Banking Interpretations

NYBL 96(1)
NYBL 200

New York State Banking Department
Memorandum

To: Deputy Stone -Foreign and Wholesale Banks Division
From: Rosanne Notaro - Legal Division
Date:

August 17, 2010
Subject: [---] - New York Branch Proposal to act as agent in marketing commodity finance
 

product for London Branch

Issue

Whether there is any legal objection to the proposed activities of the New York Branch ("NY Branch") of [---](the "Bank"), in marketing a commodity financing product to U.S. clients on behalf the Bank's London Branch.

Recommendation:

No, provided that the Foreign and Wholesale Banks Division is satisfied from a supervisory perspective.

Background:

The Bank has a commodity financing program known as [---] in its London Branch. It operates as follows: Commodity inventories are bought from the client based on a discounted forward futures price and either (i) sold back to the client at the prevailing market price at the time; or (ii) delivered to the exchange. The forward price is discounted for the cost of carrying the commodity (e.g. funding cost (i.e. interest), storage cost, insurance premium, etc.) such that the client finances the inventory and is responsible for all associated costs of the inventory. The purchase price is hedged by the London Branch by selling (physically settled) futures.1 The client will have the right but not the obligation to buy back the commodities at any time and any quantity during the agreed upon tenor at the prevailing market price. Any price difference between the initial purchase and sales price is equally offset by the futures hedge. In the event the client abandons his right to repurchase, the London Branch can deliver the commodity against its short position and retrieve full outstanding funds (i.e. substitute the risk of client with the risk of the futures exchange). The transaction tenors are short term, typically ranging from 30 to 60 days and do not exceed one year. The revenues are through the embedded funding costs plus a spread and not through trading positions.

The Bank's proposal is for its NY Branch to market this product to U.S. clients on behalf of the London Branch. The NY Branch would verbally execute transactions with U.S. clients on behalf of the London Branch within certain pre-determined parameters set by the London’s Branch.  NY Branch personnel would also relay the London Branch's hedges to [---] for the account of the London Branch. The NY Branch has a client presentation that describes SIP. According to Bank's May 14, 2010 proposal submitted to the Department (attached), the NY Branch presentation makes explicit the fact that the client would face the Bank's London Branch in any resulting transaction, and that the NY Branch's role is solely as liaison. Additionally, each trade confirmation lists the London Branch as the contractual party and is signed by the London Branch. The transactions and hedges are booked in the London Branch.

Reasoning:

The proposal appears to involve a relatively simple analysis from the Legal Division's perspective. The financing transactions are being engaged in by the London Branch, and booked in London, as are the related hedging transactions. Accordingly, the issue of whether the subject financing transactions would be permitted if conducted by and booked in the NY Branch does not arise. (Note: it is not entirely clear that the transactions would be permitted for a US bank or for the NY branch of a foreign bank. Although the transactions are clearly designed as financing transactions -obviously a banking activity ---the financing is accomplished by the bank itself purchasing and reselling the commodity. To my knowledge, there have not been regulatory interpretive letters permitting such commodity reverse repurchase finance transactions by banking institutions in the U.S. -the issue presumably being the legal permissibility of the bank owning title to the commodity. There have been prior approvals for a type of financing that is similar in certain respects --known as volumetric production payment financing -­whereby a bank provides financing to a producer and receives a limited royalty interest in the producer's lease of, for example, a hydrocarbon reserve).

In the instant case, the NY Branch proposes only to act as agent. I note that in its submission, the Bank occasionally describes the NY Branch's role as "representational". However, I believe the Department should view the NY Branch's role as going beyond "representational" functions, inasmuch as the NY Branch personnel will be executing transactions on behalf of London (e.g. negotiating with clients, signing documentation, etc., albeit pursuant to pre-determined parameters set by London).

The Banking Department has previously recognized that a NY office of a foreign bank may act as agent in marketing and/or trading bank products for a foreign office, even if such products might not be permissible for the NY office to trade or book for its own account.2  However, even where the NY office is acting only as agent, the Department recognizes that it has an interest in ensuring that such activities will be conducted in a safe and sound manner. To that end, it is recommended that the Foreign and Wholesale Banks Division review, at a minimum: (1) the service level agreement between the New York office and the foreign office; (2) sample transactional/customer deal documentation; and (3) the Bank's description of risk management procedures for the activities, including policies and procedures.

Such information should be reviewed with a view to determining: (i) whether it is clear from the customer's perspective that the NY office is acting only as agent; (ii) whether it is clear that the NY office has limited discretion in conducting the activities, and where decision-making concerning products, trades, position limits, etc. resides; (iii) whether the activities will be prudently managed and conducted in a safe and sound manner, and the roles of personnel at the New York office versus the London office in managing them; and (iv) whether the NY office is engaging in activities indirectly that it might not be permitted to engage in directly and in effect booking such activities offshore.

The Bank in its submission provided descriptions about how it would conduct the activity with appropriate controls and how it would address various risks associated with the proposed activities. I will not restate all of the points in detail that were made by the Bank, as the Foreign and Wholesale Banks Division should review these descriptions (in the Bank's submission attached) and be satisfied that the Division's concerns from a supervisory standpoint are addressed, or, if not, request additional information. The Bank addressed, among other areas, counterparty risk, market risk, liquidity risk operational risk, reputational risk, financial risk, suitability,  BSA/AML/KYC, and monitoring and reporting.

R.N.

  1. The futures position is booked with [---] for the account of the London Branch.
  2. See, e.g. memorandum dated August 15, 2008 from Rosanne Notaro to Examiner Nosikovsky, concerning a NY branch of a foreign bank trading property derivatives on behalf of a foreign branch.