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Fed Proposes Limit on Physical Commodity Activities of Financial Holding Companies
Practical Law Legal Update w-003-6564 (Approx. 3 pages)
Fed Proposes Limit on Physical Commodity Activities of Financial Holding Companies
by Practical Law Finance
| Published on 29 Sep 2016 • USA (National/Federal) |
On September 23, 2016, the Federal Reserve Board proposed a rule that would limit the physical commodity activities of financial holding companies.
On September 23, 2016, the Federal Reserve Board (FRB) proposed a rule that would strengthen existing limitations on the physical commodity activities of financial holding companies. According to the FRB, the proposal is designed to reduce potentially "catastrophic" legal, reputational, and financial risks that physical commodity activities pose to financial holding companies.
Under the Bank Holding Company Act (BHCA), bank holding companies (BHCs) and their subsidiaries were granted authority to engage in certain types of physical commodity activities. In 1999, the Gramm-Leach-Bliley Act (GLB) expanded the activities in which a BHC may engage, and permitted certain BHCs to become financial holding companies, which allows them to conduct a broader range of physical commodity activities.
Under GLB, the FRB has authorized certain financial holding companies to engage in physical commodity trading, energy management services and energy tolling. Additionally, certain financial holding companies were grandfathered under GLB and are therefore permitted to conduct activities related to trading, sale, and investment in commodities that is not otherwise permitted for BHCs.
The proposed rule would:
- Place limitations on physical commodity trading activities conducted by financial holding companies.
- Clarify existing limitations on physical commodity trading activities.
- Amend risk-based capital requirements to more accurately reflect the risks associated with a financial holding company's physical commodity activities. For example, firms would be required to hold additional capital if they are engaged in physical commodity activities that could lead to an environmental disaster.
- Rescind authorization that allows certain financial holding companies to engage in physical commodity activities involving energy management services and energy tolling. Under an energy management agreement, a financial holding company provides transactional, advisory, and administrative services to a power plant owner.
- Remove copper from the list of metals that BHCs are permitted to own and store without limit.
- Establish comprehensive regulatory reporting requirements designed to increase the transparency of physical commodity activities of financial holding companies.
If adopted, the proposed rule would have a limited practical impact since only a small number of firms supervised by the FRB engage in physical commodity trading activities and investments.
However, a few large financial holding companies, such as Goldman Sachs and Morgan Stanley, are grandfathered under a provision in GLB. These firms are therefore permitted to engage in the extraction, transportation, storage, and "alteration" of physical commodities. Under the proposed rules, these grandfathered firms would be required to hold 300% of their physical commodity holdings in risk capital reserves.
The FRB reasons that monetary damages associated with environmental catastrophes involving physical commodities have often exceeded market value of the physical commodity as well as the committed capital and insurance policies of the organization.
The FRB has extended the public comment period for this proposed rule from December 22, 2016 to February 20, 2017.
For details on the regulation of financial holding companies, see Practice Note, Financial Holding Companies: Business Activities and Regulation.