Banking Interpretations

NYSBL 96(1) & 200

New York State Banking Department

To: Deputy Fredsall -FWBD
From: Rosanne Notaro – Legal Division
Date: January 11, 2008
Subject: [---] - NY Branch - Request to engage in activities involving the Issuance of
  Certain Commodity-Linked Notes and Other Debt Obligations


Is there any legal objection to [---], New York Branch (the "Branch") engaging in the commodity-linked note issuance, as described in
[---]’s submission?


We have no legal objection, as we believe the activities constitute legally permitted powers for a New York licensed foreign branch. Your Division should be satisfied with the risk management and other safety and soundness aspects of the proposal.


The Instruments

In its submission, [---] describes the Branch's plan to offer notes, deposits, certificates of deposit, and other debt instruments, and investment agreements (together, the "Instruments"), that are linked to the performance of a single or baskets of commodities, commodity indices or any combination of the foregoing ("Reference Commodities"), and to hedge its market exposures by engaging in hedging activities as described in the submission.

The Instruments will be the New York Branch's general, direct, unconditional, unsecured and unsubordinated contractual obligations, and will rank equally with all other unsecured and unsubordinated obligations of the Branch, except those preferred by law.  The terms of the Instruments will be established on an issue-by-issue basis, but in general, they are expected to have the following features:
  • The Instruments will be denominated in minimum denominations of $250,000.

  • The Instruments will have a maximum maturity of 20 years.

  • The Instruments will not be physically settled.
  • The Instruments will principally be denominated and payable in U.S. dollars and, to the extent that they are denominated in other currencies, such currency will be hedged in dollars.
  • The Instruments will provide for an exposure (on a leveraged or unleveraged basis) to Reference Commodities.
  • The terms of the Instruments may provide for optional redemption by the Branch and/or the holder of the Instrument.
  • The Instruments may provide for mandatory redemption if the level of the Reference Commodity hits a pre-set trigger (which may be below or above the original level at issuance).
  • The Instruments will not be insured or guaranteed by the FDIC or any other U.S. Federal, State, foreign or other governmental entity.
  • The Instruments will be subject to investment risk. Principal of the Instruments may be at risk, but generally a minimum amount of the original principal will be required to be repaid to the investor.

[---] states that currently, the investor base for the Instruments primarily includes institutional investors and other qualified persons, including certain registered investment companies under the Investment Company Act of 1940. The Branch may issue the Instruments directly to the investors, or it may offer and sell the Instruments through placement agents or dealers (each, a "Placement Agent"), including, without limitation, the Branch's registered broker-dealer affiliate, [---] (“Affiliate”) to one or more purchasers. It is expected, however, that if there is a placement agent for an issue, Affiliate will be the sole placement agent for most, if not all, such issues of the Instruments other than deposits (which may be directly placed by the Branch).  There will be no obligation on the part of the Branch, or any affiliate or any placement agent to maintain a secondary market for, or engage in any market making transactions in, the Instruments.


The Branch will hedge its exposure from the Instruments with [---] (i.e. head office) by entering into a mirror note or funding obligation issued by [---]. The Branch will not make or take delivery of any physical commodities, or otherwise buy or sell any Reference Commodities or derivatives thereon as part of any hedging, or the settlement, of any Instruments.

[---]'s head office will enter into over-the-counter derivative financial contracts, such as swaps, forward contracts, and option agreements, or enter into exchange-traded futures and options contracts, relating to such commodities, for the purpose of hedging its exposure to price movements of the underlying commodities. [---] may also from time to time buy or sell such commodities or derivative instruments related to a reference index or components thereof in connection with normal business practices. [---] states that as a general matter, the cash settled commodity derivatives transactions effected by the Branch personnel are carried on the books of [---]'s head office.

Rationale and Other Matters

In its submission, [---] states that a number of the Branch's current customers desire an expanded array of commodity-based solutions, and the Branch desires to expand its financial product alternatives in order to adequately satisfy its customers' needs.

[---] has also addressed supervisory issues such as: internal reviews and approvals; accounting treatment; risk identification, measurement and management systems; and risk management activities.

Legal Analysis

I believe that the legal analysis proffered by [---]'s counsel in the submission, concerning the permissibility of the proposed activities, is correct.
To restate and summarize that analysis, the legal banking powers of the Branch are determined by both New York state and federal banking law. Under federal law, the International Banking Act ("IBA") provides that a state branch or state agency may not engage in any type of activity that is not permissible for a federal branch (unless the Federal Reserve Board (or the FDIC, in the case of an insured branch) has determined that such activity is safe and sound). (See 12 USC 3105(h)).
Under New York law, the Banking Department generally interprets the powers of a state-licensed branch of a foreign bank to be the same as those that can be exercised by a New York chartered commercial bank. Among the enumerated powers of New York commercial banks is the power to "borrow money and secure such borrowings by pledging assets", ... "receive deposits of moneys...upon such terms as the bank... shall prescribe”, and "exercise all such incidental powers as shall be necessary to carry on the business of banking…". (See NYBL 96(1)) The Branch's proposed issuance of the Instruments is within the specific authority granted by NYBL section 96 to borrow money and receive deposits. The Banking Department has previously opined that it is within the power of New York state-chartered commercial banks to make loans and take deposits linked to commodity prices and other indices, and to hedge such liabilities in the financial markets.1

The OCC has also found it to be within the power of a national bank to take deposits and issue notes linked to commodities, and federal courts have upheld the power of banks to deal in non-traditional deposit products.2 As pointed out by [---], the OCC has frequently approved commodities-related activities that are cash-settled and that do not involve a bank taking a speculative position in the commodities market.3

The IBA grants the same rights and privileges to federally-licensed foreign bank branches as are granted to national banks. (12 USC 3102(b)).  Accordingly, the commodity-linked derivative activities that have been permitted as a legal matter for national banks would also be permissible for federal branches.  Therefore, I know of no additional limitations that would be imposed by federal banking law on the Branch's proposed commodity-linked instrument activities. Accordingly, I would raise no objection on legal grounds to the proposed activities, if the FWB Division is satisfied that [---] can conduct the activities safely.

In accordance with the AEM 2006-10, if the FWB Division plans to send a letter to [---] approving the proposed activities, the proposed letter should be approved through the round robin process.

1  See Letter from Rosanne Notaro dated Jan 12, 2005; Letter from Sara Kelsey to Marcia Wallace, dated April 25, 2003 (citing November 14, 1988 Letter from David Halvorson to Anthony J. Horan). See also Letter from Sara Kelsey to Michael Wiseman, dated Oct. 5, 2005; Letter from Sara Kelsey dated December 24, 2004.

2 See NationsBank of North Carolina v. Variable Annuity Life Insurance Co., 513 U.S. 251 (1995); OCC Interpretive Letter No. 937 (June 27, 2002) (stating that OCC has allowed national banks to "issue debt instruments having terms related to commodity prices" "in order to assist customers of the Bank in managing their financial exposures"); OCC Letter No. 632 (June 30, 1993) (same). (as cited in [---]'s Nov. 13, 2006 submission).

3 See, e.g. OCC Interpretive Letter No. 1040 (Sept. 15, 2005); OCC Interpretive Letter No. 1019 (Feb. 10, 2005); OCC Interpretive Letter No. 937 (June 27, 2002).