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David R. Sahr Partner

Developments in Complementary Activities Permissible for Financial Holding Companies Institute of International Bankers October 30, 2007. David R. Sahr Partner. www.mayerbrown.com. Background on Complementary Activities.

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David R. Sahr Partner

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  1. Developments in Complementary Activities Permissible for Financial Holding CompaniesInstitute of International BankersOctober 30, 2007 David R. SahrPartner www.mayerbrown.com

  2. Background on Complementary Activities • Activities that are “complementary” to activities that are “financial in nature” under the Bank Holding Company Act (BHCA) and that do not pose substantial risk to safety and soundness. • The Federal Reserve Board can approve these activities for foreign banks and domestic bank holding companies that have elected to be financial holding companies. • Because of their non-financial nature, complementary activities should be limited in size and scope to the financial activities they complement. • These activities may be conducted in the FHC’s nonbank subsidiaries; not in U.S. banks, branches or agencies.

  3. FRB Approvals • FRB has approved by order applications by several FHC's including FBOs to trade energy commodities and is considering expanded activities. • More recently, FRB has approved health care services as complementary to health insurance activities.

  4. Physical Commodities Trading • Regulation Y permits BHCs to engage in commodity derivatives activities that do not generally involve taking or making physical delivery of the underlying commodities. • Taking or making physical delivery and the purchase and sell of commodities as an intermediary is “complementary” to the Regulation Y activities. • FHCs must have strong risk management systems to manage the risks arising from physical activities in commodities.

  5. What Kinds of Commodities Activities are Permissible? • Purchase and sell as principal power, natural gas and certain other commodities • Maintain an inventory of commodities • Contract for the transmission of electricity and the transportation and storage of natural gas and other commodities

  6. What are FRB’s Conditions on Physical Trading of Commodities? • Capital based limits - - market value of physical commodities may not exceed 5 percent of the financial holding company’s consolidated Tier 1 capital. • Permissible commodities are those for which the CFTC has authorized derivatives contracts for trading on U.S. futures exchanges or that FRB has otherwise approved. • Not authorized to own, operate or control facilities that extract, process, refine, transport, store or distribute commodities.

  7. Impact of FRB Conditions on Other Financial in Nature Activities • The capital based and CFTC product limits do not apply to activities that are financial in nature under FRB’s regulations and interpretations such as cash settled derivatives, transactions involving the instantaneous transfer of title, certain commodity repos and certain volumetric production payment transactions. • FHCs may make controlling investments in companies engaged in extracting, processing, transporting, etc, commodities under merchant banking authority subject to conditions.

  8. Emerging Commodities Developments • Applications are currently pending before FRB that would expand the kinds of energy related activities that can be conducted as a “complementary” activity. • Energy management agreements • Tolling agreements • FRB approval of additional commodities

  9. What Can Banks Themselves do in The Energy Commodities Area? • OCC interpretations for national banks • Cash settled customer driven derivatives transactions • Instantaneous transfer of title • Physical delivery permitted as hedge • Physically settled transactions otherwise not approved • New York State Banking Department • Cash settled customer derivatives transactions • Physical delivery permitted as hedge • New wild card statute and policy re prior Department approval of commodities and equity products

  10. Health Care as Complementary Activity Wellpoint • WellPoint engages in underwriting and selling health insurance, a financial in nature activity. • FRB has determined that disease management and mail-order pharmacy activities are “complementary” to health insurance. • The complementary activities are subject to limits based on WellPoint’s assets, capital and revenues — 2 percent of consolidated assets, 5 percent of consolidated revenues and assets of the subsidiaries engaged in the activities may not exceed 5 percent of WellPoint’s total capital.

  11. Concluding Observations • “Complementary” authority has emerged as a viable avenue for FHCs to be able to engage in nonfinancial activities that their competitors can more freely conduct. • These activities will be subject to quantitative caps to ensure they stay small in relation to the financial activities to which they are complementary.

  12. Presented by: David R. SahrPartnerWashington, DCP: 202.263.3332dsahr@mayerbrown.com

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