank that are subject to the

restrictions of sections 23A and 23B.

The Board intends generally to use this

reserved authority to ensure competitive

equity between foreign banks and U.S.

banks with respect to affiliates engaged

in the United States in new activities

that the Board may authorize for

financial holding companies.

The Board also has considered the

issue of how to calculate the capital

stock and surplus of a foreign bank’s

U.S. branch or agency for purposes of

section 23A. In light of the fact that

foreign banks do not separately

capitalize their U.S. branches or

agencies, the regulation defines the

capital stock and surplus of such

branches and agencies by reference to

the capital of the foreign bank as

calculated under its home country

capital standards. This definition is

consistent with the approach recently

adopted by the Board in its merchant

banking rule,82 and represents a

relaxation from the Board’s current

position with respect to foreign banks

that operate section 20 companies in the

United States.83

IX. Definitions—Subpart H

Subpart H of Regulation W sets forth

definitions of the terms used in sections

23A and 23B and in the proposed rule.

Terms that are defined in the regulation

as they are defined in the statute

generally are not discussed below.

Terms that the Board proposes to define

or clarify for purposes of the regulation

are discussed below.

A. Definition of Affiliate—223.24

1. Investment funds advised by the

bank or a bank affiliate—223.24(a)(6).

Section 23A includes as an affiliate any

company that is sponsored and advised

by the bank or any of its affiliates.84

Section 23A also includes as an affiliate

any investment company for which the

bank or its affiliate serves as an

investment advisor, as defined in the

Investment Company Act of 1940

(‘‘1940 Act’’).85 The proposed regulation

sets forth these definitions and also

includes as an affiliate any investment

fund—even if not an investment

company for purposes of the 1940 Act—

for which the bank or an affiliate of the

bank serves as an investment advisor, if

the bank or an affiliate of the bank owns

or controls more than 5 percent of any

class of voting securities of the fund.

Most investment funds that are

advised by a bank (or an affiliate of a

bank) are affiliates of the bank under

section 23A because the funds either are

investment companies under the 1940

Act or are sponsored by the bank (or an

affiliate of the bank).86 In other

instances, however, the bank or its

affiliate may advise but not sponsor an

investment fund that is not an

investment company under the 1940

Act. Although such a fund would not fit

within the statutory definition of

affiliate, section 23A also authorizes the

Board to determine, by regulation or

order, that any company is an affiliate

of a bank if the company has ‘‘a

relationship with the member bank or

any subsidiary or affiliate of the member

bank, such that covered transactions by

the member bank or its subsidiary with

that company may be affected by the

relationship to the detriment of the

member bank or its subsidiary.’’ 87

The Board believes that the advisory

relationship of a bank or affiliate with

an investment fund presents the same

potential for conflicts of interest

regardless of whether the fund is or is

not treated as an investment company

for purposes of the 1940 Act.88 An

investment fund typically escapes from

the definition of investment company

under the 1940 Act because it (i) sells

interests only to a limited number of

investors or only to sophisticated

investors; or (ii) invests primarily in

financial instruments that are not

securities.89 The Board does not believe

that the private nature or investment

strategy of a fund should have a

substantial effect on the fund’s affiliate

status under section 23A because these

factors do not alter the conflicts of

interest presented in the advisory

relationship between the bank or its

affiliate and the fund.90

The Board seeks comment on the

appropriateness of treating investment

funds as affiliates of a bank under

24204 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

91See 12 U.S.C. 371c(b)(2)(A).

92 62 FR 37744, July 15, 1997.

93 12 U.S.C. 24a(g)(3).

94 GLB Act section 103(a); 12 U.S.C. 1843(k)(4)(H)

and (I).

95 GLB Act section 121(b)(2). As noted above, this

rebuttable presumption applies only if the affiliated

financial holding company owns or controls 15

percent or more of the company’s equity capital

under the new merchant banking or insurance

company investment authorities. The Board notes,

however, that under existing Board precedents a

bank holding company may not own any shares of

a company in reliance on sections 4(c)(6) or 4(c)(7)

of the BHC Act where the holding company owns

or controls, in the aggregate under a combination

of authorities, more than 5 percent of any class of

voting securities of the company.

section 23A if the bank or its affiliate

serves as investment advisor to the fund

and owns more than 5 percent of any

class of voting securities of the fund.

The Board particularly seeks comment

on whether such investment funds

should be treated as affiliates only if the

advising bank or affiliate owns more

than 5 percent of a class of voting

securities of the fund.

The Board is considering adding to

the definition of ‘‘affiliate’’ any

company controlled by an investment

fund that is an affiliate of the bank. The

conflicts of interest that exist between a

bank and any investment fund that it or

its affiliate advises also would appear to

exist between the bank and a portfolio

company controlled by such a fund. The

Board invites public comment on this

issue.

2. Financial subsidiaries—

223.24(a)(8); 223.26. Section 23A

defines an affiliate of a bank to include

any company that controls the bank and

any company that is under common

control with the bank. Since 1982,

however, section 23A has excluded

from the definition of affiliate any

subsidiary of the bank (other than a

bank subsidiary) unless the Board

determines by regulation or order that

the subsidiary should be considered an

affiliate.91 In 1997, the Board issued for

comment a proposal to extend section

23A to covered transactions between a

bank and a subsidiary of the bank

engaged in activities not permissible for

the bank to engage in directly.92

Consistent with this proposal, the

GLB Act recently amended section 23A

to cover transactions between a bank

and its ‘‘financial subsidiaries.’’ The

GLB Act defines a financial subsidiary

as any subsidiary of a bank that would

be a financial subsidiary of a national

bank under section 5136A of the

Revised Statutes of the United States.

Section 5136A of the Revised Statutes,

in turn, defines a financial subsidiary of

a national bank as any company that is

controlled by one or more insured

depository institutions, other than a

subsidiary that (i) engages solely in

activities that national banks are

permitted to engage in directly (and

subject to the same terms and

conditions as apply to national banks)

or (ii) a national bank is specifically

authorized by the express terms of a

federal statute (other than section

5136A), and not by implication or

interpretation, to control.93 The GLB

Act provides that a financial subsidiary

of a bank is considered an affiliate of the

bank for purposes of section 23A.

Regulation W specifically provides,

consistent with the GLB Act, that a

financial subsidiary of a bank is an

affiliate of the bank. The proposed

regulation includes a definition of

financial subsidiary that is identical to

the definition of financial subsidiary set

forth in section 23A, as amended by the

GLB Act. The Board notes that many

state banks have authority to engage

directly in activities that would not be

permissible for a national bank and

seeks comment on how the definition of

financial subsidiary should be applied

to subsidiaries of state banks, including

general insurance agency subsidiaries

and real estate investment and

development subsidiaries.

The definition of financial subsidiary

in section 23A and Regulation W would

cover some subsidiaries of banks that

are engaged only in agency activities.

The Board invites public comment on

the appropriateness of exempting such

subsidiaries from the definition of

financial subsidiary in the regulation.

Regulation W also provides that any

subsidiary of a bank’s financial

subsidiary will be considered a financial

subsidiary of the bank, even if the

subsidiary would not otherwise qualify

as a financial subsidiary. The Board

believes that treating such companies as

financial subsidiaries is consistent with

the anti-evasion provisions that the GLB

Act added to section 23A and will help

prevent banks from avoiding the special

restrictions that the GLB Act placed on

a bank’s transactions with its financial

subsidiaries.

3. Companies held under merchant

banking or insurance company

investment authority—223.24(a)(9). The

GLB Act amended the BHC Act to

permit bank holding companies and

foreign banks that qualify as financial

holding companies to engage in

merchant banking and insurance

company investment activities.94 If a

financial holding company owns or

controls more than 25 percent of a class

of voting shares of a company under the

merchant banking or insurance

company investment authority, the

company is an affiliate of any bank

controlled by the financial holding

company by operation of the statutory

definitions contained in section 23A.

The GLB Act also added paragraph

(b)(11) to section 23A, which creates a

rebuttable presumption that a company

is an affiliate of a bank for purposes of

section 23A if the bank is affiliated with

a financial holding company and the

financial holding company owns or

controls 15 percent or more of the

equity capital of the company pursuant

to the financial holding company’s

merchant banking or insurance

company investment authority.95 The

proposed regulation includes within the

definition of ‘‘affiliate’’ any company

subject to this rebuttable presumption.

The regulation also provides a

definition of equity capital, identifies

three situations or ‘‘safe harbors’’ where

the statute’s presumption of control

would be deemed to be rebutted, and

clarifies the application of the

presumption to private equity funds.

The statute does not provide a

definition of equity capital. The

regulation defines equity capital roughly

in accordance with the GAAP definition

of stockholders’ equity. Equity capital

includes a company’s perpetual

preferred stock, common stock, capital

surplus, retained earnings, and

accumulated other comprehensive

income, less treasury stock. The

definition of equity capital also makes

clear that any other account of the

company that constitutes equity should

be included in the company’s equity

capital. Accordingly, the Board retains

its authority on a case-by-case basis to

require a holding company to treat a

subordinated debt investment in a

company as equity capital of the

company for purposes of applying the

presumption of control. The Board asks

for comment on whether the proposed

definition of equity capital is

appropriate.

The regulation also provides three

specific regulatory safe harbors from the

statute’s presumption of affiliate status.

These safe harbors apply in situations

where the holding company owns or

controls more than 15 percent of the

total equity of the company under the

merchant banking or insurance

company investment authority (thereby

triggering the statutory presumption)

and less than 25 percent of any class of

voting securities of the company

(thereby not meeting the statutory

definition of control). The three

situations are substantially identical to

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24205

96See 12 CFR 225.176(b)(2) and (3).

97See 12 CFR 225.176(b)(5).

98See 12 U.S.C. 371c(b)(1)(A) and (b)(2)(A).

Section 23A defines a subsidiary of a specified

company as a company that is controlled by the

specified company. Under the statute, a company

controls another company if the first company owns

or controls 25 percent or more of a class of voting

securities of the other company, controls the

election of a majority of the directors of the other

company, or exercises a controlling influence over

the policies of the other company. 12 U.S.C.

371c(b)(3) and (4).

99 12 U.S.C. 371c(b)(2)(A).

those listed in the Board’s merchant

banking regulation.96

The first exemption applies where no

director, officer, or employee of the

holding company serves as a director of

the company. The second exemption

applies where an independent third

party controls a greater percentage of the

equity capital of the company than is

controlled by the holding company, and

no more than one officer or employee of

the holding company serves as a

director of the company. The third

exemption applies where an

independent third party controls more

than 50 percent of the voting shares of

the company, and officers and

employees of the holding company do

not constitute a majority of the directors

of the company.

For purposes of these safe harbors, the

rule provides that the term ‘‘holding

company’’ includes any subsidiary of

the holding company, including any

subsidiary depository institution of the

holding company. Accordingly, if a

director of a subsidiary bank or nonbank

subsidiary of a financial holding

company also serves as a director of a

portfolio company, the first safe harbor,

for example, would be unavailable.

These safe harbors do not require

Board review or approval. Moreover, the

safe harbors are not intended to be a

complete list of circumstances in which

the presumption may be rebutted. The

regulation also provides, consistent with

the GLB Act, that a bank or company

may rebut the presumption of affiliation

with respect to a company by presenting

information to the Board that

demonstrates, to the Board’s

satisfaction, that the holding company

does not control the portfolio company.

A financial holding company

generally is considered to own or

control only those shares or other

ownership interests that are owned or

controlled by itself or by a subsidiary of

the holding company. The rule clarifies

that, for purposes of applying the

presumption of affiliation described

above, a financial holding company that

has an investment in a private equity

fund (as defined in the Board’s

merchant banking rule) will not be

considered indirectly to own the equity

capital of a company in which the fund

has invested unless the financial

holding company controls the private

equity fund (as described in the Board’s

merchant banking rule).97

4. Certain joint venture companies—

223.24(b)(1)(iii). As noted above, under

the terms of section 23A, subsidiaries of

a bank generally are not treated as

affiliates of the bank, even if they would

otherwise qualify as affiliates.98 The

statute contains two specific exceptions

to this general rule: financial

subsidiaries of a bank and bank

subsidiaries of a bank are treated as

affiliates of the parent bank. The statute

also provides that the Board may

determine that other subsidiaries of a

bank should be treated as affiliates if

covered transactions between the bank

and the subsidiary may be affected by

the relationship between the companies

to the detriment of the bank.99

Pursuant to this authority, the Board

proposes to determine that two

additional classes of subsidiaries of a

bank should be treated as affiliates.

First, the proposed regulation provides

that any subsidiary of a bank in which

an affiliate of the bank directly owns or

controls 25 percent or more of any class

of voting securities would be considered

an affiliate of the bank. For example, a

joint venture company that is 50 percent

owned by a bank holding company and

50 percent owned by one of its

subsidiary banks, would be treated as an

affiliate of the bank. In such

circumstances, although the joint

venture company qualifies as a

subsidiary of the bank under section

23A because the bank owns more than

25 percent of the company’s voting

stock, the holding company’s

substantial direct interest in the

company creates the potential for

conflicts of interest that may endanger

the bank.

This proposed treatment of certain

bank-affiliate joint ventures as affiliates

does not apply to joint ventures between

a bank and affiliated banks or insured

savings associations. For example, if

two affiliated banks each own 50

percent of the stock of a company, the

company would continue to qualify as

a subsidiary and not an affiliate of each

bank (despite the fact that an affiliate of

each bank owned more than 25 percent

of a class of voting securities of the

company). Such a special rule for joint

ventures between a bank and affiliated

banks or insured savings associations is

consistent with the purpose behind the

sister-bank and affiliated-bank

exemptions contained in section 23A.

The Board does not believe that

transactions between a bank and a

company that is wholly owned by the

bank and its affiliated banks and

insured savings associations generally

pose material risks to the safety and

soundness of the shareholding

institutions or to the Federal deposit

insurance funds. The Board would

retain authority to treat such joint

ventures as affiliates under section 23A

on a case-by-case basis.

5. Employee benefit plans—

223.24(b)(1)(iv). The second proposed

regulatory exception to the general rule

that subsidiaries of a bank are not

treated as affiliates of the bank relates to

employee benefit plans. Board staff

traditionally has taken the position that

most employee stock option plans,

trusts, or similar entities that exist to

benefit shareholders, members, officers,

directors, or employees of a bank or its

affiliates (‘‘ESOPs’’) should be treated as

affiliates of the bank for purposes of

sections 23A and 23B. In most cases, the

ESOP’s share ownership or the

interlocking management between the

ESOP and its associated bank or bank

holding company exceeds the statutory

thresholds for determining that a

company is an affiliate. Some

institutions have argued, however, that

ESOPs should be considered

subsidiaries of the bank and therefore

exempt from coverage.

The Board believes that the

relationship between a bank and its or

its affiliates’ ESOP warrants coverage by

sections 23A and 23B. In the past, banks

have made unsecured loans to such

ESOPs or have guaranteed loans to such

ESOPs that were made by a third party.

These ESOPs, however, generally have

no means to repay the loans other than

with funds provided by the bank. In

addition, the issuance of holding

company shares to an ESOP that is

funded by a bank loan could be used as

a vehicle by the bank to provide funds

to its parent holding company when the

bank is unable to pay dividends or is

otherwise restricted in providing funds

to its holding company. Accordingly,

the proposed rule provides that a bank

or bank affiliate’s ESOP cannot avoid

classification as an affiliate of the bank

by also qualifying as a subsidiary of the

bank.

The Board asks for comment on

whether other subsidiaries of a bank

should be treated as affiliates of the

bank under section 23A.

The Board notes that Regulation W

also defines as an affiliate of a bank any

partnership for which the bank or any

affiliate of the bank serves as a general

partner or for which the bank or any

affiliate of the bank causes an officer or

24206 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

100 12 U.S.C. 371c(b)(7).

101 62 FR 45295 Aug. 27, 1997.

102See 12 U.S.C. 371c(a)(2).

103See Letter dated Aug. 6, 1993, from J. Virgil

Mattingly, General Counsel fo the Board, to Richard

Lasner.

104A floating-rate loan does not become a new

covered transaction whenever there is a change in

the relevant index (for example, LIBOR or the

bank’s prime rate) from which the loan’s interest

rate is calculated. If the bank and the borrower,

however, amend the loan agreement to change the

employee of the bank or affiliate to serve

as a general partner.

B. Definition of Covered Transaction—

223.25

The restrictions of section 23A do not

apply to every transaction between a

bank and its affiliates. The section only

applies to ‘‘covered transactions’’

between a bank and its affiliates. The

statute defines a covered transaction as

(i) an extension of credit to an affiliate;

(ii) a purchase of or investment in

securities issued by an affiliate; (iii) a

purchase of assets from an affiliate; (iv)

the acceptance of securities issued by an

affiliate as collateral for an extension of

credit to any person; and (v) the

issuance of a guarantee, acceptance, or

letter of credit on behalf of an

affiliate.100 Among the transactions that

generally are not subject to section 23A

are dividends paid by a bank to its

holding company, sales of assets by a

bank to an affiliate, an affiliate’s

purchase of securities issued by a bank,

and many service contracts between a

bank and an affiliate. This section

discusses several interpretive issues that

have arisen in determining whether

transactions between a bank and an

affiliate are covered transactions for

purposes of section 23A.

1. Confirmation of a letter of credit

issued by an affiliate. Section

23A(b)(7)(E) includes as a covered

transaction the issuance of a letter of

credit by a bank on behalf of an affiliate.

The proposed regulation clarifies that

the confirmation of a letter of credit

issued by an affiliate is a covered

transaction. When a bank confirms a

letter of credit, it assumes the risk of the

underlying transaction to the same

extent as if it had issued the letter of

credit.

2. Credit enhancements supporting a

securities underwriting. The Board has

confirmed previously that section 23A’s

definition of guarantee would not

include a bank’s issuance of a guarantee

in support of securities issued by a third

party and underwritten by a securities

affiliate of the bank.101 Such a credit

enhancement would not be issued ‘‘on

behalf of’’ the affiliate. In addition,

although the guarantee does provide

some benefit to the affiliate (by

facilitating the underwriting), this

benefit is indirect. Accordingly, the

proceeds of the guarantee would not be

transferred to the affiliate for purposes

of the attribution rule of section 23A.102

Of course, section 23B would apply to

the transaction and, where an affiliate

was issuer as well as underwriter, the

transaction would be covered by section

23A because the credit enhancement

would be on behalf of the affiliate.

3. Cross-guarantee agreements and

cross-affiliate netting arrangements. In

addition, Board staff has confirmed

previously that a cross-guarantee

agreement among a bank, an affiliate,

and a nonaffiliate in which the

nonaffiliate may use the bank’s assets to

satisfy the obligations of a defaulting

affiliate is a guarantee for purposes of

section 23A.103 The Board believes that

such cross-guarantee arrangements

among banks and their affiliates should

be subject to the quantitative limits and

collateral requirements of section 23A.

Similarly, the Board understands that

some banks have entered into or are

contemplating entering into crossaffiliate netting arrangements. These are

arrangements among a bank, one or

more affiliates of the bank, and one or

more nonaffiliates of the bank, where a

nonaffiliate is permitted to net

obligations of an affiliate of the bank to

the nonaffiliate when settling the

nonaffiliate’s obligations to the bank.

These arrangements also would include

agreements where a bank is required to

add the obligations of an affiliate of the

bank to a nonaffiliate when determining

the bank’s obligations to the

nonaffiliate.

Cross-affiliate netting arrangements

expose a bank to the credit risk of its

affiliates. Under these agreements, a

bank may become obligated effectively

to make good on the obligations of its

affiliates. The exposure of a bank to its

affiliates in such an arrangement

resembles closely the exposure of a bank

when it issues a guarantee on behalf of

an affiliate or extends credit to an

affiliate. Accordingly, the Board

believes that cross-affiliate netting

arrangements are credit transactions

under section 23A. Accordingly, the

quantitative limits of section 23A would

prohibit a bank from entering into a

cross-affiliate netting arrangement to the

extent that the netting arrangement does

not cap the potential exposure of the

bank to the participating affiliate(s).

The Board asks for comment on

whether alternative treatments of crossguarantees or cross-affiliate netting

arrangements under section 23A would

be appropriate.

4. Keepwell agreements. Banks have

asked for guidance on the question of

whether a ‘‘keepwell’’ agreement should

be considered a guarantee for purposes

of section 23A. In a keepwell agreement

between a bank and an affiliate, the

bank typically commits to maintain the

capital levels or solvency of the affiliate.

The credit risk incurred by the bank in

entering into such a keepwell agreement

is similar to the credit risk incurred by

a bank in connection with issuing a

guarantee on behalf of an affiliate.

Accordingly, keepwell agreements

generally should be treated as

guarantees for purposes of section 23A

and, if unlimited in amount, would be

prohibited by the quantitative limits of

section 23A.

5. Securitization vehicles. The Board

seeks comment on whether additional

clarification is necessary in the area of

securitizations. In the securitization

process, a bank segregates certain of its

or its customer’s assets into a relatively

homogenous pool and then transfers the

pool to a bankruptcy-remote special

purpose entity (‘‘SPE’’). The SPE, all of

whose voting securities are generally

held by a party other than the bank or

the bank’s customer, then issues

securities to investors. The asset-backed

securities issued by the SPE often

receive some form of credit

enhancement from the bank, the bank’s

customer, or a third-party guarantor.

The Board requests comment on the

question of whether such SPEs should

in any circumstances be deemed to be

affiliates of the bank involved in the

securitization and, if so, what

transactions between the bank and the

SPE should be considered covered

transactions under section 23A.

6. Loans and extensions of credit.

Although section 23A includes a ‘‘loan

or extension of credit’’ as a covered

transaction, the statute does not define

these terms. The proposed regulation

defines ‘‘extension of credit’’ to mean an

extension or renewal of a loan, a grant

of a line of credit, or an extension of

credit in any manner whatsoever,

including on an intraday basis. The

regulation also provides a

nonexhaustive list of transactions that

the Board deems to be extensions of

credit, including an advance by means

of an overdraft, cash item, or otherwise;

a lease that is the functional equivalent

of an extension of credit; a purchase of

a note or other obligation, including

commercial paper or other debt

securities; and any increase in the

amount of, extension of the maturity of,

or adjustment in the interest rate term

or other material term of an extension of

credit.104A floating-rate loan does not

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24207

interest rate term from ‘‘LIBOR plus 100 basis

points’’ to ‘‘LIBOR plus 150 basis points,’’ the

parties have engaged in a new covered transaction. 105This position is consistent with the Board’s

long-standing view that a purchase of an affiliate’s

note represents an extension of credit to the affiliate

under section 23A. See 37 Federal Reserve Bulletin

960 (1951).

106As discussed above, however, the regulation

requires a bank to value purchases of the debt

securities of an affiliate, for purposes of computing

compliance with the quantitative limits and

collateral requirements of section 23A, in

accordance with the valuation principles for

purchases of debt securities and not those for

extensions of credit.

107The carve-out for insured branches is

explicitly required by the Federal Deposit Insurance

Act, which provides that a foreign bank should not

be treated as a member bank under section 23A

solely because the foreign bank has an insured

branch. 12 U.S.C. 1828(j)(3)(A).

108 12 U.S.C. 371c(a)(1). 109 12 CFR 250.242. 110See, e.g., 12 CFR part 225, appendix A. 111 12 CFR 32.2(b). 112 12 CFR 215.2(i); see also 61 FR 19805, May

3, 1996. 113 12 U.S.C. 24a(c)(1). 114 12 U.S.C. 1831w(a)(2).

become a new covered transaction

whenever there is a change in the

relevant index (for example, LIBOR or

the bank’s prime rate) from which the

loan’s interest rate is calculated. If the

bank and the borrower, however, amend

the loan agreement to change the

interest rate term from ‘‘LIBOR plus 100

basis points’’ to ‘‘LIBOR plus 150 basis

points,’’ the parties have engaged in a

new covered transaction.

As noted, the regulation proposes to

clarify that a bank’s purchase of a note

or debt security, including commercial

paper, issued by an affiliate is a loan or

extension of credit by the bank to the

affiliate for purposes of section 23A.105

The Board is aware that some banks

have purchased or have proposed to

purchase the commercial paper of their

holding companies, and have done so or

proposed to do so without

collateralizing the purchase. These

banks have argued that a purchase of

commercial paper is a ‘‘purchase of or

investment in securities issued by an

affiliate’’ for purposes of section 23A,

and that such a purchase cannot also

then be an ‘‘extension of credit’’ for

purposes of section 23A and its

collateral requirements.

Although the Board is aware that

section 23A’s definition of covered

transaction separately includes a bank’s

purchase of securities issued by an

affiliate and a bank’s extension of credit

to an affiliate, the fact that a holder of

debt securities expects repayment of

principal upon maturity makes debt

securities closely resemble loans for

purposes of section 23A and the

statute’s objective of protecting the

bank. Therefore, Regulation W provides

that a bank that buys debt securities

issued by an affiliate has made an

extension of credit to an affiliate under

section 23A and must collateralize the

transaction in accordance with the

section 23A collateral requirements

applicable to extensions of credit.106

The Board seeks comment on whether

the rule should permit banks in certain

circumstances to purchase debt

securities issued by an affiliate without

satisfying the collateral requirements of

section 23A. In particular, the Board

seeks comment on whether it should

require section 23A collateralization in

circumstances where a bank purchases

an affiliate’s debt securities (i) from a

third party in a bona fide secondary

market transaction; or (ii) pursuant to a

registered public offering document or a

private placement memorandum in an

offering in which the affiliate receives

significant participation from third

parties. In these circumstances, the risk

that a bank’s purchase of an affiliate’s

debt securities is designed to shore up

an ailing affiliate may be reduced.

Moreover, in both of these situations,

the purchase of affiliate debt securities

would be subject to the quantitative

limits of section 23A and the market

terms requirement of section 23B.

The Board asks for comment on

whether other aspects of the definition

of extension of credit are in need of

clarification.

C. Other Definitions—223.26

1. Bank—223.26(c). Regulation W

applies to all ‘‘banks.’’ As discussed

above, sections 23A and 23B apply by

their terms to member banks of the

Federal Reserve System, and the Federal

Deposit Insurance Act subjects insured

nonmember banks to the restrictions of

sections 23A and 23B as if they were

member banks. Accordingly, the

proposed rule defines the term ‘‘bank’’

to include any ‘‘member bank,’’ as

defined in section 1 of the Federal

Reserve Act, and any ‘‘insured bank’’

other than an ‘‘insured branch,’’ as such

terms are defined in section 3 of the

Federal Deposit Insurance Act.107

The definition of bank in the

regulation also states that most

subsidiaries of a bank are to be treated

as the bank itself for purposes of

sections 23A and 23B. The only

subsidiaries of a bank that are excluded

from this treatment are financial

subsidiaries, depository institution

subsidiaries, certain joint venture

subsidiaries, and ESOPs—companies

that are deemed affiliates of the bank

under the regulation. This treatment of

subsidiaries reflects the fact that the

statute typically does not distinguish

between a member bank and its

subsidiaries, and all of the significant

restrictions of the statute apply to

actions taken by a member bank ‘‘and its

subsidiaries.’’ The Board believes that

defining the term ‘‘bank’’ as described

above and using the term ‘‘bank’’

wherever the statute says ‘‘member bank

and its subsidiaries’’ makes the

regulation shorter and easier to

understand while also reminding banks

that certain subsidiaries of a bank

should not be treated as part of the bank

for purposes of the statute.

2. Capital stock and surplus—

223.26(d). Under section 23A, the

quantitative limits on covered

transactions are based on the ‘‘capital

stock and surplus’’ of the bank.108 The

proposed regulation includes a

definition of capital stock and surplus

that the Board previously adopted as an

interpretation of section 23A.109 Capital

stock and surplus is defined as the sum

of the bank’s tier 1 capital and tier 2

capital and the balance of the bank’s

allowance for loan and lease losses not

included in its tier 2 capital. This

definition employs familiar concepts

contained in the Federal banking

agencies’ capital adequacy

guidelines,110 and is consistent with the

loans-to-one-borrower limits applicable

to national banks 111 and the Board’s

Regulation O, which limits lending to a

bank’s insiders. 112 Use of a common

definition across these rules should

reduce compliance burden. The Board

requests comment, however, on whether

the balance of a bank’s allowance for

loan and lease losses not included in its

tier 2 capital should be included in

section 23A’s ‘‘capital stock and

surplus.’’

The National Bank Act requires a

national bank, ‘‘in determining

compliance with applicable capital

standards,’’ to deduct from its capital

the aggregate amount of any outstanding

equity investments, including retained

earnings, of the bank in all its financial

subsidiaries.113 The Federal Deposit

Insurance Act imposes the same capital

deduction requirement on insured state

banks that establish financial

subsidiaries.114 In determining

compliance with the quantitative limits

of section 23A, a bank is required by

statute to include in its covered

transactions any equity investments

(excluding retained earnings) of the

bank in its financial subsidiaries. It

would be unfair to compel a bank to

include such investments in its covered

transaction amount (the numerator of

the fraction in section 23A’s

quantitative limits) but to exclude such

investments from capital (the

24208 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

115 12 U.S.C. 371c(b)(3)(A)(ii).

116See 12 CFR 225.2(e)(2)(i).

117See 12 CFR 225.31(d)(1)(i).

118 12 U.S.C. 371c(a)(3).

119 12 U.S.C. 371c(c)(3).

120 12 U.S.C. 371c(b)(10).

121The Federal banking agencies generally

consider non-investment grade securities to be

classified assets. See, e.g., ‘‘Uniform Agreement on

the Classification of Assets and Appraisal of

Securities Held by Banks’’ (May 7, 1979); Federal

Reserve Commercial Bank Examination Manual

§ 2020.1. The Board also notes that assets identified

by examiners through the Shared National Credit

and International Country Exposure Review

Committee processes should be considered

classified assets for purposes of section 23A.

122See Federal Reserve Commercial Bank

Examination Manual § 7040.1.

123William F. Treacy & Mark S. Carey, Credit

Risk Rating at Large U.S. Banks, 84 Federal Reserve

Bulletin 897 (1998). 124 12 U.S.C. 371c(b)(9).

denominator of the fraction).

Accordingly, a bank with a financial

subsidiary may add back to its section

23A ‘‘capital stock and surplus’’ the

amount of any investment in a financial

subsidiary that counts as a covered

transaction and is required to be

deducted from the bank’s capital for

regulatory capital purposes.

3. Control—223.26(f). Section 23A

provides that a company or shareholder

shall be deemed to have control over

another company if, among other things,

such company or shareholder controls

in any manner the election of a majority

of the ‘‘directors or trustees’’ of the other

company.115 Regulation W expands this

prong of the control definition to

conform it to the control definition

contained in the Board’s Regulation Y

by adding that control also exists when

a company or shareholder controls the

election of a majority of the ‘‘general

partners (or individuals exercising

similar functions)’’ of another company.

This expansion of the control definition

is intended to ensure that banks

understand that a company or

shareholder would be deemed to control

another company (including a

partnership, limited liability company,

or other similar organization) if the

company or shareholder controlled the

election of a majority of the principal

policymakers of such other company.

In addition, the regulation includes

two additional presumptions of control

that are similar to presumptions

contained in Regulation Y. First, a

company will be deemed to control

securities, assets, or other ownership

interests controlled by any subsidiary of

the company.116 Second, a company

that controls securities (including

options and warrants) that are

convertible, at the option of the holder

or owner, into other securities, will be

deemed to control the other

securities.117

4. Low-quality asset—223.26(q). Two

provisions of section 23A restrict a

bank’s ability to engage in transactions

with affiliates that involve low-quality

assets. First, the statute prohibits a bank

from purchasing a low-quality asset

from an affiliate unless the bank

performed an independent credit

evaluation and committed itself to

purchase the asset prior to the asset’s

acquisition by the affiliate.118 Second,

the statute prohibits a bank from

counting a low-quality asset toward

section 23A’s collateral requirements for

a credit transaction with an affiliate.119

For purposes of these provisions,

section 23A defines a low-quality asset

to include (i) an asset classified as

‘‘substandard,’’ ‘‘doubtful,’’ or ‘‘loss’’ or

treated as ‘‘other loans especially

mentioned’’ in the most recent report of

examination or inspection by a Federal

or State supervisory agency (a

‘‘classified asset’’); (ii) an asset in

nonaccrual status; (iii) an asset on

which payments are more than thirty

days past due; or (iv) an asset whose

terms have been renegotiated or

compromised due to the deteriorating

financial condition of the obligor.120

The Board notes that any asset meeting

one of the above four criteria, including

securities and real property, is a lowquality asset.121

The regulation broadens the

definition of low-quality asset in three

ways. First, the regulation provides that

an asset identified by examiners as an

‘‘other transfer risk problem’’ (‘‘OTRP’’)

is a low-quality asset. Such assets

represent credits to countries that are

not complying with their external debtservice obligations, but are taking

positive steps to restore debt service

through economic adjustment measures,

generally as part of an International

Monetary Fund program. Although

OTRP assets are not considered

classified assets, examiners are

instructed to consider such assets in

their assessment of a bank’s asset

quality and capital adequacy.122 The

Board asks for comment on the

appropriateness of treating OTRP assets

as low-quality assets under section 23A.

Second, the regulation reflects the

increasing use by financial institutions

of their own internal asset classification

systems. A recent Board study of the 50

largest U.S. banks demonstrated that all

use internal loan classifications, and a

substantial proportion of such

institutions have relatively advanced

internal rating systems.123 Although

there is considerable variance in how

large banks rate performing assets, the

banks generally use the same categories

employed by the Federal banking

agencies for rating classified assets.

Because examinations may be twelve

months apart—eighteen months for

smaller banks—these internal

classification systems may cause a bank

to regrade an asset long before its next

examination. Accordingly, the Board is

proposing to include within the

definition of low-quality asset not only

assets classified during the last

examination but also assets classified by

the affiliate’s internal classification

system (or assets that received an

internal rating that is substantially

equivalent to classified in such an

internal system). These assets generally

have been renegotiated or compromised

because the borrower is in financial

distress and, thus, typically would meet

the fourth prong of the statutory

definition of low-quality asset.

Moreover, the purchase of such assets

by a bank raises safety and soundness

concerns.

The Board has some concern that this

interpretation may induce companies to

avoid or defer reclassification of an asset

in order to allow its sale to an affiliated

bank, but believes that such evasions

can be addressed through the

examination process. The Board expects

companies with internal rating systems

to use the systems consistently over

time and over similar classes of assets

and will view as an evasion of section

23A any company’s deferral or

alteration of an asset’s rating to facilitate

sale of the asset to an affiliated bank.

Finally, the proposed rule defines

low-quality asset to include foreclosed

property designated ‘‘other real estate

owned,’’ until it is reviewed by an

examiner and receives a favorable

classification. In the Board’s experience,

such property is often of such poor

quality that its ownership poses the

same risk to the bank as a low-quality

loan that was purchased or taken as

collateral.

5. Securities—223.26(w). Section 23A

defines ‘‘securities’’ to mean ‘‘stocks,

bonds, debentures, notes, or other

similar obligations.’’124 In light of the

ambiguous nature of this definition, the

Board generally has looked to the

securities laws for guidance in

determining which financial

instruments should be considered

securities for purposes of section 23A.

In light of the similarities between

commercial paper and debentures and

notes and the countervailing fact that

the Securities Exchange Act of 1934

excludes some forms of commercial

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24209

125See 15 U.S.C. 78c(a)(10).

126See 12 CFR 225.2(q).

paper from its definition of security,125

the proposed regulation clarifies that

commercial paper is a security for

purposes of section 23A. Accordingly,

as discussed in more detail above, when

a bank purchases commercial paper

issued by an affiliate, the bank makes an

extension of credit to the affiliate

(which must be secured in accordance

with section 23A’s collateral

requirements) and purchases securities

issued by the affiliate for purposes of

section 23A.

6. Voting securities—223.26(aa).

Section 23A uses both the terms ‘‘voting

shares’’ and ‘‘voting securities.’’ To

remove any ambiguity and to provide

additional guidance to banks, the

proposed regulation replaces all

statutory uses of the term ‘‘voting

shares’’ with the term ‘‘voting

securities’’ and defines ‘‘voting

securities’’ to have the same meaning as

‘‘voting securities’’ in Regulation Y.126

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 rulemaking. Sections 23A and

23B of the Federal Reserve Act limit

transactions between a bank and its

affiliates and authorize the Board to

issue regulations as may be necessary to

administer and carry out the purposes of

the sections. The proposed rule would

comprehensively implement these

sections of the Federal Reserve Act. The

rule would simplify for banks the task

of complying with the sections and

would help ensure that the sections are

consistently interpreted and applied by

the Federal banking agencies and the

banking industry. A description of the

reasons why action by the Board is

being considered 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 all

banks regardless of their size. Although

the rule potentially affects all banks, the

regulation mainly codifies existing

practice. The Board specifically seeks

comment on the likely burden that the

proposed rule would impose on banks.

Paperwork Reduction Act

In accordance with the Paperwork

Reduction Act of 1995 (44 U.S.C. 3501

et seq.), the Board has reviewed the

proposed rule under the authority

delegated to the Board by the Office of

Management and Budget. No collections

of information pursuant to the

Paperwork Reduction Act are contained

in the proposed rule.

Solicitation of Comments Regarding

Use of ‘‘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. The Board invites

comments about how to make the

proposed rule easier to understand,

including answers to the following

questions:

(1) Has the Board organized the

material in an effective manner? If not,

how could the material be better

organized?

(2) Are the terms of the rule clearly

stated? If not, how could the terms be

more clearly stated?

(3) Does the rule contain technical

language or jargon that is unclear? If so,

which language requires clarification?

(4) Would a different format (with

respect to grouping and order of

sections and use of headings) make the

rule easier to understand? If so, what

changes to the format would make the

rule easier to understand?

(5) Would increasing the number of

sections (and making each section

shorter) clarify the rule? If so, which

portions of the rule should be changed

in this respect?

(6) What additional changes would

make the rule easier to understand?

List of Subjects in 12 CFR Part 223

Banks, Banking, Federal Reserve

System.

For the reasons set out in the

preamble, title 12, chapter II of the Code

of Federal Regulations is proposed to be

amended by adding a new part 223 to

read as follows:

PART 223—TRANSACTIONS

BETWEEN BANKS AND THEIR

AFFILIATES (REGULATION W)

Subpart A Introduction

Sec.

223.1 Authority, purpose, and scope.

Subpart B—General Provisions of Section

23A

223.2 What is the maximum amount of

covered transactions that a bank may

enter into with any single affiliate?

223.3 What is the maximum amount of

covered transactions that a bank may

enter into with all affiliates?

223.4 What safety and soundness

requirement applies to covered

transactions?

223.5 What are the collateral requirements

for a credit transaction with an affiliate?

223.6 May a bank purchase a low-quality

asset from an affiliate?

223.7 What transactions by a bank with any

person are treated as transactions with

an affiliate?

Subpart C—Valuation and Timing Principles

Under Section 23A

223.8 What valuation and timing principles

apply to credit transactions?

223.9 What valuation and timing principles

apply to asset purchases?

223.10 What valuation and timing

principles apply to purchases of and

investments in securities issued by an

affiliate?

223.11 What valuation principles apply to

extensions of credit secured by affiliate

securities?

Subpart D—Other Considerations Under

Section 23A

223.12 How does section 23A apply to a

bank’s acquisition of an affiliate that

becomes a subsidiary of the bank after

the acquisition?

223.13 What rules apply to financial

subsidiaries of a bank?

223.14 What rules apply to derivative

contracts? [Reserved]

Subpart E—Exemptions From the

Provisions of Section 23A

223.15 What covered transactions between

a bank and an insured depository

institution are exempt from the

quantitative limits and collateral

requirements?

223.16 What covered transactions are

exempt from the quantitative limits,

collateral requirements, and low-quality

asset prohibition?

223.17 What are the standards under which

the Board may grant additional

exemptions from the requirements of

section 23A?

Subpart F—General Provisions of Section

23B

223.18 What is the market terms

requirement of section 23B?

223.19 What transactions with affiliates or

others must comply with section 23B’s

market terms requirement?

223.20 What asset purchases are prohibited

by section 23B?

223.21 What advertisements and statements

are prohibited by section 23B?

223.22 What are the standards under which

the Board may grant exemptions from

the requirements of section 23B?

Subpart G—Application of Sections 23A

and 23B to U.S. Branches and Agencies of

Foreign Banks

223.23 How do sections 23A and 23B apply

to U.S. branches and agencies of foreign

banks?

Subpart H—Definitions of Terms

223.24 What is an ‘‘affiliate’’ for purposes of

sections 23A and 23B?

223.25 What transactions with affiliates are

covered by section 23A?

223.26 What are the meanings of the other

terms used in sections 23A and 23B?

Authority: 12 U.S.C. 371c(b)(1) (E) and (f),

371c–1(e), 1828(j), 1468.

24210 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

Subpart A—Introduction

§ 223.1 Authority, purpose, and scope.

(a) Authority. The Board of Governors

of the Federal Reserve System (Board)

has issued this part (Regulation W)

under the authority of sections 23A(f)(1)

and 23B(e) of the Federal Reserve Act

(12 U.S.C. 371c(f)(1), 371c–1(e)).

(b) Purpose. Sections 23A and 23B of

the Federal Reserve Act (12 U.S.C. 371c,

371c–1) establish certain quantitative

limits and other prudential

requirements for loans, purchases of

assets, and certain other transactions

between a bank and its affiliates. This

Regulation W implements sections 23A

and 23B by defining terms used in those

sections, explaining the requirements of

the sections, and exempting certain

transactions from certain of the

requirements.

(c) Scope. Sections 23A and 23B

apply by their terms to ‘‘member

banks’’—that is, national banks, State

banks, trust companies, and other

institutions that are members of the

Federal Reserve System. The Federal

Deposit Insurance Act (12 U.S.C.

1828(j)) subjects insured nonmember

banks to sections 23A and 23B as if they

were member banks. Accordingly, this

Regulation W applies to member banks

and insured nonmember banks, and

uses the term ‘‘banks’’ to describe the

companies that are subject to its

provisions. This regulation implements

sections 23A and 23B of the Federal

Reserve Act (12 U.S.C. 371c, 371c–1); it

does not contain every statutory or

regulatory restriction on transactions

between banks and their affiliates,

including those that may apply to banks

subject to prompt corrective action

under section 38 of the Federal Deposit

Insurance Act (12 U.S.C. 1831o).

Subpart B—General Provisions of

Section 23A

§ 223.2 What is the maximum amount of

covered transactions that a bank may enter

into with any single affiliate?

A bank may not engage in a covered

transaction with an affiliate if the

aggregate amount of the bank’s covered

transactions with any affiliate would

exceed 10 percent of the capital stock

and surplus of the bank.

§ 223.3 What is the maximum amount of

covered transactions that a bank may enter

into with all affiliates?

A bank may not engage in a covered

transaction with any affiliate if the

aggregate amount of the bank’s covered

transactions with all affiliates would

exceed 20 percent of the capital stock

and surplus of the bank.

§ 223.4 What safety and soundness

requirement applies to covered

transactions?

A bank may not engage in any

covered transaction, including any

covered transaction exempt under this

regulation, unless the transaction is on

terms and conditions that are consistent

with safe and sound banking practices.

§ 223.5 What are the collateral

requirements for a credit transaction with

an affiliate?

(a) Collateral required for extensions

of credit and certain other covered

transactions. A bank must ensure that

each of its credit transactions with an

affiliate is secured by the amount of

collateral required by paragraph (b) of

this section at the time of the

transaction.

(b) Amount of collateral required. A

credit transaction described in

paragraph (a) of this section must be

secured by collateral having a market

value equal to at least:

(1) 100 percent of the amount of the

transaction, if the collateral is:

(i) Obligations of the United States or

its agencies;

(ii) Obligations fully guaranteed by

the United States or its agencies as to

principal and interest;

(iii) Notes, drafts, bills of exchange, or

bankers’ acceptances that are eligible for

rediscount or purchase by a Federal

Reserve Bank; or

(iv) A segregated, earmarked deposit

account with the bank that is for the

sole purpose of securing the transaction

and is so identified;

(2) 110 percent of the amount of the

transaction, if the collateral is

obligations of any State or political

subdivision of any State;

(3) 120 percent of the amount of the

transaction, if the collateral is other debt

instruments, including loans and other

receivables; or

(4) 130 percent of the amount of the

transaction, if the collateral is stock,

leases, or other real or personal

property.

(c) Ineligible collateral. The following

items are not eligible collateral for

purposes of this section:

(1) Low-quality assets;

(2) Securities issued by any affiliate or

the bank;

(3) Intangible assets, including

servicing assets; and

(4) Guarantees and letters of credit.

(d) Perfection and priority

requirements for collateral. (1) A bank

must maintain a security interest in

collateral required by this section that is

perfected and enforceable under

applicable law, including in the event of

default resulting from insolvency,

liquidation, or similar circumstances.

(2) A bank either must obtain a first

priority security interest in collateral

required by this section or must deduct

from the value of collateral obtained by

the bank the lesser of:

(i) The amount of any security interest

in the collateral that is senior to that of

the bank; or

(ii) The amount of any credit secured

by the collateral that is senior to that of

the bank.

(e) Replacement requirement for

retired or amortized collateral. A bank

must replace any required collateral that

subsequently is retired or amortized

with additional eligible collateral as

needed to keep the percentage of the

collateral value relative to the amount of

the outstanding credit transaction equal

to the minimum percentage required at

the inception of the transaction.

(f) Inapplicability of the collateral

requirements to certain acceptances.

The collateral requirements of this

section do not apply to an acceptance

that already is fully secured either by

attached documents or by other

property that is involved in the

transaction and has an ascertainable

market value.

(g) Inapplicability of the collateral

requirements to the undrawn portion of

certain extensions of credit. The

collateral requirements of this section

do not apply to the undrawn portion of

an extension of credit to an affiliate so

long as the bank does not have any legal

obligation to advance additional funds

under the extension of credit until the

affiliate posts the amount of collateral

required by paragraph (b) of this section

with respect to the entire drawn portion

of the extension of credit.

§ 223.6 May a bank purchase a low-quality

asset from an affiliate?

(a) In general. A bank may not

purchase a low-quality asset from an

affiliate unless the bank, pursuant to an

independent credit evaluation,

committed itself to purchase the asset

prior to the time the asset was acquired

by the affiliate.

(b) Exemption for renewals of loan

participations involving problem loans.

The prohibition contained in paragraph

(a) of this section does not apply to the

renewal of, or extension of additional

credit with respect to, a bank’s

participation in a loan to a nonaffiliate

that was originated by an affiliated

depository institution if:

(1) The loan was not a low-quality

asset at the time the bank purchased its

participation;

(2) The renewal or extension of

additional credit is approved by the

board of directors of the participating

bank as necessary to protect the bank’s

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24211

investment by enhancing the ultimate

collection of the original indebtedness;

(3) The participating bank’s share of

the renewal or additional extension of

credit does not exceed its proportional

share of the original transaction; and

(4) The participating bank provides its

appropriate Federal banking agency

with 20 days’ prior notice of the

proposed renewal or additional

extension of credit.

§ 223.7 What transactions by a bank with

any person are treated as transactions with

an affiliate?

(a) In general. A bank must treat any

of its transactions with any person as a

transaction with an affiliate to the extent

that the proceeds of the transaction are

used for the benefit of, or transferred to,

an affiliate.

(b) Exemptions. Notwithstanding

paragraph (a) of this section, the

following transactions are not subject to

the quantitative limits of §§ 223.2 and

223.3 or the collateral requirements of

§ 223.5. The transactions are, however,

subject to the safety and soundness

requirement of § 223.4, the prohibition

on the purchase of a low-quality asset of

§ 223.6, and the market terms

requirement and other provisions of

subpart F of this part.

(1) Certain riskless principal

transactions. An extension of credit by

a bank to a nonaffiliate, if:

(i) The proceeds of the extension of

credit are used to purchase a security

through a securities affiliate of the bank,

and the securities affiliate is acting

exclusively as a riskless principal for

the nonaffiliate in the transaction;

(ii) The security purchased by the

nonaffiliate is not issued or

underwritten by, or sold out of the

inventory of, any affiliate of the bank;

and

(iii) Any riskless principal mark-up or

other compensation received by the

affiliate from the proceeds of the

extension of credit meets the market

terms standard set forth in paragraph

(b)(2) of this section.

(2) Brokerage commissions, agency

fees, and riskless principal mark-ups.

An affiliate’s retention of a portion of

the proceeds of an extension of credit

described in paragraph (b)(1) of this

section or in 12 CFR 250.243 as a

brokerage commission, agency fee, or

riskless principal mark-up, if that

commission, fee, or mark-up is

substantially the same as, or lower than,

those prevailing at the same time for

comparable transactions with or

involving other nonaffiliates, in

accordance with the market terms

requirement of § 223.18.

(3) Preexisting lines of credit. An

extension of credit by a bank to a

nonaffiliate, if:

(i) The proceeds of the extension of

credit are used to purchase a security

from or through a securities affiliate of

the bank; and

(ii) The extension of credit is made

pursuant to, and consistent with any

conditions imposed in, a preexisting

line of credit that was not established in

contemplation of the purchase of

securities from or through an affiliate of

the bank.

(4) General purpose credit card

transactions. An extension of credit by

a bank to a nonaffiliate, if:

(i) The proceeds of the extension of

credit are used by the nonaffiliate to

purchase a product or service from an

affiliate of the bank; and

(ii) The extension of credit is made

pursuant to, and consistent with any

conditions imposed in, a general

purpose credit card issued by the bank

to the nonaffiliate.

Subpart C—Valuation and Timing

Principles under Section 23A

§ 223.8 What valuation and timing

principles apply to credit transactions?

(a) Valuation. (1) Initial valuation of

direct credit transactions. Except as

provided in paragraph (a)(2) or (3) of

this section, a credit transaction with an

affiliate initially must be valued at the

sum of:

(i) The amount provided to, or on

behalf of, the affiliate in the transaction;

and

(ii) Any additional amount that the

bank could be required to provide to, or

on behalf of, the affiliate under the

terms of the transaction.

(2) Initial valuation of indirect credit

transactions. If a bank acquires a credit

transaction with an affiliate, the covered

transaction initially must be valued at

the sum of:

(i) The total amount of consideration

given (including liabilities assumed) by

the bank in exchange for the credit

transaction; and

(ii) Any additional amount that the

bank could be required to provide to, or

on behalf of, the affiliate under the

terms of the transaction.

(3) Debt securities. The valuation

principles of paragraphs (a)(1) and (2) of

this section do not apply to a bank’s

purchase of or investment in a debt

security issued by an affiliate, which is

governed by § 223.10.

(b) Timing. (1) In general. A bank

engages in a credit transaction with an

affiliate:

(i) At the time during the day that the

bank becomes legally obligated to make

an extension of credit to, issue a

guarantee, acceptance, or letter of credit

on behalf of, or confirm a letter of credit

issued by, an affiliate; and

(ii) At the time during the day that the

bank acquires an extension of credit to,

or guarantee, acceptance, or letter of

credit issued on behalf of, an affiliate.

(2) Credit transactions by a bank with

a nonaffiliate that becomes an affiliate

of the bank. (i) In general. A credit

transaction with a nonaffiliate becomes

a covered transaction at the time that

the nonaffiliate becomes an affiliate of

the bank. The bank must ensure that any

such credit transaction complies with

the collateral requirements of § 223.5

promptly after the nonaffiliate becomes

an affiliate. The bank also must treat the

amount of any such credit transaction as

part of the aggregate amount of the

bank’s covered transactions for purposes

of determining compliance with the

quantitative limits of §§ 223.2 and 223.3

in connection with any future covered

transactions. Except as described in

paragraph (b)(2)(ii) of this section, the

bank is not required to reduce the

amount of its covered transactions with

any affiliate because the nonaffiliate has

become an affiliate.

(ii) Credit transactions by a bank with

a nonaffiliate in contemplation of the

nonaffiliate becoming an affiliate of the

bank. In addition to the provisions of

paragraph (b)(2)(i) of this section, if a

bank engages in a credit transaction

with a nonaffiliate in contemplation of

the nonaffiliate becoming an affiliate of

the bank, the bank must ensure that the

aggregate amount of the bank’s covered

transactions (including any such

transaction with the nonaffiliate) would

not exceed the quantitative limits of

§§ 223.2 or 223.3 at the time the

nonaffiliate becomes an affiliate.

(iii) Example. A bank with capital

stock and surplus of $1,000 and no

outstanding covered transactions makes

a $120 unsecured loan to a nonaffiliate.

Several years later, the bank’s holding

company purchases all the stock of the

nonaffiliate, thereby making the

nonaffiliate an affiliate of the bank.

Promptly after the time of the stock

acquisition, the bank must ensure that

the loan is in compliance with the

collateral requirements of section 23A of

the Federal Reserve Act (12 U.S.C.

371c). The bank will not be in violation

of the quantitative limits of section 23A

at the time of the stock acquisition

(unless the loan was made by the bank

in contemplation of the nonaffiliate

becoming an affiliate). The bank will,

however, be prohibited from engaging in

any additional covered transactions

until such time as the value of the loan

24212 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

transaction falls below 10 percent of the

bank’s capital stock and surplus.

§ 223.9 What valuation and timing

principles apply to asset purchases?

(a) Valuation. (1) In general. Unless

the transaction is described in § 223.12,

a purchase of an asset (other than a

security issued by an affiliate or a note

or obligation of an affiliate) by a bank

from an affiliate must be valued initially

at the total amount of consideration

given (including liabilities assumed) by

the bank in exchange for the asset. The

value of the covered transaction after

the purchase may be reduced to reflect

amortization or depreciation of the

asset, to the extent that such reductions

are consistent with GAAP.

(2) Examples of the valuation of asset

purchases. The following are examples

of how to value a bank’s purchase of an

asset from an affiliate.

(i) Cash purchase of assets. A bank

purchases a pool of loans from an

affiliate for $10 million. The bank

initially must value the covered

transaction at $10 million. Going

forward, if the borrowers on the loans

pay down $6 million of the principal

amount of the loans, the bank may value

the covered transaction at $4 million.

(ii) Purchase of assets through an

assumption of liabilities. An affiliate of

a bank contributes real property with a

fair market value of $200,000 to the

bank. The bank pays the affiliate no

cash for the property, but assumes a

$50,000 mortgage on the property. The

bank has engaged in a covered

transaction with the affiliate and

initially must value the transaction at

$50,000. Going forward, if the bank

retains the real property but pays off the

mortgage, the bank must continue to

value the covered transaction at

$50,000.

(b) Timing. (1) In general. A purchase

of an asset remains a covered

transaction for a bank for as long as the

bank holds the asset.

(2) Asset purchases by a bank from a

nonaffiliate in contemplation of the

nonaffiliate becoming an affiliate of the

bank. If a bank purchases assets from a

nonaffiliate in contemplation of the

nonaffiliate becoming an affiliate of the

bank, the asset purchase becomes a

covered transaction at the time that the

nonaffiliate becomes an affiliate of the

bank. In addition, the bank must ensure

that the aggregate amount of the bank’s

covered transactions (including any

such transaction with the nonaffiliate)

would not exceed the quantitative limits

of §§ 223.2 or 223.3 at the time the

nonaffiliate becomes an affiliate.

§ 223.10 What valuation and timing

principles apply to purchases of and

investments in securities issued by an

affiliate?

(a) Valuation. (1) In general. Except as

provided in paragraph (b) of § 223.13

with respect to securities issued by a

financial subsidiary, a bank’s purchase

of or investment in a security issued by

an affiliate must be valued at the greater

of:

(i) The total amount of consideration

given (including liabilities assumed) by

the bank in exchange for the security,

reduced to reflect amortization of the

security to the extent consistent with

GAAP; or

(ii) The carrying value of the security

on the financial statements of the bank,

determined in accordance with GAAP.

(2) Examples of the valuation of

purchases of and investments in the

securities of an affiliate (other than a

financial subsidiary). The following are

examples of how to value a bank’s

purchase of or investment in securities

issued by an affiliate (other than a

financial subsidiary). Examples of how

to value a bank’s purchase of or

investment in securities issued by a

financial subsidiary are provided in

paragraph (b)(3) of § 223.13.

(i) Purchase of the debt securities of

an affiliate that is not a financial

subsidiary. The parent holding company

of a bank owns 100 percent of the shares

of a mortgage company. The bank

purchases debt securities issued by the

mortgage company for $600. The initial

carrying value of the securities on the

bank’s GAAP financial statements is

$600. The bank initially must value the

investment at $600.

(ii) Purchase of the shares of an

affiliate that is not a financial

subsidiary. The parent holding company

of a bank owns 51 percent of the shares

of a mortgage company. The bank

purchases an additional 30 percent of

the shares of the mortgage company

from a third party for $100. The initial

carrying value of the shares on the

bank’s GAAP financial statements is

$100. The bank initially must value the

investment at $100. Going forward, if

the bank’s carrying value of the shares

declines to $40, the bank must continue

to value the investment at $100.

(iii) Contribution of the shares of an

affiliate that is not a financial

subsidiary. The parent holding company

of a bank owns 100 percent of the shares

of a mortgage company and contributes

30 percent of the shares to the bank. The

bank gives no consideration in exchange

for the shares. If the initial carrying

value of the shares on the bank’s GAAP

financial statements is $300, then the

bank initially must value the investment

at $300. Going forward, if the bank’s

carrying value of the shares increases to

$500, the bank must value the

investment at $500.

(b) Timing. A purchase of or

investment in a security issued by an

affiliate remains a covered transaction

for a bank for as long as the bank holds

the security.

§ 223.11 What valuation principles apply to

extensions of credit secured by affiliate

securities?

(a) Valuation of extensions of credit

secured exclusively by affiliate

securities. An extension of credit by a

bank to a nonaffiliate secured

exclusively by securities issued by an

affiliate of the bank must be valued at

the lesser of:

(1) The total value of the extension of

credit; or

(2) The fair market value of the

affiliate’s securities that are pledged as

collateral, if such securities meet the

market quotation standard contained in

paragraph (e)(1) of § 223.16 or the

standards set forth in paragraphs

(e)(2)(i) and (v) of § 223.16.

(b) Valuation of extensions of credit

secured by affiliate securities and other

collateral. An extension of credit by a

bank to a nonaffiliate secured in part by

securities issued by an affiliate of the

bank and in part by other collateral

must be valued at the lesser of:

(1) The total value of the extension of

credit less the fair market value of the

nonaffiliate collateral; or

(2) The fair market value of the

affiliate’s securities that are pledged as

collateral, if such securities meet the

market quotation standard contained in

paragraph (e)(1) of § 223.16 or the

standards set forth in paragraphs

(e)(2)(i) and (v) of § 223.16.

Subpart D—Other Considerations

Under Section 23A

§ 223.12 How does section 23A apply to a

bank’s acquisition of an affiliate that

becomes a subsidiary of the bank after the

acquisition?

(a) Certain acquisitions by a bank of

securities issued by an affiliate are

treated as a purchase of assets from an

affiliate. A bank’s acquisition of a

security issued by a company that was

an affiliate of the bank before the

acquisition is treated as a purchase of

the assets of an affiliate, if:

(1) As a result of the transaction, the

company becomes a subsidiary of the

bank and ceases to be an affiliate of the

bank; and

(2) The company has liabilities, or the

bank gives cash or any other

consideration in exchange for the

security.

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24213

(b) Valuation. A transaction described

in paragraph (a) of this section but not

exempt under paragraph (d) of this

section must be valued initially at the

sum of:

(1) The total amount of consideration

given by the bank in exchange for the

security; and

(2) The total liabilities of the company

whose securities have been acquired by

the bank, as of the time of the

acquisition.

(c) Valuation example. The parent

holding company of a bank contributes

between 25 and 100 percent of the

voting shares of a mortgage company to

the bank. The bank gives no

consideration in exchange for the

shares. The mortgage company has total

assets of $300,000 and total liabilities of

$100,000. As a result of the transaction,

the mortgage company becomes a

subsidiary of the bank and ceases to be

an affiliate of the bank. The transaction

is treated as a purchase of the assets of

the mortgage company by the bank from

an affiliate under paragraph (a) of this

section. The bank initially must value

the transaction at $100,000, the total

amount of the liabilities of the mortgage

company.

(d) Exemption for step transactions. A

transaction described in paragraph (a) of

this section is not subject to the

provisions of subpart B of this part

(other than the safety and soundness

requirement of § 223.4) if:

(1) The bank acquires the securities

issued by the company immediately

after the company becomes an affiliate

of the bank;

(2) The bank acquires all the

securities of the company that were

transferred in connection with the

transaction that made the company an

affiliate of the bank; and

(3) The acquisition complies with the

market terms requirement of § 223.18.

§ 223.13 What rules apply to financial

subsidiaries of a bank?

(a) Exemption from the 10 percent

limit for covered transactions between a

bank and a single financial subsidiary.

The 10 percent quantitative limit

contained in § 223.2 does not apply

with respect to covered transactions

between a bank and a financial

subsidiary of the bank. The 20 percent

quantitative limit contained in § 223.3

does apply to such transactions.

(b) Valuation of purchases of or

investments in the securities of a

financial subsidiary. (1) General rule. A

bank’s purchase of or investment in a

security issued by a financial subsidiary

must be valued at the greater of:

(i) The total amount of consideration

given (including liabilities assumed) by

the bank in exchange for the security,

reduced to reflect amortization of the

security to the extent consistent with

GAAP; and

(ii) The carrying value of the security

on the financial statements of the bank,

determined in accordance with GAAP

but without reflecting the bank’s pro

rata portion of any earnings retained or

losses incurred by the financial

subsidiary after the bank’s acquisition of

the security.

(2) Carrying value of an investment in

a consolidated financial subsidiary. If a

financial subsidiary is consolidated

with its parent bank under GAAP, the

carrying value of the bank’s investment

in securities issued by the financial

subsidiary shall be equal to the carrying

value of the securities on parent-only

financial statements of the bank,

determined in accordance with GAAP

but without reflecting the bank’s pro

rata portion of any earnings retained or

losses incurred by the financial

subsidiary after the bank’s acquisition of

the securities.

(3) Examples of the valuation of

purchases of and investments in the

securities of a financial subsidiary. The

following are examples of how a bank

must value its purchase of or investment

in the securities of a financial

subsidiary. Each example involves a

securities underwriter that becomes a

financial subsidiary of the bank after the

transactions described below.

(i) Initial valuation. (A) Direct

acquisition by a bank. A bank pays $500

to acquire 100 percent of the shares of

a securities underwriter. The initial

carrying value of the shares on the

bank’s parent-only GAAP financial

statements is $500. The bank initially

must value the investment at $500.

(B) Contribution of a financial

subsidiary to a bank. The parent

holding company of a bank acquires 100

percent of the shares of a securities

underwriter in a transaction valued at

$500, and immediately contributes the

shares to the bank. The bank gives no

consideration in exchange for the

shares. The bank initially must value

the investment at the carrying value of

the shares on the bank’s parent-only

GAAP financial statements. If the parent

holding company’s acquisition of the

securities underwriter was accounted

for as a purchase, the bank’s initial

carrying value of the shares would be

$500. Alternatively, if the parent

holding company’s acquisition of the

securities underwriter was accounted

for as a pooling-of-interests, the bank’s

initial carrying value of the shares

would equal the book value of the

underwriter prior to the acquisition,

which may be less than $500.

(ii) Carrying value not adjusted for

earnings and losses of the financial

subsidiary. A bank and its parent

holding company engage in the

transaction described in paragraph

(b)(3)(i)(B) of this section, and the bank

initially values the investment at $500.

In the following year, the securities

underwriter earns $25 in profit, which

is added to its retained earnings. The

bank’s carrying value of the shares of

the underwriter is not adjusted for

purposes of this part, and the bank must

continue to value the investment at

$500. If, however, the bank contributes

$100 of additional capital to the

securities underwriter, the bank must

value the investment at $600.

(c) Treatment of an affiliate’s

investments in, and extensions of credit

to, a financial subsidiary of a bank. (1)

Investments. Any purchase of, or

investment in, the securities of a

financial subsidiary of a bank by an

affiliate of the bank (other than an

affiliate that is itself a bank or an

insured savings association) will be

treated as a purchase of or investment

in such securities by the bank.

(2) Extensions of credit. Any

extension of credit to a financial

subsidiary of a bank by an affiliate of the

bank (other than an affiliate that is itself

a bank or an insured savings

association) will be treated as an

extension of credit by the bank to the

financial subsidiary, if the Board

determines, by regulation or order, that

such treatment is necessary or

appropriate to prevent evasions of the

Federal Reserve Act or the GrammLeach-Bliley Act.

(3) An extension of credit that is

treated as regulatory capital of the

financial subsidiary. The Board has

determined, under the authority of

paragraph (c)(2) of this section, that any

extension of credit to a financial

subsidiary of a bank by an affiliate of the

bank (other than an affiliate that is itself

a bank or an insured savings

association) will be treated as an

extension of credit by the bank to the

financial subsidiary if the extension of

credit is treated as capital of the

financial subsidiary under any Federal

or State law, regulation, or

interpretation applicable to the

subsidiary.

24214 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

§ 223.14 What rules apply to derivative

contracts? [Reserved]

Subpart E—Exemptions From the

Provisions of Section 23A

§ 223.15 What covered transactions

between a bank and an insured depository

institution are exempt from the quantitative

limits and collateral requirements?

The following transactions are not

subject to the quantitative limits of

§§ 223.2 and 223.3 or the collateral

requirements of § 223.5. The

transactions are, however, subject to the

safety and soundness requirement of

§ 223.4 and the prohibition on the

purchase of a low-quality asset of

§ 223.6.

(a) Parent institution/subsidiary

institution transactions. Transactions

with an insured depository institution if

the bank controls 80 percent or more of

the voting securities of the insured

depository institution or the insured

depository institution controls 80

percent or more of the voting securities

of the bank;

(b) Transactions between a bank and

an insured depository institution owned

by the same holding company.

Transactions with an insured depository

institution if the same company controls

80 percent or more of the voting

securities of the bank and the insured

depository institution; and

(c) Certain loan purchases from an

affiliated insured depository institution.

Purchasing a loan on a nonrecourse

basis from an affiliated insured

depository institution.

§ 223.16 What covered transactions are

exempt from the quantitative limits,

collateral requirements, and low-quality

asset prohibition?

The following transactions are not

subject to the quantitative limits of

§§ 223.2 and 223.3, the collateral

requirements of § 223.5, or the

prohibition on the purchase of a lowquality asset of § 223.6. The transactions

are, however, subject to the safety and

soundness requirement of § 223.4.

(a) Making correspondent banking

deposits. Making a deposit in an

affiliated depository institution or

affiliated foreign bank that represents an

ongoing, working balance maintained in

the ordinary course of correspondent

business;

(b) Giving credit for uncollected items.

Giving immediate credit to an affiliate

for uncollected items received in the

ordinary course of business;

(c) Transactions secured by cash or

U.S. government securities. Engaging in

a credit transaction with an affiliate that

is fully secured by:

(1) Obligations of the United States or

its agencies;

(2) Obligations fully guaranteed by the

United States or its agencies as to

principal and interest; or

(3) A segregated, earmarked deposit

account with the bank that is for the

sole purpose of securing the credit

transaction and is identified as such;

(d) Purchasing securities of a

servicing affiliate. Purchasing a security

issued by any company engaged solely

in providing services described in

section 4(c)(1) of the Bank Holding

Company Act of 1956 (12 U.S.C.

1843(c)(1));

(e) Purchasing certain liquid assets.

(1) Purchasing an asset (other than a

security issued by an affiliate) having a

readily identifiable and publicly

available market quotation and

purchased at or below the asset’s

current market quotation. An asset has

a readily identifiable and publicly

available market quotation if:

(i) The asset’s price is quoted

routinely in a widely disseminated

news source; or

(ii) The asset is an obligation of the

United States or its agencies or an

obligation fully guaranteed by the

United States or its agencies as to

principal and interest; or

(2) Purchasing a security from a

securities affiliate, if:

(i) The security has a ‘‘ready market,’’

as defined in 17 CFR 240.15c3–

1(c)(11)(i);

(ii) The security is eligible for a State

member bank to purchase directly,

subject to the same terms and

conditions that govern the investment

activities of a State member bank, and

the bank records the transaction as a

purchase of a security for purposes of

the bank Call Report, consistent with

the requirements for a State member

bank;

(iii) The security is not a low-quality

asset;

(iv) The bank does not purchase the

security during an underwriting, or

within 30 days of an underwriting, if an

affiliate is an underwriter of the

security, unless the security is

purchased as part of an issue of

obligations of, or obligations fully

guaranteed as to principal and interest

by, the United States or its agencies;

(v) The security’s price is quoted

routinely on an unaffiliated electronic

service that provides indicative data

from real-time financial networks,

provided that:

(A) The price paid by the bank is at

or below the current market quotation

for the security; and

(B) The size of the transaction

executed by the bank does not cast

material doubt on the appropriateness of

relying on the current market quotation

for the security; and

(vi) The security is not issued by an

affiliate, unless the security is an

obligation fully guaranteed by the

United States or its agencies as to

principal and interest.

(f) Purchasing municipal securities.

Purchasing a municipal security from a

securities affiliate if:

(1) The security is rated by a

nationally recognized statistical rating

agency or is part of an issue of securities

that does not exceed $25 million;

(2) The security is eligible for

purchase by a State member bank,

subject to the same terms and

conditions that govern the investment

activities of a State member bank, and

the bank records the transaction as a

purchase of a security for purposes of

the bank Call Report, consistent with

the requirements for a State member

bank; and

(3)(i) The security’s price is quoted

routinely on an unaffiliated electronic

service that provides indicative data

from real-time financial networks,

provided that:

(A) The price paid by the bank is at

or below the current market quotation

for the security; and

(B) The size of the transaction

executed by the bank does not cast

material doubt on the appropriateness of

relying on the current market quotation

for the security; or

(ii) The price paid for the security can

be verified by reference to two or more

actual, current price quotes from

unaffiliated broker-dealers on the exact

security to be purchased or a security

comparable to the security to be

purchased, where:

(A) The price quotes obtained from

the unaffiliated broker-dealers are based

on a transaction similar in size to the

transaction that is actually executed;

and

(B) The price paid is no higher than

the average of the price quotes; or

(iii) The price paid for the security

can be verified by reference to the

written summary provided by the

syndicate manager to syndicate

members that discloses the aggregate par

values and prices of all bonds sold from

the syndicate account, if the bank:

(A) Purchases the municipal security

during the underwriting period;

(B) Obtains a copy of the summary

from its securities affiliate and retains

the summary for three years; and

(C) Purchases the municipal security

at a price that is at or below that

indicated in the summary;

(g) Purchasing an extension of credit

subject to a repurchase agreement.

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24215

Purchasing from an affiliate an

extension of credit that was originated

by the bank and sold to the affiliate

subject to a repurchase agreement or

with recourse;

(h) Asset purchases by a de novo

bank. The purchase of an asset from an

affiliate by a de novo bank, if the

appropriate Federal banking agency for

the bank has approved the asset

purchase in writing in connection with

its review of the formation of the bank;

(i) Transactions approved under the

Bank Merger Act. Any merger or

consolidation between a bank and an

affiliated insured depository institution,

or any acquisition of assets or

assumption of deposit liabilities by a

bank from an affiliated insured

depository institution, if the transaction

has been approved by the responsible

Federal banking agency pursuant to the

Bank Merger Act (12 U.S.C. 1828(c));

(j) Purchasing an extension of credit

from an affiliate. Purchasing an

extension of credit from an affiliate, if:

(1) The bank makes an independent

evaluation of the creditworthiness of the

borrower prior to the affiliate making or

committing to make the extension of

credit;

(2) The bank commits to purchase the

extension of credit prior to the affiliate

making or committing to make the

extension of credit;

(3) The bank does not make a blanket

advance commitment to purchase

extensions of credit from the affiliate;

(4) The dollar amount of the bank’s

total accumulated purchases from the

affiliate, when aggregated with all other

assets purchased from the affiliate by

banks and insured savings associations

that are affiliates of the bank, does not

represent more than 50 percent of the

dollar amount of extensions of credit

originated by the affiliate; and

(5) The bank and its affiliated banks

and insured savings associations do not

provide substantial, ongoing funding to

the affiliate through this exemption.

(k) Certain intraday extensions of

credit. (1) In general. An intraday

extension of credit that arises in

connection with the performance by a

bank, in the ordinary course of business,

of securities clearing and settlement

transactions or payment transactions on

behalf of an affiliate and effected

through one or more accounts that the

affiliate holds with the bank, if the bank:

(i) Has no reason to believe that the

affiliate will have difficulty repaying the

extension of credit in the ordinary

course of business;

(ii) Establishes and maintains prudent

limits on the net amount of intraday

credit that the bank may extend to each

affiliate, and all affiliates in the

aggregate, and integrates these limits

into the bank’s overall credit risk

exposure limits and systems;

(iii) Establishes and maintains

policies, procedures, and systems

reasonably designed to:

(A) Assess the credit quality of each

affiliate that obtains an intraday

extension of credit from the bank and

determine each such affiliate’s ability to

repay such credit extensions;

(B) Periodically monitor each such

affiliate’s compliance with the

established limits during the business

day;

(C) Review an affiliate’s intraday

extensions of credit in the event of the

affiliate’s violation of the established

limits; and

(D) Ensure that any intraday extension

of credit received by an affiliate

complies with the market terms

requirement of § 223.18;

(iv) Maintains records and supporting

information that are sufficient to enable

the appropriate Federal banking agency

to review the position limits and the

policies, procedures, and systems

described in paragraph (k)(1)(iii) of this

section; and

(v) Treats any such extension of credit

(regardless of jurisdiction) that exists at

the end of the bank’s business day in the

United States, as a nonexempt covered

transaction as of the end of the bank’s

business day in the United States

(assuming no other exemption applies

to the transaction at such time).

(2) Definition of ‘‘payment

transactions’’. For purposes of this

paragraph (k), ‘‘payment transactions’’

means transactions undertaken for the

purpose of transferring funds to another

account of the affiliate or to a third party

and includes funds transfers, ACH

transactions, check transactions, and

other similar transactions.

§ 223.17 What are the standards under

which the Board may grant additional

exemptions from the requirements of

section 23A?

(a) The standards. The Board may, at

its discretion, by regulation or order,

exempt transactions or relationships

from the requirements of section 23A of

the Federal Reserve Act (12 U.S.C. 371c)

and subpart B of this Regulation W if it

finds such exemptions to be in the

public interest and consistent with the

purposes of section 23A.

(b) Procedure. A bank may request an

exemption from the requirements of

section 23A and subpart B of this

Regulation W by submitting a written

request to the General Counsel of the

Board.

Subpart F—General Provisions of

Section 23B

§ 223.18 What is the market terms

requirement of section 23B?

A bank may not engage in a

transaction described in § 223.19 unless

the transaction is:

(a) On terms and under

circumstances, including credit

standards, that are substantially the

same, or at least as favorable to the

bank, as those prevailing at the time for

comparable transactions with or

involving nonaffiliates; or

(b) In the absence of comparable

transactions, on terms and under

circumstances, including credit

standards, that in good faith would be

offered to, or would apply to,

nonaffiliates.

§ 223.19 What transactions with affiliates

or others must comply with section 23B’s

market terms requirement?

(a) The market terms requirement of

§ 223.18 applies to the following

transactions:

(1) Any covered transaction with an

affiliate, unless the transaction is:

(i) Exempt under § 223.15 or

paragraphs (a) through (e)(1) or (g)

through (i) of § 223.16; and

(ii) Consistent with the safety and

soundness requirement of § 223.4;

(2) The sale of a security or other asset

to an affiliate, including an asset subject

to an agreement to repurchase;

(3) The payment of money or the

furnishing of a service to an affiliate

under contract, lease, or otherwise;

(4) Any transaction in which an

affiliate acts as an agent or broker or

receives a fee for its services to the bank

or to any other person; and

(5) Any transaction or series of

transactions with a nonaffiliate, if an

affiliate:

(i) Has a financial interest in the

nonaffiliate; or

(ii) Is a participant in the transaction

or series of transactions.

(b) For the purpose of this section,

any transaction by a bank with any

person will be deemed to be a

transaction with an affiliate of the bank

if any of the proceeds of the transaction

are used for the benefit of, or transferred

to, the affiliate.

§ 223.20 What asset purchases are

prohibited by section 23B?

(a) Fiduciary purchases of assets from

an affiliate. A bank may not purchase as

fiduciary any security or other asset

from any affiliate unless the purchase is

permitted:

(1) Under the instrument creating the

fiduciary relationship;

(2) By court order; or

24216 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

(3) By law of the jurisdiction

governing the fiduciary relationship.

(b) Purchase of a security

underwritten by an affiliate. (1) A bank,

whether acting as principal or fiduciary,

may not knowingly purchase or

otherwise acquire, during the existence

of any underwriting or selling syndicate,

any security if a principal underwriter

of that security is an affiliate of the

bank.

(2) Paragraph (b)(1) of this section

does not apply if the purchase or

acquisition of the security has been

approved, before the security is initially

offered for sale to the public, by a

majority of the directors of the bank

based on a determination that the

purchase is a sound investment for the

bank, or for the person on whose behalf

the bank is acting as fiduciary, as the

case may be, irrespective of the fact that

an affiliate of the bank is a principal

underwriter of the security.

(3) The approval requirement of

paragraph (b)(2) of this section may be

met if:

(i) A majority of the directors of the

bank approves standards for the bank’s

acquisitions of securities described in

paragraph (b)(1) of this section, based on

the determination set forth in paragraph

(b)(2) of this section;

(ii) Each acquisition described in

paragraph (b)(1) of this section meets

the standards; and

(iii) A majority of the directors of the

bank periodically reviews acquisitions

described in paragraph (b)(1) of this

section to ensure that they meet the

standards and periodically reviews the

standards to ensure that they continue

to meet the criterion set forth in

paragraph (b)(2) of this section.

(c) Special definitions. For purposes

of this section:

(1) Principal underwriter means any

underwriter who, in connection with a

primary distribution of securities:

(i) Is in privity of contract with the

issuer or an affiliated person of the

issuer;

(ii) Acting alone or in concert with

one or more other persons, initiates or

directs the formation of an underwriting

syndicate; or

(iii) Is allowed a rate of gross

commission, spread, or other profit

greater than the rate allowed another

underwriter participating in the

distribution.

(2) Security has the same meaning as

in section 3(a)(10) of the Securities

Exchange Act of 1934 (15 U.S.C.

78c(a)(10)).

§ 223.21 What advertisements and

statements are prohibited by section 23B?

(a) In general. A bank and its affiliates

may not publish any advertisement or

enter into any agreement stating or

suggesting that the bank will in any way

be responsible for the obligations of its

affiliates.

(b) Guarantees, acceptances, and

letters of credit subject to section 23A.

Paragraph (a) of this section does not

prohibit a bank from issuing a

guarantee, acceptance, or letter of credit

on behalf of an affiliate to the extent

otherwise permitted under this

Regulation W.

§ 223.22 What are the standards under

which the Board may grant exemptions

from the requirements of section 23B?

The Board may prescribe regulations

to exempt transactions or relationships

from the requirements of section 23B of

the Federal Reserve Act (12 U.S.C.

371c–1) and subpart F of this Regulation

W if it finds such exemptions to be in

the public interest and consistent with

the purposes of section 23B.

Subpart G—Application of Sections

23A and 23B to U.S. Branches and

Agencies of Foreign Banks

§ 223.23 How do sections 23A and 23B

apply to U.S. branches and agencies of

foreign banks?

(a) Applicability of sections 23A and

23B to foreign banks engaged in

underwriting insurance, underwriting or

dealing in securities, merchant banking,

or insurance company investment in the

United States. Sections 23A and 23B of

the Federal Reserve Act (12 U.S.C. 371c

and 371c–1) and the provisions of this

Regulation W apply to transactions

between each U.S. branch, agency, or

commercial lending company of a

foreign bank and:

(1) Any affiliate of the foreign bank

directly engaged in the United States in

any of the following activities:

(i) Insurance underwriting pursuant to

section 4(k)(4)(B) of the Bank Holding

Company Act (12 U.S.C. 1843(k)(4)(B));

(ii) Securities underwriting, dealing,

or market making pursuant to section

4(k)(4)(E) of the Bank Holding Company

Act (12 U.S.C. 1843(k)(4)(E));

(iii) Merchant banking activities

pursuant to section 4(k)(4)(H) of the

Bank Holding Company Act (12 U.S.C.

1843(k)(4)(H)) (but only to the extent

that the proceeds of the transaction are

used for the purpose of funding the

affiliate’s merchant banking activities);

(iv) Insurance company investment

activities pursuant to section 4(k)(4)(I)

of the Bank Holding Company Act (12

U.S.C. 1843(k)(4)(I)); or

(v) Any other activity designated by

the Board;

(2) Any subsidiary of an affiliate

described in paragraph (a)(1) of this

section; and

(3) Any portfolio company (as defined

in 12 CFR 225.177(c)) that the foreign

bank or affiliate controls (for purposes

of 12 CFR 225.173(d)(4)) and any

company that would be an affiliate of

the branch, agency, or commercial

lending company of the foreign bank

under paragraph (a)(9) of § 223.24 if the

branch, agency, or commercial lending

company were a bank.

(b) Method of applying sections 23A

and 23B to foreign banks. (1) In general.

Sections 23A and 23B of the Federal

Reserve Act and the provisions of this

Regulation W will apply to transactions

described in paragraph (a) of this

section in the same manner and to the

same extent as if the branch, agency, or

commercial lending company of the

foreign bank were a bank and the

companies described in paragraphs

(a)(1) through (3) of this section were

affiliates of the branch, agency, or

commercial lending company.

(2) Attribution rule. Sections 23A and

23B of the Federal Reserve Act and the

provisions of this Regulation W will

apply to transactions between each U.S.

branch, agency, or commercial lending

company of a foreign bank and any

person to the extent that the proceeds of

the transaction are used for the benefit

of, or transferred to, a company

described in paragraphs (a)(1) through

(3) of this section.

(3) Capital stock and surplus. For

purposes of §§ 223.2 and 223.3, the

‘‘capital stock and surplus’’ of a U.S.

branch, agency, or commercial lending

company of a foreign bank will be

determined by reference to the capital of

the foreign bank as calculated under its

home country capital standards.

Subpart H—Definitions of Terms

§ 223.24 What is an ‘‘affiliate’’ for

purposes of sections 23A and 23B?

(a) For purposes of this part and

except as provided in paragraphs (b)

and (c) of this section, ‘‘affiliate’’ with

respect to a bank means:

(1) Parent companies. Any company

that controls the bank;

(2) Companies under common

ownership by a parent company. Any

company, including any subsidiary of

the bank, that is controlled by a

company that controls the bank;

(3) Companies under other common

ownership. Any company, including

any subsidiary of the bank, that is

controlled, directly or indirectly, by

trust or otherwise, by or for the benefit

of shareholders who beneficially or

otherwise control, directly or indirectly,

by trust or otherwise, the bank or any

company that controls the bank;

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24217

(4) Companies with interlocking

directorates. Any company in which a

majority of its directors or trustees (or

individuals exercising similar functions)

constitute a majority of the persons

holding any such office with the bank

or any company that controls the bank;

(5) Sponsored and advised

companies. Any company, including a

real estate investment trust, that is

sponsored and advised on a contractual

basis by the bank or an affiliate of the

bank;

(6) Investment companies. (i) Any

investment company for which the bank

or any affiliate of the bank serves as an

investment adviser, as defined in

section 2(a)(20) of the Investment

Company Act of 1940 (15 U.S.C. 80a–

2(a)(20)); and

(ii) Any other investment fund for

which the bank or any affiliate of the

bank serves as an investment advisor, if

the bank or any affiliate of the bank

owns or controls more than 5 percent of

any class of voting shares or similar

interests in the fund;

(7) Depository institution subsidiaries.

A depository institution that is a

subsidiary of the bank;

(8) Financial subsidiaries. A financial

subsidiary of the bank;

(9) Companies held under merchant

banking or insurance company

investment authority. (i) In general. Any

company in which a holding company

that controls the bank (or a holding

company that is controlled by

shareholders that control the bank)

owns or controls, directly or indirectly,

or acting through one or more other

persons, 15 percent or more of the

equity capital pursuant to section

4(k)(4)(H) or (I) of the Bank Holding

Company Act (12 U.S.C. 1843(k)(4)(H)

or (I)).

(ii) General exemption. A company

may avoid affiliate status under

paragraph (a)(9)(i) of this section if the

holding company presents information

to the Board that demonstrates, to the

Board’s satisfaction, that the holding

company does not control the company.

(iii) Specific exemptions. A company

also may avoid affiliate status under

paragraph (a)(9)(i) of this section if:

(A) No director, officer, or employee

of the holding company serves as a

director, trustee, or general partner (or

individual exercising similar functions)

of the company;

(B) A person that is not affiliated or

associated with the holding company

owns or controls a greater percentage of

the equity capital of the company than

is owned or controlled by the holding

company, and no more than one officer

or employee of the holding company

serves as a director or trustee (or

individual exercising similar functions)

of the company; or

(C) A person that is not affiliated or

associated with the holding company

owns or controls more than 50 percent

of the voting shares of the company, and

officers and employees of the holding

company do not constitute a majority of

the directors or trustees (or individuals

exercising similar functions) of the

company.

(iv) Application of rule to private

equity funds. A holding company will

not be deemed to own or control the

equity capital of a company for

purposes of paragraph (a)(9)(i) of this

section solely by virtue of an investment

made by the holding company in a

private equity fund (as defined in 12

CFR 225.173(a)) that owns or controls

the equity capital of the company unless

the holding company controls the

private equity fund (as described in 12

CFR 225.173(d)(4)).

(v) Definition of ‘‘holding company’’.

For purposes of this paragraph (a)(9),

‘‘holding company’’ means the holding

company and all of its subsidiaries

(including any subsidiary depository

institution of the holding company);

(10) Partnerships for which the bank

or an affiliate serves as general partner.

Any partnership for which the bank or

any affiliate of the bank serves as a

general partner or for which the bank or

any affiliate of the bank causes any

officer or employee of the bank or

affiliate to serve as a general partner;

and

(11) Other companies. Any company

that the Board determines by regulation

or order to have a relationship with the

bank, or any affiliate of the bank, such

that covered transactions by the bank

with that company may be affected by

the relationship to the detriment of the

bank.

(b) ‘‘Affiliate’’ with respect to a bank

does not include:

(1) Subsidiaries. Any company that is

a subsidiary of the bank, other than:

(i) A depository institution;

(ii) A financial subsidiary;

(iii) A subsidiary in which any

affiliate or affiliates of the bank (other

than a bank or insured savings

association) directly owns or controls 25

percent or more of any class of voting

securities;

(iv) An employee stock option plan,

trust, or similar organization that exists

for the benefit of the shareholders,

partners, members, or employees of the

bank or any of its affiliates; and

(v) Any other company determined to

be an affiliate under paragraph (a)(11) of

this section;

(2) Bank premises. Any company

engaged solely in holding premises of

the bank;

(3) Safe deposit. Any company

engaged solely in conducting a safe

deposit business;

(4) Government securities. Any

company engaged solely in holding

obligations of the United States or its

agencies or obligations fully guaranteed

by the United States or its agencies as

to principal and interest; and

(5) Companies held DPC. Any

company where control results from the

exercise of rights arising out of a bona

fide debt previously contracted. This

exclusion from the definition of

‘‘affiliate’’ applies only for the period of

time specifically authorized under

applicable State or Federal law or

regulation or, in the absence of such law

or regulation, for a period of two years

from the date of the exercise of such

rights. The Board may authorize, upon

application and for good cause shown,

extensions of time for not more than one

year at a time, but such extensions in

the aggregate will not exceed three

years.

(c) For purposes of subpart F of this

part, ‘‘affiliate’’ with respect to a bank

also does not include any insured

depository institution.

§ 223.25 What transactions with affiliates

are covered by section 23A?

For purposes of this part, a ‘‘covered

transaction’’ with respect to an affiliate

of a bank means:

(a) An extension of credit to the

affiliate;

(b) A purchase of, or an investment in,

a security issued by the affiliate;

(c) A purchase of an asset from the

affiliate, including an asset subject to

recourse or an agreement to repurchase,

except such purchases of real and

personal property as may be specifically

exempted by the Board by order or

regulation;

(d) The acceptance of a security

issued by the affiliate as collateral for an

extension of credit to any person or

company; and

(e) The issuance of a guarantee,

acceptance, or letter of credit, including

an endorsement or standby letter of

credit, on behalf of the affiliate, and a

confirmation of a letter of credit issued

by the affiliate.

§ 223.26 What are the meanings of the

other terms used in sections 23A and 23B?

For purposes of this part:

(a) Aggregate amount of covered

transactions means the amount of the

covered transaction about to be engaged

in added to the current amount of all

outstanding covered transactions.

24218 Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules

(b) Appropriate Federal banking

agency has the same meaning as in

section 3 of the Federal Deposit

Insurance Act (12 U.S.C. 1813).

(c) Bank. (1) In general. Bank means:

(i) Any member bank, as defined in

section 1 of the Federal Reserve Act (12

U.S.C. 221); and

(ii) Any insured bank that is not an

insured branch, as such terms are

defined in section 3 of the Federal

Deposit Insurance Act (12 U.S.C. 1813).

(2) Subsidiaries of banks. For

purposes of paragraph (c)(1) of this

section, a subsidiary of a bank (other

than a subsidiary described in

paragraphs (b)(1)(i) through (v) of

§ 223.24) is treated as the bank.

(d) Capital stock and surplus means

the sum of:

(1) A bank’s tier 1 and tier 2 capital

under the risk-based capital guidelines

of the appropriate Federal banking

agency, based on the bank’s most recent

consolidated Report of Condition and

Income filed under 12 U.S.C. 1817(a)(3);

and

(2) The balance of a bank’s allowance

for loan and lease losses not included in

its tier 2 capital under the risk-based

capital guidelines of the appropriate

Federal banking agency, based on the

bank’s most recent consolidated Report

of Condition and Income filed under 12

U.S.C. 1817(a)(3).

(e) Company means a corporation,

partnership, limited liability company,

business trust, association, or similar

organization and, unless specifically

excluded, includes a bank and a

depository institution.

(f) Control. (1) In general. Control by

a company or shareholder over another

company means that:

(i) The company or shareholder,

directly or indirectly, or acting through

one or more other persons, owns,

controls, or has power to vote 25

percent or more of any class of voting

securities of the other company;

(ii) The company or shareholder

controls in any manner the election of

a majority of the directors, trustees, or

general partners (or individuals

exercising similar functions) of the other

company; or

(iii) The Board determines, after

notice and opportunity for hearing, that

the company or shareholder, directly or

indirectly, exercises a controlling

influence over the management or

policies of the other company.

(2) Ownership or control of shares as

fiduciary. Notwithstanding any other

provision of this Regulation W, no

company will be deemed to control

another company by virtue of its

ownership or control of shares in a

fiduciary capacity, except as provided

in paragraph (a)(3) of § 223.24 or if the

company owning or controlling the

shares is a business trust.

(3) Ownership or control of shares by

subsidiary. A company will be deemed

to control securities, assets, or other

ownership interests owned or

controlled, directly or indirectly, by any

subsidiary (including a bank) of the

company.

(4) Ownership or control of

convertible securities. A company that

owns or controls securities (including

options and warrants) that are

convertible, at the option of the holder

or owner, into other securities, controls

the other securities.

(g) Credit transaction with an affiliate

means:

(1) An extension of credit to the

affiliate; and

(2) An issuance of a guarantee,

acceptance, or letter of credit, including

an endorsement or standby letter of

credit, on behalf of the affiliate and a

confirmation of a letter of credit issued

by the affiliate.

(h) Depository institution means a

State bank, national bank, banking

association, or trust company, or an

insured savings association.

(i) Equity capital means:

(1) With respect to a corporation,

perpetual preferred stock, common

stock, capital surplus, retained earnings,

and accumulated other comprehensive

income, less treasury stock, plus any

other account that constitutes equity of

the corporation; and

(2) With respect to a partnership,

limited liability company, or other

company, equity accounts similar to

those described in paragraph (i)(1) of

this section.

(j) Extension of credit means an

extension or renewal of a loan, a grant

of a line of credit, or an extension of

credit in any manner whatsoever,

including on an intraday basis. An

extension of credit includes, without

limitation:

(1) An advance by means of an

overdraft, cash item, or otherwise;

(2) A lease that is the functional

equivalent of an extension of credit;

(3) A purchase of a note or other

obligation, including commercial paper

or other debt securities (which is

deemed an extension of credit to the

obligor); and

(4) Any increase in the amount of,

extension of the maturity of, or

adjustment to the interest rate term or

other material term of, an extension of

credit.

(k) Financial subsidiary means:

(1) Any subsidiary of a bank that

would be a financial subsidiary of a

national bank under section 5136A of

the Revised Statutes of the United States

(12 U.S.C. 24a); and

(2) Any subsidiary of a company

described in paragraph (k)(1) of this

section.

(l) Foreign bank and an agency,

branch, or commercial lending company

of a foreign bank have the same

meanings as in section 1(b) of the

International Banking Act of 1978 (12

U.S.C. 3101).

(m) GAAP means U.S. generally

accepted accounting principles.

(n) General purpose credit card means

a credit card issued by a bank if:

(1) The card may be used to purchase

products or services from nonaffiliates

of the bank;

(2) The card is widely accepted by

merchants that are not affiliates of the

bank for the purchase of products or

services; and

(3) Less than 25 percent of the

aggregate amount of products and

services purchased with the card by all

cardholders are purchases of products

or services from an affiliate of the bank.

(o) Insured depository institution has

the same meaning as in section 3 of the

Federal Deposit Insurance Act (12

U.S.C. 1813), but (except for purposes of

§ 223.16(i)) does not include any branch

or agency of a foreign bank or any

commercial lending company owned or

controlled by a foreign bank.

(p) Insured savings association means

a savings association (as defined in

section 3 of the Federal Deposit

Insurance Act (12 U.S.C. 1813)) the

deposits of which are insured by the

Federal Deposit Insurance Corporation.

(q) Low-quality asset means:

(1) An asset (including a security)

classified as ‘‘substandard,’’ ‘‘doubtful,’’

or ‘‘loss’’ or treated as ‘‘other assets

especially mentioned’’ or ‘‘other transfer

risk problems’’ either in the most recent

report of examination or inspection of

an affiliate prepared by either a Federal

or State supervisory agency or in any

internal classification system used by

the bank or the affiliate (including an

asset that receives a rating that is

substantially equivalent to classified in

the internal system of the bank or

affiliate);

(2) An asset in a nonaccrual status;

(3) An asset on which principal or

interest payments are more than thirty

days past due;

(4) An asset whose terms have been

renegotiated or compromised due to the

deteriorating financial condition of the

obligor; and

(5) A foreclosed asset designated as

‘‘other real estate owned’’ that has not

yet been reviewed in an examination or

inspection.

(r) Municipal securities has the same

meaning as in section 3(a)(29) of the

Federal Register / Vol. 66, No. 92 / Friday, May 11, 2001 / Proposed Rules 24219

Securities Exchange Act of 1934 (17

U.S.C. 78c(a)(29)).

(s) Nonaffiliate with respect to a bank

means any person that is not an affiliate

of the bank.

(t) Payment transactions is defined in

§ 223.16(k)(2).

(u) Principal underwriter is defined in

§ 223.20(c)(1).

(v) Purchase of assets means the

acquisition of an asset in exchange for

cash or any other consideration,

including an assumption of liabilities.

(w) Securities means stocks, bonds,

debentures, notes, or similar obligations

(including commercial paper).

(x) Securities affiliate means a broker

or dealer that is an affiliate of the bank

and is registered with the Securities and

Exchange Commission.

(y) State bank has the same meaning

as in section 3 of the Federal Deposit

Insurance Act (12 U.S.C. 1813).

(z) Subsidiary with respect to a

specified company means a company

that is controlled by the specified

company.

(aa) Voting securities has the same

meaning as the term ‘‘voting securities’’

found in 12 CFR 225.2(q).

By order of the Board of Governors of the

Federal Reserve System, May 3, 2001.

Jennifer J. Johnson,

Secretary of the Board.

[FR Doc. 01–11610 Filed 5–10–01; 8:45 am]

BILLING CODE 6210–01–P