One of the remaining significant issues facing the Board of Governors of the Federal Reserve System (Board) is its Notice of Proposed Rulemaking (Proposed Rule) relating to the physical commodities activities of U.S. and non-U.S. financial holding companies (FHCs). The public comment period for the Proposed Rule closed in February 2017, and like the Board’s 2014 Advanced Notice of Proposed Rulemaking (ANPR), the Proposed Rule drew comments from a diverse group of parties, including members of Congress, academics, interest groups, the banking industry, and end-users of commodities and commodity-based derivatives. Commentary: Key Points 44 end-users, comprising individual businesses, municipal end-users, and related trade groups and associations, reacted to the Proposed Rule with concern, citing issues including risk mitigation, market liquidity, transaction costs, and counterparty credit risk. Proponents, comprised of interest groups, academics and certain U.S. Senators, filed 11 submissions. They echoed the Board’s concern over perceived environmental risks and, in addition, noted the importance of restricting the potential for market manipulation. The comments filed by participants in the commodities markets show serious concerns with the Board’s approach to the Proposed Rule and disbelief that the costs of the regulation will be outweighed by market benefits. Market participants argued that the Board failed to connect the proposed restrictions on commodities activities to the Board’s perceived risks, and that the Board did not sufficiently acknowledge the tangible commercial benefits that FHCs provide to U.S. counterparties. Market participants further contended that existing laws and regulations adequately constrain potential adverse effects. In particular, the commercial end-user community expressed strong concerns with the limitations that the Board proposed. 24 comment letters were filed by end-users and municipal end-users of commodities and commodities-based derivatives, and their related associations and industry groups, including a letter from the National Association of Corporate Treasurers, on to which 18 additional end-users signed. These comment letters generally expressed a strong preference to transact with sophisticated, well-capitalized, and well-regulated FHC counterparties, as well as fear that FHCs will continue to exit commodities markets. Background The current legal authority for FHCs to engage in physical commodities activities is derived from several provisions of the Gramm-Leach-Bliley Act of 1999 (GLB Act), which amended the U.S. Bank Holding Company Act of 1956 (BHC Act) to expand the permissible business activities of bank holding companies. The GLB Act permitted expanded financial activities to be carried out by a subset of bank holding companies – those whose insured depository institution subsidiaries met heightened capital and management standards and had “satisfactory” or better ratings under the U.S. Community Reinvestment Act. This subset of bank holding companies could elect “financial holding company” status; under a new section of the BHC Act, Section 4(k), FHCs could engage not only in the “closely related to banking” activities that had been permissible for all bank holding companies, but also activities that were “financial in nature” and “incidental to a financial activity,” and, on receiving a specific Federal Reserve approval, activities “complementary” to a financial activity as well. Under Section 4(k)’s complementary authority, the Federal Reserve was required to find that the activity did not pose “a substantial risk to the safety or soundness of depository institutions or the financial system generally,” and that the public benefits from the activity outweighed any adverse effects. In addition to Section 4(k), the GLB Act added a new Section 4(o) to the BHC Act. Section 4(o) provided that a company that was not a bank holding company when the GLB Act was enacted but that became an FHC after November 12, 1999, could “continue to engage in, or directly or indirectly own or control shares of a company engaged in, activities related to the trading, sale, or investment in commodities and underlying physical properties that were not permissible for bank holding companies to conduct in the United States as of September 30, 1997, if . . . the holding company, or any subsidiary of the holding company, lawfully was engaged, directly or indirectly, in any of such activities as of September 30, 1997, in the United States.” In 2003, the Federal Reserve made its first interpretation under Section 4(k)’s complementary authority, and determined that certain physical commodities activities were “complementary” to financial activities and thus permissible for FHCs. It did so in permitting Citigroup to retain its subsidiary Phibro, which had been a subsidiary of Travelers Group before the Citigroup-Travelers merger. Following the Citigroup approval, a number of other domestic and foreign FHCs received approval to engage in physical commodities trading activities. In other orders, the Board declared energy tolling and energy management activities to be complementary to financial activities. During the 2008 Financial Crisis, Morgan Stanley and Goldman Sachs became FHCs and subject to Board supervision and regulation. Both companies had been engaged in physical commodities activities in 1997 and therefore came under the legal authority contained in Section 4(o) of the BHC Act. For more information on the legal authorities that permit FHCs to engage in commodities-related activities, please see Appendix B. The ANPR In July 2013, the Board surprised most observers by announcing that it was re-evaluating its determination that physical commodities activities were complementary to financial activities. Commodities activities had not been identified as contributing to the Financial Crisis, and Congress had specifically excluded spot commodities from the Volcker Rule’s proprietary trading prohibition, thus indicating a degree of comfort with the risks posed by commodities trading. In January 2014, the Board issued its ANPR, requesting public comment with respect to three specific GLB Act authorities relevant to physical commodities activities: Section 4(k)’s complementary authority, Section 4(k)’s merchant banking authority, and The grandfather authority contained in Section 4(o) of the BHC Act. The ANPR also posed twenty-four questions that fall into the following three categories: Whether commodity-related activities by FHCs pose unacceptable systemic risk; What other costs and benefits are created by FHC engagement in commodity-related activities; and What other regulation of FHC activities in this area is necessary. Our Client Alert summarizing the ANPR and public comment is available here. The Proposed Rule On September 8, 2016, the Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued a study required by Section 620 of the Dodd-Frank Act (Section 620 Study). In it, the Board recommended that Congress repeal both Section 4(k)’s merchant banking authority and Section 4(o)’s grandfather provision. A little over two weeks later, the Board issued the Proposed Rule, premised on concerns over environmental risks such activities could pose. Notably, the Board did not address allegations of market manipulation as a reason for the Proposed Rule. Seen largely as a “de-risking” mechanism, the Proposed Rule was issued notwithstanding that many FHCs, for business reasons, have actively reduced commodity-related activities. The Proposed Rule would restrict FHC commodities activities in several ways: It would tighten the conditions for finding certain commodity activities to be “complementary” to a financial activity – most notably, by counting the value of commodities held in bank subsidiaries towards the 5 percent of Tier 1 capital limit; It would impose a 300% risk weighting on certain physical commodities held under Section 4(k) authority, and a 1,250% risk weighting on certain commodities and related assets held under Section 4(o) and the merchant banking authority; It would rescind the findings underlying the Federal Reserve orders that permitted certain FHCs to engage in energy tolling and energy management services; It would revise Regulation Y to provide that the owning and storing of copper is not an activity closely related to banking, which would remove the ability of bank holding companies to own and store copper absent a Section 4(k) complementary determination, which would be available only to FHCs; and It would impose new public reporting requirements in the form of a new Schedule HC-W, Physical Commodities and Related Activities, which would collect more specific information on the covered physical commodities holdings and activities of FHCs. In particular, the Proposed Rule’s increased risk-weights would apply to commodities defined: As a “hazardous substance” under section 104 of the Comprehensive Environmental Response, Compensation, and Liability Act (42 U.S.C. 9601) and interpreting regulations; As “oil” under section 1001 of the Oil Pollution Act of 1990 (33 U.S.C. 2701) or section 311 of the Clean Water Act (33 U.S.C. 1321) and interpreting regulations; As a “hazardous air pollutant” under section 112 of the Clean Air Act (42 U.S.C. 7412) and interpreting regulations; or In a state statute, or regulation promulgated thereunder, that makes a party other than a governmental entity or fund responsible for removal or remediation efforts related to the unauthorized release of the substance or for costs incurred as a result of the unauthorized release; provided that the Board-regulated institution owned the commodity in the state that promulgated the law imposing such liability during the last reporting period. Comments on the Proposed Rule were originally due on December 22, 2016, but the Board agreed to extend the comment period through February 20, 2017. Scope of Comments to the Proposed Rule As of the close of business on April 26, 2017, the Board had posted 43 unique comment letters on its website. We have categorized commenters based on the following: End-Users 27 end-user companies submitted their own letter or joined a trade association letter; 8 municipal utility districts submitted their own or joint letters; 8 end-user trade associations submitted their own or joint letters; and 1 private equity firm with end-user operating companies submitted its own letter. Financial Holding Companies 1 FHC submitted a letter; 9 trade associations from the financial services industry submitted their own or joint letters; and 2 other financial companies submitted their own letters. Others 4 U.S. Senators and Representatives submitted their own or joint letters; 6 academics submitted their own or joint letters; and 9 interest groups submitted their own or joint letters. We summarize below the key points made by end-users, banks, and their trade associations as well as the arguments raised by certain U.S. Senators, interest groups, and academics. For a list of commenters and a breakdown of certain key points raised in the comment letters, please see Appendix A. Comments to the Proposed Rule: Key Points The end-user community focused on how the proposed rule could impact commodities markets. They fear that the proposed rule could cause additional FHCs to exit commodities markets and identified the following concerns: End-users could be denied the ability to trade with the counterparties of their choosing. FHCs are market-makers and necessary counterparties that provide economies of scale, creditworthiness, and sophistication, which in turn provide affordable financing, risk mitigation, and other business solutions for end-user businesses. Non-bank financial institutions lack the institutional knowledge, capital, creditworthiness, transparency, and regulatory oversight necessary to serve as market makers and price commodities-related products as efficiently. With a departure of additional FHCs, the commodities markets generally would suffer from diminished liquidity and greater risk concentration. There would be fewer counterparties with the ability to enter into long-term transactions and to offer a range of financial solutions, as certain products essential to end-user operations were generally not available from non-FHCs; as a result, costs for end-user businesses and consumers would increase. Comments from an FHC commenter and industry trade groups made the following principal contentions: FHCs provide substantial benefits to consumers, commodity producers, investors, financial markets, and the broader economy by their participation in physical commodities markets and making merchant banking investments. FHC physical commodity activities are already subject to extensive regulation by the Federal Reserve and other government agencies, and Basel III has imposed additional capital requirements for certain of these activities. Risks identified by the Board as justification for additional capital levies may already be captured under current regulatory requirements, such as requirements for FHCs to account for the credit risk of subsidiaries. Section 4(o) authority is an explicit recognition by Congress of the importance of the expertise and risk management provided by grandfathered companies in the physical commodity markets. The Proposed Rule undermines this statutory grant and is a direct contradiction of the authority outlined in the GLB Act. Such fundamental changes are contrary to well-recognized limits to administrative powers and, as suggested by the Board in its Section 620 Study, are solely within the purview of Congress. Before imposing punitive risk-weights, the Board should conduct in-depth empirical and qualitative studies to assess the potential effects that increased capital requirements and the related departure of FHCs would have on the physical commodities markets. The environmental risks cited by the Board are exaggerated and speculative. In addition to the Board’s failure to point to a material environmental liability borne by an FHC since the inception of the GLB Act, generally accepted principles of corporate separateness prevent enterprise-wide liability of FHCs. Moreover, the parties legally responsible for environmental liabilities are often the facility owners and operators, not the underlying commodity owners. The lack of empirical data supporting the Proposed Rule and acknowledgment of its failure to consider unforeseen consequences warrants further caution. The Board should present data to support its claim that additional capital requirements improve the safety and soundness of FHCs and the U.S. financial markets. Additionally, the Board should also consider the public benefits FHCs provide to the physical commodity markets and the potential downsides to their departure from such markets. Several U.S. Senators, interest groups like Public Citizen, Amazon Watch, and Americans for Financial Reform, and certain academics supported the Proposed Rule, making the following principal arguments: Physical commodities activities present risks that are wide-ranging and whose severity is unpredictable, therefore justifying new limitations and capital requirements. The Federal Reserve should narrowly construe the authority contained in Section 4(o) to pre-GLB Act activities due to the risks posed by commodities activities. The Board had interpreted Section 4(k)’s “complementary” authority in an expanded manner that did not accord with congressional intent. Additional disclosures of FHC commodities activities were required for the Federal Reserve to regulate such activities adequately. There have been and will continue to be conflicts of interest in the commodities markets when FHCs are allowed both to own physical commodities and trade their financial equivalents. Potentially adverse effects on the commodities markets are not outweighed by the benefits of reducing risk to particular FHCs and to the financial system generally. Comments to the Proposed Rule: Key Themes and Contentions The debate over the appropriate extent of bank commodities activities in the comment letters shows four principal issues at play: Conflicting Viewpoints: Market Participants vs. Interest Groups and Academics There was a clear delineation in the views of market participants, on the one hand, and representatives of interest groups and academia, on the other. Outnumbering all other commenters nearly [three-to-one], end-users of physical commodities, including municipal end-users, noted their reliance on FHCs as counterparties to finance their businesses and engage in risk mitigation. End-users expressed concern that the Proposed Rule could force more FHCs out of the commodities markets, which they argued could lead to (1) decreased market liquidity, (2) increased counterparty risk, (3) increased transaction costs, (4) decreased counterparty sophistication, and (5) greater price volatility. In contrast, academics, several U.S. Senators, and various interest groups contended that the Proposed Rule should be strengthened in various ways in light of the risks that they claimed financial institutions pose to the commodity markets and the U.S. economy. Suggested changes to the Proposed Rule included: (1) reinterpreting and limiting Section 4(o) authority to restrict permissible activities to pre-GLB Act activities; (2) expanding the scope of commodities covered by the key provisions of the Proposed Rule (copper and aluminum, agricultural commodities, electricity); (3) increasing FHC commodities disclosure requirements (such as by requiring FHCs to provide narrative disclosures detailing how their operations and assets related to physical commodities are interdependent); and (4) redefining merchant banking authority (removing FHCs from business strategy formulation, decisionmaking, and employee overlap with boards of portfolio companies). Authority: Congress vs. the Board Relatedly, many commenters were divided on the scope of Section 4(o) authority and the Board’s authority to interpret it. As to the first issue, academics, interest group representatives, and several U.S. Senators suggested that the rulemaking should limit Section 4(o) activities to the actual activities in which the FHCs were engaged at the time that Section 4(o) was passed. Those concerned with the Proposed Rule noted that since Section 4(o) was enacted, there has been a steady decline in the number of FHC-eligible Section 4(o) institutions participating in physical commodity markets, and therefore that additional limitations on this provision could have economically adverse effects. Commenters also were divided on the question of the appropriate scope of Board rulemaking authority. Those advocating for Board restrictions on the extent of Sections 4(k) and 4(o) argued that it was within the Board’s power, as it was when issuing its original interpretations, to reinterpret the scope of such authorities, particularly in light of the environmental, market, and financial risks alleged. End-users, financial institutions, and trade associations countered that although the Board has the authority to issue capital standards as a general matter, the use of punitive risk weightings, which would make certain physical commodity activities economically unviable, amounted to agency legislation, and ignored the fact that Congress explicitly authorized additional financial activities without revising the attendant capital rules. Public Benefits: Healthy Markets vs. Systemic Effects Commenters also disagreed on whether perceived benefits to commodities markets or the broader financial system should be the priority in the Board’s analysis. End-users and financial entities urged the Board to focus on the “real-world” implications that the Proposed Rule would have on U.S. businesses and the physical commodity markets. Central to their concern was the apparent lack of consideration in the ANPR and Proposed Rule in estimating the economic effects of additional FHC departures, as well as a failure to consider the entities that would replace FHCs as market makers and counterparties. Similarly, Congressman Bradley Byrne of Alabama cautioned that the Board should postpone rulemaking until adequate consideration is given to “the potential adverse impact upon costs to the American public, the reduction in competition, the loss of markets, and the potential for fewer creditworthy and highly regulated bank counterparties with whom end-users may transact.” Academics, interest group representatives, and certain U.S. Senators noted potential risks that FHCs pose to the market, and that the benefits considered by the Board should focus on overall market stability. Proponents cited past instances of manipulation in energy and aluminum markets and the potential for future abuses; however, the Board did not discuss, nor did it advance, past instances of market manipulation as a justification for the Proposed Rule. Interestingly, Novelis, Inc., a major producer of aluminum, noted the substantial benefits that FHCs provide to its business. Subscribing to the belief of general de-risking and separation of commercial and investment banking, proponents urged the Board to consider the overall health of the U.S. financial system over the effects of FHC departures. Liability: Environmental Risks vs. Principles of Corporate Separateness Although the Board premised much of the Proposed Rule on the existence of serious environmental risks, there was a substantial debate in the public comments over the factual basis of the Board’s claims. Opponents of the Proposed Rule noted the Board’s lack of substantive discussion on the extent of environmental risks posed by FHC commodity activities. They argued that, historically, FHC physical commodity activities have been conducted safely, without a major environmental incident since the inception of Section 4(k) and Section 4(o) authority. In addition, they contended that such speculative risks are already captured by capital requirements mandating that FHCs account for the credit risk of their subsidiaries, arguing that the larger capital reserves FHCs maintain to address institutional credit risk guard against environmental risks at the subsidiary level. Opponents further cited studies on legal principles of corporate separateness, which they stated demonstrated that most courts were not willing to pierce the corporate veil by reason of an environmental disaster alone. Like the Board, supporters of the Proposed Rule focused on environmental disasters, albeit disconnected to FHC activity, like the Deepwater Horizon disaster, as evidence of the potential for massive environmental liabilities; however, and also like the Board, they did not identify actual examples of material FHC liability stemming from physical commodity activities to date. Instead, they referred to the specific holdings of large FHCs, and cited disasters in related activities, such as oil exploration and energy projects, in contending that such holdings pose unacceptable risks that should be divorced from banking activities. Conclusion Because many FHCs have retreated from the commodity markets since the Financial Crisis for other reasons, the concerns of market participants that further limitations on FHC activities will adversely affect their businesses and their customers—concerns expressed by numerous such participants during the comment period—appear justified. When weighed against the lack of concrete evidence of widespread veil piercing in environmental cases, these concerns justify a cautious approach in restricting commodity authority, particularly in the absence of congressional action. Appendix A: Summary of Key Points Raised by Commenters Commenter Type of Entity Key Points Raised in Comment Letter 1. Alon USA Energy, Inc. End-User Alon is an independent refinery owner and marketer of petroleum products in the United States that transacts with FHCs to hedge against normal and expected price volatilities. Relies on FHCs to timely access physical commodity markets to hedge against price volatilities and maintain stable funding. FHCs allow Alon to use excess inventory as collateral to hedge long- and short-term inventory needs. FHCs further serve to bring better convergence between financial and physical assets which Alon uses to mitigate risks. Concerned that the departure of FHCs would force Alon to transact with counterparties in markets in which they do not operate. 2. Barrick Gold End-User Barrick is the largest gold-mining company in the world and a significant miner of copper. Argues that the Board has not and cannot demonstrate that the metals market poses a sufficient risk to warrant the proposed changes. It maintains that the proposal should be rescinded, but that if it is not, it should at least be modified so as to not cover the metals market. Concerned that risks to BHCs from metals activities are not substantial and that the oil and gas incidents that the Board cites are clearly distinguishable from any risks faced in the metals markets. Explains that there is no risk posed by metals since copper or precious metals are not released into the environment, mining activities are subject to rigorous safety and environmental controls and financial assurance requirements, mere owners of commodities are generally outside the scope of liability of environmental statues, and courts are very unlikely to pierce the corporate veil. Proposes the following revisions: excluding metals from the definition of “covered physical commodity”; reclassifying copper under the “closely related” authority only to the extent that it is in a form primarily suited for industrial or commercial use; and excluding non-covered physical commodities from the tighter Section 4(k) cap on assets held under the complementary authority (otherwise, this risks the possibility that FHCs will exit the metals market). 3. Calpine Corporation End-User Calpine is the largest generator of electricity from natural gas and geothermal resources in the U.S. Opposes the rulemaking because it will hinder its ability to engage in risk-mitigation and could result in it having access to fewer credit-worthy counterparties. 4. Cheniere Energy, Inc. End-User Cheniere is involved in the development and operations of liquefied natural gas terminals and transacts in the physical commodities markets to manage its risks. Argues that the Board’s analysis of the impact of the Proposed Rule is inconsistent with Cheniere’s experience in these markets. Contests the Board’s assumption that FHCs only consist of 1% of the physical commodity markets and notes that companies like Cheniere transact with FHCs on a daily and monthly basis to address funding needs and mitigate risks. Concerned that increased regulation will cause FHCs to leave the markets. Notes that they rely on FHCs to serve as market makers and facilitate liquid markets. By contrast, commercial companies transact only to meet their acute needs. 5. Cogentrix Energy Power Management, LLC End-User Cogentrix is a manager and operator of power generation facilities across the U.S. Concerned that the new rules will make it more difficult and expensive for it to achieve risk-mitigation through the use of commodity-related derivatives, will restrict competition and innovation, and will reduce market liquidity and result in higher prices for commodities and commodity-related production. Argues that this will ultimately result in higher prices for consumers. 6. Delek US Holdings, Inc. End-User Delek is a diversified downstream energy company with operations in two primary business segments: petroleum refining and logistics. Notes that FHCs provide liquidity, offer customized solutions to meet its business needs, and provide important risk-mitigation opportunities. Also asserts that it prefers to transact with financially sound and well-regulated counterparties such as FHCs. Economies of scale allow Delek to quickly sell and source inventory at market prices to FHCs to eliminate backlog and excess inventory. Notes that arrangements like these eliminate the need for complex financing facilities and reduce exposures to price volatility given the short periods of ownership. FHCs allow access to lower crude oil prices even when Delek’s refinery does not have capacity, since FHCs will continue purchasing at advantageous prices and store the crude oil for Delek until Delek’s refinery has capacity for the oil. 7. Novelis Inc. End-User Novelis is the world’s leading aluminum rolled products producer. It produces aluminum sheet and light gauge products primarily for use in the beverage can, automotive, specialties (including transportation, consumer electronics, and architecture), and foil markets. Depends on FHCs to shift the metal price risk associated with aluminum to creditworthy third parties. Argues that having multiple FHCs that participate in the aluminum futures market available to Novelis has helped keep hedging transactions costs relatively low and stable and given manufacturers in the aluminum industry improved liquidity. Notes that FHCs also allow Novelis to manage operational and business risks by engaging in repo transactions with excess inventory, acting as intermediaries between Novelis and related businesses, and carrying inventory on consignment. Concerned with the Proposed Rule because it will (1) reduce market liquidity, (2) increase costs and ultimately its costs to consumers, (3) increase price divergence, and (4) increase counterparty risks. 8. Philadelphia Energy Solutions LLC End-User Philadelphia Energy Solutions LLC owns and operates a merchant fuel refinery (gasoline, ultra-low sulfur diesel, etc.). Argues that risk-mitigating derivatives make the commodity markets more stable and that increased capital requirements will make hedging risks more expensive and less effective. Notes that many FHCs have already scaled back their physical commodity activities. Relies on expansive market knowledge of FHCs to tailor products to meet its needs. Asserts that high-risk weighting should be reserved for “the riskiest of bank exposures” and that physical commodities do not qualify. 9. Black Belt Energy Gas District Municipal End-User Black Belt is a public corporation formed by three member municipalities in Alabama. It is a joint action gas supply agency that provides wholesale sales service to municipal gas systems both within and outside the State of Alabama. Black Belt also provides natural gas management services for certain large industrial customers. Argues that FHCs assist municipal end-users in financing and purchasing natural gas via long-term pre-paid purchase transactions. By closing such a transaction with an FHC in 2016, more than 150 cities and towns spread across several southern states will have stable energy prices for the next 30 years. Further notes that given the nature of their business and transactions, FHCs are creditworthy counterparties that are necessary for small municipalities in securing long-term, stable natural gas prices. 10. Central Plains Energy Project Municipal End-User CPEP is a joint action gas supply agency that provides wholesale sales service to its members and other municipal natural gas distribution systems in the states of Nebraska, Iowa, and South Dakota. Relies on prepayment transactions to meet the domestic and commercial needs of its customers. Notes that the natural gas energy markets are primarily supported by FHCs and that their departure from this market would be hard to replicate with non-bank companies. Argues that the departure of FHCs from the physical natural gas marketplace would be highly adverse to the interests of municipal gas systems and gas consumers, while serving no countervailing public purpose. 11. City of Rocky Mount, North Carolina, Richard H. Worsinger Municipal End-User As a community-owned electric and natural gas system, the goal of Energy Resources is to provide safe, efficient, and reliable electric and natural gas services to all customers. Argues that if FHCs stop participating in long-term municipal gas supply transactions, this will cause an increase in gas prices for its customers. Transactions with FHCs lead to discounted gas for its customers, and its customers have come to depend upon lower gas prices. 12. Clarke-Mobile Counties Gas District Municipal End-User CMC is a public corporation formed by three member municipalities in Alabama. It is a municipal gas transmission and distribution system that provides natural gas transportation and sales service to retail gas customers in an eight-county area in southwestern Alabama. CMC also provides wholesale natural gas sales service to other municipal gas systems and their joint action agencies that it purchases in gas prepayment transactions. Relies on natural gas prepayments to serve Alabama counties. Notes that FHCs play a critical role in providing stable and affordable supplies of natural gas. For example, the use of prepayment transactions in 2016 are now serving gas consumers in Alabama, Louisiana, Florida, Georgia, Tennessee, and Kentucky. Concerned that the potential departure of FHCs would be replaced with less-liquid, less-capitalized, and less-efficient counterparties. As a result, transaction costs would likely increase and it would not be able to provide services at their current rates. 13. Greenville Utilities Commission Municipal End-User Electric utility company in Greenville, NC. Critical of the proposed requirements as increasing the likelihood that FHCs will be driven out of the commodities markets, which will result in a decrease in natural gas supply and an increase in natural gas prices. 14. Public Utility District No. 1 of Chelan County, Washington Municipal End-User Consumer-owned electric utility that generates electricity and transacts in power markets. Manages power needs, volatility, and exposure to price and volumetric risks by selling and buying wholesale power using short-, mid-, and long-term contracts. Cautions against new rulemaking because market access could become more difficult, more expensive, and less efficient without FHC participation. Argues that reduced FHC participation will ultimately increase the cost and difficulty for end-users to serve customers. 15. Tennessee Energy Acquisition Corporation Municipal End-User Tennessee Energy is an instrumentality of the State of Tennessee and certain Tennessee municipalities. It is a joint action natural gas supply agency that provides wholesale sales service to municipal gas distribution systems and to other joint action agencies within and outside the State of Tennessee. Tennessee Energy also provides natural gas supply, transportation, and storage management services for other municipal gas systems and joint action agencies, and supplies price-hedging services for its associated municipalities and others to whom it sells long-term gas supplies as part of its sales service to them. Relies on gas prepayment transactions (prepaid long-term natural gas contracts) which are offered by FHCs. States that FHCs’ role in this regard could not and would not be replicated by other industry participants. Concerned that the Proposed Rule will force FHCs out of the natural gas marketplace by making it more expensive for them to participate. Argues that this will result in the increase of natural gas prepayments and hedging services for Tennessee Energy, which would then increases costs for its customers. Suggests that FHCs are the most creditworthy counterparties with which they deal, and that they are more efficient and operate in a regulated environment. Notes that the fear of environmental catastrophe is completely misplaced in the natural gas industry. 16. Town of Slaughter, Louisiana Municipal End-User Member of the Louisiana Municipal Gas Authority. FHC involvement in commodities activities provides their residents and retail and industrial consumers with affordable energy products. Argues that their Town has come to rely on FHC involvement and the economic savings involved. 17. American Public Gas Association End-User Trade Association APGA is the national association for publicly owned, not-for-profit natural gas distribution systems, comprising over 700 public gas systems. Increased capital requirements threaten APGA members’ reliance on natural gas prepayment transactions—using swaps transactions and tax-exempt financing for the long-term purchase of natural gas—to provide affordable energy solutions. 18. American Wind Energy Association End-UserTrade Association Trade association for a range of entities interested in encouraging the expansion of wind energy in the U.S. Notes wind industry reliance on FHC merchant banking authority investments to bring projects from development and construction into operation. In 2015, over $14.7 billion was invested in new wind energy projects in the U.S. This included $5.9 billion from tax equity providers, including under the merchant banking authority. Concerned that some of the restrictions being considered by the Federal Reserve would unnecessarily limit or eliminate the ability of banking entities to help finance wind generation. Relies on FHCs to transact in stable, low-risk investment for long-term contracts to purchase their power at a set price. Argues that this enables wind industry companies to reinvest money into growth rather than hedge against energy price fluctuations. 19. Edison Electric Institute and the National Rural Electric Cooperative Association End-User Trade Associations Joint letter from the Edison Electric Institute (“EEI”) and the National Rural Electric Cooperative Association (“NRECA”). EEI is the association of U.S. shareholder-owned electric companies. EEI’s members comprise approximately 70% of the U.S. electric power industry, provide electricity for 220 million Americans, operate in all 50 states and the District of Columbia, and directly employ more than 500,000 workers. NRECA is the national service organization for more than 900 not-for-profit rural electric utilities that provide electric energy to more than 42 million people in 47 states or 12% of electric customers. Relies on banking entities and their affiliates as counterparties to customized energy commodity forward contracts and commodity trade options that can be physically settled to hedge and mitigate their commercial risks. Concerned that the proposed changes will make risk management more difficult and more expensive by disincentivizing banking entities from engaging in hedging transactions. Concerned that substantial increase in the regulatory capital requirements for FHCs’ holdings of certain commodities will have indirect cascading effects on the wholesale physical electric markets. 20. National Association of Corporate Treasurers, et al. End-User Trade Association NACT represents companies and trade associations (like its 18 co-signatories) that are end-users of physical commodities and commodity-related derivatives. Expresses concern that increased capital requirements would fuel the departure of FHCs from the commodities markets. Notes that FHCs provide affordable, well-tailored products and that non-bank financial replacements would likely be unable to address specific end-user needs. Notes that emerging and start-up end-users are likely to be the most affected as they will no longer be able to use their physical commodity assets as collateral to hedge risk, and would otherwise be unable to engage in risk management due to cash-flow and credit-rating constraints. Further notes that without such benefits, such entities would have to enter into less-favorable, costly, and restrictive credit facilities. 21. National Mining Association End-User Trade Association NMA is a national trade association that includes the producers of most of the nation’s metals, coal, industrial, and agricultural minerals; the manufacturers of mining and mineral processing machinery, equipment, and supplies; and the engineering and consulting firms, financial institutions, and other firms serving the mining industry. Notes that Mining is critical to the success of American manufacturers. Cites a 2014 Edelman Berland survey of 400 manufacturing executives, where more than 90% of respondents expressed their concern about supply disruptions outside of their control. FHCs enable mining companies to hedge risks associated with long-term investment projects. A departure of FHCs would decrease liquidity in the commodities markets with no discernible corresponding benefit. Cites the robust federal and state environmental regulations applicable to mining operations, including those that require mining companies invest in and secure sites, as well as to post financial assurance instruments designed to cover potential unintended environmental releases. 22. Natural Gas Supply Association End-User Trade Association Trade-association for the downstream natural gas industry. Argues that the Proposed Rule would reduce liquidity and efficiency in relevant markets, which will ultimately result in higher costs and increased credit risk for end-users, increased volatility in physical and financial markets, and a reduction in consumer choice for counterparties. Notes concern that increased capital requirements would also result in increased hedging costs. Argues that FHC financial products and market making activities have fostered growth within the natural gas industry. Cites to overall reductions in CO2 emissions, increased technological breakthroughs, and job growth, all made possible with FHC backing. 23. International Energy Credit Association End-User Trade Association The IECA is the leading global membership organization for credit professionals in the energy industry. IECA is a not-for-profit association with over 1400 individual members who are involved in energy credit management. Urges the Board to reconsider issuing a final rule at all and also proposes a number of modifications that should be made to the rule before issuance. Argues that the Board does not present any evidence in support of its Proposal (“no precedent where financial entities involved in the physical commodities markets were held liable for environmental incidents”) and asserts that the Board is emphasizing hypothetical, potential risks (“possibility of a possibility of loss”) over the many positive effects of FHC activities. Also notes that corporate separateness would shield FHCs from liability for environmental catastrophes. States that the definition for covered physical commodities is overly broad and the Board should provide a clear list of those commodities that are expressly covered by the definition (and those commodities should have evidence concerning the risks they post). Also argues that the requirements should be proportional to the risks (e.g., natural gas activities do not pose the same risks as other commodities of concern). 24. The Goldman Sachs Group, Inc. FHC Goldman Sachs has been a participant and market maker in the commodities and commodity derivatives markets since 1981. Argues that FHCs provide substantial benefits to consumers, commodity producers, investors, financial markets, and the broader economy by their participation in physical commodities markets and making merchant banking investments. Notes that FHCs enable end-users to obtain competitive pricing, manage their risks, and serve as stable, highly regulated counterparties. Argues that punitive capital requirements effectively pre-empt Congressional authority granted to FHCs under Section 4(k) and Section 4(o). Explains that the capital requirements do not reflect any change in the intrinsic risk of owning the physical commodities. Further notes that an FHC engaged in a physically settled hedging transaction pursuant to Section 4(o) authority may be subject to the 1250% risk-weighting, while another FHC engaging in an identical transaction under Complementary Authority would only be subject to a 300% capital charge. 25. The Clearing House Association, L.L.C., the American Bankers Association, the Financial Services Forum, the Financial Services Roundtable, and the Institute of International Bankers Financial Trade Associations Believes that limitations on FHC activities should be addressed by Congress, as suggested by the Board in its Section 620 study. Notes that punitive rulemaking undermines current statutory authority. Concerned that additional capital charges are not commensurate with the environmental risks cited and that current capital standards already address the true risks. Argues that corporate veil piercing standards are very difficult to overcome and such theories have not changed in recent years. FHCs are an efficient tool for providing capital to companies and industries. Merchant banking authority affords FHCs flexibility to contribute capital at various stages in a company’s growth. Notes that preliminary data to a Clearing House study suggests that FHCs provide ~40% of the renewable energy market’s financing needs. Argues that the Proposed Rule fails to address the impact it would have on the economy, small business, and the commodity markets. Argues that further rulemaking in this area should take into account the impact on customers, markets, industries, and economic growth. 26. The Futures Industry Association Financial Trade Association FIA is the leading trade organization for the global futures, options, and over-the-counter cleared derivatives markets. Its mission is to support open, transparent, and competitive markets, protect and enhance the integrity of the financial system, and to promote high standards of professional conduct. FlA’s members, their affiliates, and their customers are active users of physical commodities, futures, and over-the-counter derivatives. Urges the Board not to adopt restrictive regulatory measures or, at the very least, to conduct an analysis of the potential costs and benefits of the restrictions and to submit that analysis to the public for comment. Argues that FHCs provide many benefits to the physical commodities markets, including market depth, liquidity (serving as market-makers), and by offering a broad spectrum of financial services available to the market (e.g., risk-mitigating commodity-linked swaps and other derivatives). Highlights the fact that commercial energy firms rely on inventory financing, which requires the FHC to take temporary title to the physical commodity. This would now be subject to higher capital requirements, which would result in reduction of the practice. Makes the point that the Board does not support with any evidence its conclusion that any reduction in activity by FHCs in the commodities markets would not have a material impact on participants in those markets. 27. International Swaps and Derivatives Association, Inc. Financial Trade Association Trade association for the global derivatives market with more than 850 member institutions in 67 countries. Members comprise a broad range of derivatives market participants, including corporations, investment managers, government and supranational entities, insurance companies, energy and commodities firms, and international and regional banks. Requests that the Board revise the Proposed Rule so as not to: impose heightened capital requirements in the absence of supporting evidence; lower the cap of total value of physical commodities permitted under Section 4(k)’s “complementary authority”; rescind the previous authorizations of FHCs to engage in energy management services and energy tolling activities; and implement restrictions on copper trading, and to limit the reporting provisions. Concerned with the lack of empirical support for restricting the activities of FHCs, and the failure to cite any instances where FHCs were liable for the full extent of an environmental catastrophe. Argues that removing FHCs will decrease liquidity, increase volatility, and ultimately result in higher costs to consumers (also specifically points to the practice of providing inventory financing transactions). 28. Securities Industry and Financial Markets Association and the Institute of International Bankers Financial Trade Association The associations believe that “the benefits of continuing to permit FHCs to engage in physical commodities activities should continue to produce public benefits that outweigh their potential risks.” Argues that the risks cited in the Proposed Rule are speculative and unsupported by facts and the law, and that the Board failed to point to a single instance where an FHC incurred a significant loss arising from environmental liability related to these activities. Notes that case law and real-world examples demonstrate that FHC involvement in commodities-based activities do not pose a substantial risk to the safety and soundness of the institution or the financial system. Cites to a Joint Memorandum of Law, prepared by four law firms, which concludes that “appropriately limited investment and trading activities relating to environmentally sensitive commodities present limited environmental liability risk” to FHCs, and “well-established doctrines of corporate separateness protect FHC groups from liability for investments in enterprises that engage in environmentally sensitive activities.” Argues that proposed capital charges would be duplicative of FHC requirements to maintain capital based on the credit risk (i.e., bankruptcy risk) of its subsidiaries engaged in commodities activities. Argues that environmental risks are accounted for by credit risk capital requirements. As a result, increased capital charges would force FHCs out of the market, causing adverse effects on competition, end-users, the liquidity of commodities markets, small- and medium-sized companies in the commodities sector, and the real economy. Concerned that the Proposed Rule ignores the substantial public benefits accruing from FHCs’ participation in these activities. Notes that numerous public benefits flow from the participation by FHCs in the commodities markets, including greater competition, increased liquidity in commodities, increased price convergence between cash and derivatives markets and more economical financing for end-users, among many others. Further notes that prior Federal Reserve determinations have found that FHC involvement in commodities activities provide: (1) greater convenience, (2) increased competition, and (3) enable efficient hedging. Counters the argument that the tail risks associated with FHCs’ current physical commodities activities pose unique and/or more significant risks than any of the other permissible banking and financial activities conducted by FHCs. Notes that the scope of regulated commodities is overly broad and should be limited to substances defined by the EPA as “Extremely Hazardous Substances,” such as arsenic, hydrogen sulfide, and sulfuric acid. Notes that the Proposed Rule captures commodities that present no meaningful risk of environmental harm (e.g., iron, vinegar, silver, silicon). 29. U.S. Chamber of Commerce Center For Capital Markets Competitiveness End-User Trade Association The Chamber is the world’s largest federation of business and associations, representing the interests of more than three million U.S. businesses and professional organizations of every size and every economic sector. These members are users, preparers, and auditors of financial information. Argues that the Section 4(o) risk-weighting requirements and the new Section 4(k) thresholds will push FHCs out of the physical commodities markets. This will result in reduced competition, which will ultimately lead to less liquidity and higher prices for the commodities on which end-users depend, and ultimately to higher prices for customers. Reasons that the regulation contradicts Congress’ intent when enacting Sections 4(k) and 4(o), as both Section 4(o) and 4(k) provide authority to facilitate efficient functioning of commodity markets and the efficient exchange of risk. Concerned that the Board has provided no evidence for hypothetical extreme circumstances where FHCs could be subject to massive liability. Emphasizes that the risk-weighting requirements are particularly unjustified, as the Fed cannot and has not provided any evidence of material loss. Also notes that that the potential costs to FHCs are remote, and argues that there are no examples of “corporate veil piercing” occurring in the FHC context. Calls for the need to undertake a comprehensive study of various regulatory initiatives as well as the effects of those initiatives on the broader global economy and the capital formation system. 30. Exante Regulatory Compliance Consultants Inc. Financial Services Company Exante is a financial services consulting firm specializing in regulatory compliance under SEC, CFTC, and FINRA. Urges the Federal Reserve to work with the Financial Stability Oversight Council to strengthen the Proposed Rule to prevent future instances of market manipulation by FHCs. 31. TrailStone Group Financial Entity TrailStone is an asset-backed trading and logistics company with in-depth experience in mining, oil and gas investment and finance, energy asset management, energy logistics, and trading. Argues that new restrictions will force FHCs out of the market, thus reducing market depth (i.e., the number of sophisticated parties in which TrailStone relies on to efficiently hedge, finance, and otherwise transact in commodities), and liquidity of the commodities market. Concerned that lack of FHC activity will increase price divergence between physical and financial products. Because TrailStone regularly makes use of both, it requires closely aligned pricing to prevent market arbitrage. Notes that its end-user subsidiaries need FHCs to take physical commodities as collateral to hedge and manage market risks. 32. Elise J. Bean and Tyler E. Gellasch Academic Elise Bean is the former Staff Director and Chief Counsel of the U.S. Senate Permanent Subcommittee on Investigations, and Tyler Gellasch is the former Senior Counsel of the U.S. Senate Permanent Subcommittee on Investigations. Reaffirms the Board’s position to limit FHCs’ physical commodity holdings in order to mitigate the dangers associated with an overconcentration of assets, volatile price swings, and unexpected costs arising from catastrophic events. Cites a 2012 Federal Reserve study supporting greater disclosure, reporting, capital requirements, and enhanced risk management measures for FHCs engaged in physical commodities activities. Supports stronger prohibitions on FHCs’ ability to own and operate facilities connected to the distribution of commodities through Section 4(k)’s complementary authority, as well as the prohibition of energy tolling, the reclassification of copper as an industrial metal, and increased capital requirements. Contends that the U.S. Senate Permanent Subcommittee’s investigation found evidence of market manipulation and conflicts of interest with respect to FHC commodity activities. Recommends strengthening the Proposed Rule as it relates to Section 4(k)’s complementary authority so that it also addresses catastrophes caused by safety violations; clarifying the definition of “covered physical commodities” by making use of a straightforward list (e.g., petroleum and petroleum products, natural gas, fertilizer), and clarifying the scope of Section 4(o) on whether or not the clause is confined to physical commodity activities the entities were engaged in prior to 1997. 33. James D. Hanson Academic Supports removing copper and silver from lists of bank permissible precious metals. Expresses concern over the conflicts of interests banks may have when they both transact in financial products related to physical commodities and also hold physical commodity assets. 34. Reid B. Stevens and Jeffery Y. Zhang Academic Reid Stevens is a Professor of Agriculture Economics at Texas A&M University; Jeffrey Zhang is a Professor of Economics at Yale and Harvard Law School. Presents a case study concerning alleged manipulation of the U.S. aluminum market from 2010 to 2014. Argues that the Proposed Rule will improve the detection of manipulation, since it strengthens the prohibition on owning and operating storage facilities and increases reporting requirements for FHCs. 35. Saule T. Omarova, Professor of Law, Cornell University Law School Academic Urges the Board to strengthen the Proposed Rule to expand the scope of covered commodities, tighten complementary authority, narrow Section 4(o) authority, and require additional quantitative and qualitative disclosures of FHC activity. Notes that even markets for “non-hazardous” commodities are subject to the distortive and manipulative effects of FHCs. Cites examples in the aluminum, copper, and electricity markets. Argues for several changes to the Proposed Rule: The key operative provisions should apply to all physical commodities (e.g., copper and aluminum, agricultural commodities, electricity, etc.) as opposed to just hazardous substances that carry the greatest potential liability. The rule needs broader prohibitions on FHCs’ ability to manage, direct, conduct, or provide advice regarding business operations of entities engaged in the physical commodities business. Should restrict Section 4(o) activity to only those activities that were conducted before 1997. Should require from FHCs a detailed qualitative narrative of the entire complex of their operations and assets involving, or related to, physical commodities and how they are linked or interdependent. 36. Aidenvironment, et al. Interest Group Consortium of environmentally focused organizations and investors. Supports the Proposed Rule in order for FHCs to account for the material financial, environmental, and social risks associated with their physical commodities activities. Argues that Section 4(o) and Section 4(k) authority contribute to deforestation and other environmental effects. Cites independent research which suggests that asset impairment due to environmental and social degradation poses significant risk to FHCs holding physical assets. For example, references a study which suggests that the Noble Group’s balance sheet was reduced by $400 million due to impairments of their palm oil and coal assets and receivables. 37. Amazon Watch Interest Group Nonprofit organization for the protection of the rainforest and advancement of the rights of indigenous peoples in the Amazon Basin. Argues that FHCs should not have business financing or owning commodities and assets that harm the environment or indigenous communities. Contends that FHC holdings are problematic, including jet fuel supplies and the recent purchase, sale, transport, and storage of oil, natural gas, coal, metals, electricity, and agricultural products. Further cites the extractive activities of FHC-owned or -backed entities, such as oil drilling in the Amazon. Argues that FHCs’ direct involvement in commodities financing and ownership creates layers of legal liability, as well as political, reputational, and financial risks. 38. Americans for Financial Reform Interest Group AFR is a coalition of more than 200 national, state, and local groups who advocate for reform of the financial industry. Their members include consumer, civil rights, investor, retiree, community, labor, faith-based and business groups along with prominent independent experts. Believes in the elimination or the significant reduction of commodity ownership from bank portfolios. Supports limitations and restrictions to FHCs commodity activities to limit exposures to both changes in commodity prices and commodity-related catastrophic events. Notes that increased capital requirements would further serve as a stop-gap to such losses. Argues that FHC commodities activities concentrate economic power and pose potential market manipulation risks. Cites the concerns related to energy and aluminum market manipulation. Urges the Board to interpret Section 4(o)’s grandfather provision more narrowly, such as by limiting activities to those permitted when the GLB Act was passed. 39. Better Markets, Inc. Interest Group Better Markets is a non-profit, non-partisan, and independent organization founded in the wake of the 2008 financial crisis to promote the public interest in the financial markets and support financial reform. Supports the new requirements and offers a number of proposals and amendments to strengthen the rulemaking and its enforcement. Supports restrictions on commercial activities of banking entities, which aligns with the original intent of the GLB Act. Also supports the proposals outlined in the Section 620 Study to (1) repeal the authority of FHCs to engage in merchant banking activities entirely, and (2) repeal the grandfather authority under Section 4(o). Argues that this will result in “reduced institutional and systemic risk; more fair competition; and better fulfillment of original Congressional intent.” Recommends that the Board: engage in coordination with other regulatory agencies (e.g., CFTC, FERC, etc.) with regard to physical commodities trading, such as by establishing a mechanism for sharing the nature and percentage of commodities ownership among BHCs and FHCs; prevent evasion of other laws dealing with financial market oversight (e.g., FHCs that own commodity businesses have insider information, which can lead to insider trading and manipulation); ensure that non-banking business are not given an unfair advantage through Discount Window funding; and refrain from exempting FHCs from disclosure requirements (suggests that they should define the exemption from disclosure as narrowly as possible). 40. Institute for Agriculture and Trade Policy Interest Group Nonprofit organization focused on ensuring fair and sustainable food, farm, and trade systems. Supportive of the proposed capital requirements but cautions that the Board has underestimated FHC and bank involvement and market share within the physical commodity markets, and therefore may underestimate the impact of commodity derivatives losses on the FHC trading losses in physical commodities. Skeptical of FHCs’ claims that their involvement in physical commodities trading benefits end-users. Recommends that the Board require FHCs to divulge comprehensive and standardized data about their complementary commodity activities to verify their claims of harm from the Board’s action, and their claims of end-user and social benefits from those activities. Suggests that the Board should possibly broaden its understanding of what constitutes a catastrophe for the purposes of determining whether an FHC could be liable for a catastrophe involving its physical commodity activities. 41. Public Citizen, Inc. Interest Group Non-profit consumer rights advocacy group and think tank. Supports the increased capital requirements, the prohibition of FHCs from entering into energy tolling agreements, and the copper amendment, but cautions that the Board should narrow the language for what it means to be “closely related” to banking. Proposes that the Board should modify the reporting requirements to require (1) disclosure of ownership or control over infrastructure assets and (2) restrictions on communications between a bank’s energy infrastructure and energy trading affiliates (otherwise they have an “insider’s peek” into the physical movements of energy products which is unavailable to other traders). 42. Congressman Bradley Byrne U.S. House Requests an extension of the comment period until the 115th Congress has convened and has a chance to review the proposal. Notes that the Board needs to “consider the potential adverse impact upon costs to the American public, the reduction in competition, the loss of markets, and the potential for fewer creditworthy and highly regulated bank counterparties with whom end-users may transact.” 43. Senators Sherrod Brown, Jeff Merkley, and Jack Reed U.S. Senate Argues that the recent departure of FHCs from the physical commodity markets demonstrates that FHCs are not pivotal intermediaries as they claim to be. Cites airline practices of engaging with non-financial companies for their fuel needs. Supports the expansion of covered physical commodities on the ground that volatility and sudden swings are not limited to those commodities enumerated in the Proposed Rule. Contends that the Proposed Rule fails to address additional environmental concerns related to international and other long-term liabilities. The Senators note that reclamation and remediation of abandoned mines in the U.S. is problematic. Concerned with the ability of FHCs to utilize repo-style transactions to move commodities exposures off the balance sheet. Argues that this would allow FHCs to continue to engage in commodity activities beyond the proposed 5% Tier 1 Capital cap. Supports a limitation of Section 4(o) activities to those permissible pre-1997. Appendix B: Physical Commodities Legal Authorities Type of Authority Covered Entities Applicable Statutes, Rules and Guidance Scope of Activities 1. Banking and “Closely Related to Banking” Activities All BHCs and FHCs. 12 U.S.C. § 1843(a), (c)(8) 12 C.F.R. §§ 225.21(a), 225.28(a)-(b), 225.123, 225.126, 225.129, 225.131 Within two years of becoming a BHC (subject to three one-year extensions from the Board), a BHC may only own shares in banks, or engage in, or own companies that engage in, banking activities or activities that the Board has determined by regulation or order to be “so closely related to banking as to be incident thereto.” The Board has determined that commodities derivatives activities are “closely related to banking” as long as the contract requires cash settlement or the BHC makes every reasonable effort to avoid physical delivery or receives and instantaneously transfers the asset by operation of contract and without taking physical delivery. BHCs generally must file a notice with the Board and receive approval prior to engaging in any “closely related to banking” activities. FHCs and certain well- capitalized and well-managed BHCs may commence the activities and file a notice after the fact. 2. “Financial in Nature” Activities and Merchant Banking All FHCs. 12 U.S.C. §§ 1843(k)(1), (k)(4)(H), (k)(7); 12 C.F.R. 225 Subpart J (225.170-177) Fed. Res. Interp. Ltr. from J. Mattingly, Esq. to P. Grauer (Credit Suisse First Boston) (Dec. 21, 2001) All FHCs are permitted to engage in, and to acquire and own shares of any company engaged in, activities that are “financial in nature or incidental to such financial activity.” Merchant banking is a permissible “financial in nature” activity for FHCs and their non-depository institution subsidiaries. The merchant banking authority permits an FHC to: acquire an ownership interest in any company as “part of a bona fide underwriting or merchant or investment banking activity,” so long as the FHC controls (i) a registered broker-dealer or (ii) an insurance company that is advised by a registered investment adviser; hold such ownership interests “only for a period of time to enable the sale or disposition thereof,” which period generally may not exceed 10 years; select all of the directors of a portfolio company; enter into an agreement with a portfolio company giving it approval rights over non-routine matters; and provide advice to officers and employees of a portfolio company. The merchant banking authority does not permit FHCs to: own assets other than securities or other ownership interests in a portfolio company, unless the assets are held by a portfolio company that maintains a separate existence from the FHC and has separate management; or “routinely manage or operate a portfolio company” other than for a limited period 3. “Complementary” Activities FHCs that have applied to, and received approval from, the Board to engage in specific complementary activity. 12 U.S.C. § 1843(j), (k)(1)(B) 12 C.F.R. § 225.89 Board complementary activities orders, including Citigroup (2003), Barclays (2004), and RBS (2008) FHCs are permitted to engage in, and to acquire and own shares of any company engaged in, any activity that the Board has determined by regulation or order “is complementary to a financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.” A FHC must request approval from the Board to engage in a complementary activity, which the Board will evaluate as to whether the benefits to the public outweigh potential adverse effects. In a series of orders beginning with the Citigroup order, the Board has determined that the purchase and sale of commodities in the spot market and taking physical delivery of commodities in connection with commodity derivatives activities—including owning and disposing of nonfinancial commodities (collectively, “Physical Trading Activities”)—are complementary to the financial activity of engaging as principal in BHC-permissible (i.e., cash settled) derivatives activities based on those commodities. As conditions to approval of its proposed Physical Trading Activities, Citigroup committed: that the market value of commodities held as a result of the activities would at no time exceed 5 percent of Citigroup’s consolidated Tier 1 capital; that it would notify its supervising Reserve Bank if the market value of commodities held by Citigroup as a result of its Physical Commodities Trading activities exceeded 4 percent of its Tier 1 capital; to only make and take delivery of physical commodities for which derivatives had been approved for trading on a U.S. futures exchange by the CFTC, unless explicitly excluded or approved by the Board. 4. “Grandfathered” Activities Any company that is not a BHC or foreign bank that becomes a FHC after November 12, 1999. 12 U.S.C. § 1843(o). Any company that is not a BHC or foreign bank that becomes a FHC after November 12, 1999 “may continue to engage in, or directly or indirectly own or control shares of a company engaged in, activities related to the trading, sale, or investment in commodities and underlying physical properties that were not permissible for bank holding companies to conduct in the United States as of September 30, 1997” if certain conditions are met. These conditions are: that the FHC or one of its subsidiaries was engaged in any of such activities as of September 30, 1997; that the value of the assets of the company held by the FHC that are not otherwise permissible for a FHC are equal to or less than 5% of the total consolidated assets of the FHC (except as permitted by the Board); and that the FHC does not permit the company whose shares the FHC owns pursuant to section 4(o) to offer or market any product or service of an affiliated depository institution or vice versa. The Board, while not formally interpreting the extent of section 4(o) authority, has noted that the GLBA permits “FHCs that meet the criteria in section 4(o) to engage in a potentially broader set of physical commodity activities than generally authorized for BHCs and other FHCs.” 5. Sub-5% Investments All BHCs and FHCs. 12 U.S.C. § 1843(c) (6). BHCs are permitted to own “shares of any company which do not include more than 5 per centum of the outstanding voting shares of such company.” BHCs may own more than 5% of the economic interest in such a company, but the size of such additional economic ownership may depend on the facts and circumstances. Sub-5% investments must be passive and non-controlling in nature.  Notice of Proposed Rulemaking, Regulations Q and Y; Risk-Based Capital and Other Regulatory Requirements for Activities of Financial Holding Companies Related to Physical Commodities and Risk-Based Capital Requirements for Merchant Banking Investments, 81 Fed. Reg. 67220 (Sept. 30, 2016) [hereinafter the “Proposed Rule”].  Complementary Activities, Merchant Banking Activities, and Other Activities of Financial Holding Companies Related to Physical Commodities, 79 Fed. Reg. 3329 (January 21, 2014); Complementary Activities, Merchant Banking Activities, and Other Activities of Financial Holding Companies Related to Physical Commodities, 79 Fed. Reg. 12414 (March 5, 2014) (extending the comment period to April 16, 2014).  In previous Client Alerts, we analyzed public comments to the ANPR and the historical justifications for bank commodity activities in light of the enhanced regulatory framework existing after the passage of the Dodd-Frank Act, available at http://www.gibsondunn.com/publications/Pages/Commodities-Activities-of-Banks–Comments-on-Federal-Reserve-Advance-Notice-of-Proposed-Rulemaking.aspx and http://www.gibsondunn.com/publications/Pages/Federal-Reserve-to-Reevaluate-Permissibility-of-Physical-Commodities-Trading-Rationale-Historically-and-Today.aspx.  In total, there were 44 individual end-users and municipal end-users signatories to the 24 letters.  Trade associations and end-users that signed on to this letter include Accuride Corporation, Air Products and Chemicals, Inc., the American Investment Council, Apache Corporation, Ball Corporation, The Boeing Company, BP, Cummins Inc., FMC Corporation, General Electric Company, General Motors Company, Harley-Davidson, Inc., The Hershey Company, Honeywell International, NextEra Energy Resources LLC, Northern Virginia Electric Cooperative, Orbital ATK, Inc., and Southwest Airlines Co.  Pub. L. 106-102, 113 Stat. 1338 (Nov. 12, 1999).  The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required that such conditions be met at the bank holding company level as well. 12 U.S.C. § 1843(l)(1)(C).  12 U.S.C. § 1843(k).  Id. § 1843(j)-(k). Note that, under Section 4(k) of the BHC Act, making “merchant banking” investments in non-financial companies is an activity financial in nature.  Id. § 1843(o).  See Citigroup Inc., 89 Fed. Res. Bull. 508 (2003) (Citigroup Order).  The FHCs other than Citigroup that received approval to engage in complementary physical commodities activities included UBS AG, 90 Fed. Res. Bull. 215, 216 (2004); Barclays Bank plc, 90 Fed. Res. Bull. 511, 512 (2004) (Barclays Order); Deutsche Bank AG, 92 Fed. Res. Bull. C54, C56 (2006); Société Générale, 91 Fed. Res. Bull. C113, C115 (2006); JPMorgan Chase & Co., 92 Fed. Res. Bull. C57, C58 (2006); Fortis S.A./N.V., 94 Fed. Res. Bull. C22 (2008) (Fortis Order); and The Royal Bank of Scotland Group plc, 94 Fed. Res. Bull. C60 (2008) (RBS Order). Beginning in 2006, many determinations were made by delegated authority to the Director of the Division of Banking Supervision and Regulation. See, e.g., Wachovia Co., Letter to Elizabeth T. Davy, Esq., dated Apr. 13, 2006; Credit Suisse Group, Letter to Paul E. Glotzer, Esq., dated Mar. 27, 2007; Bank of America, Letter to Gregory A. Baer, Esq., Apr. 24, 2007; BNP Paribas, Letter to Paul E. Glotzer, Esq., dated Aug. 31, 2007; Wells Fargo, Letter to John Shrewsberry, dated Apr. 10, 2008; Bank of Nova Scotia, Letter to Andrew S. Baer, Esq., dated Feb. 17, 2011.  See RBS Order (energy tolling); Fortis Order (2008) (energy management). In an energy tolling arrangement, an FHC enters into an agreement with the owner of a power plant under which the FHC pays the plant owner a periodic payment that compensates the owner for its fixed costs in exchange for the right to all or part of the plant’s power output. Energy management services include acting as a financial intermediary for a power plant owner to facilitate transactions relating to the acquisition of fuel and the sale of power and advising on risk management.  12 U.S.C. § 1851(h)(4) (definition of proprietary trading includes only commodity futures and derivatives).  Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, Report to the Congress and Financial Stability Oversight Council Pursuant to Section 620 of the Dodd-Frank Act (Sept. 8, 2016). For more information, please see our Client Alert, available at http://www.gibsondunn.com/publications/Pages/US-Bank-Regulators-Section-620-Study-Federal-Reserve-De-Risks-Merchant-Banking-Commodities.aspx.  Comment letters are available at: https://www.federalreserve.gov/apps/foia/ViewAllComments.aspx?doc_id=R-1547&doc_ver=1. For purpose of counting comment letters, we have removed instances where a commenter has submitted more than one letter.  See, e.g., Comments submitted by the U.S. Chamber of Commerce Center for Capital Markets Competitiveness (“[M]arket liquidity would suffer because FHC affiliates are frequently the most knowledgeable participants and the most willing to enter into customized trades, and there are few potential new market entrants who can replace them.”); Comments submitted by Novelis Inc. (“Having multiple FHCs that participate in the aluminum futures market available to us has . . . given manufacturers in the aluminum industry improved liquidity.”).  See, e.g., Comments submitted on behalf of end-users and end-user trade associations by the National Association of Corporate Treasurers (“[W]e will likely find ourselves having to transact with less-resilient and less-regulated non-bank counterparties, who offer a less-sophisticated and less-customized array of products, and who are often located outside the United States.”).  See, e.g., Comments submitted by end-users and municipal end-users such as Alon USA Energy, Inc., the Town of Slaughter, Louisiana, and Cogentrix Energy Power Management, LLC.  See, e.g., Comments submitted by the TrailStone Group (“[O]nly FHCs can provide practical market solutions to transparency, bid/ask pricing, and the tenor in which market participants need.”); Comments submitted by Delek US Holdings Inc. (“[W]we do not believe that the remaining intermediaries that exist in or could be expected to enter the market would be able to service our physical commodity and commodity derivatives needs as well as FHCs currently do because of FHCs’ unique combination of favorable characteristics”).  See, e.g., Comments submitted by the International Swaps and Derivatives Association (“[L]limitations and restrictions in the Propos[ed] [Rule] on the ability of banking organizations to engage in certain activities relating to physical commodities may have negative effects on the physical and financial commodities markets, including less liquid and efficient markets, greater volatility and higher costs for end-users and consumers.”).  See, e.g., Comments submitted by U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed.  See, e.g., Comments submitted by Former Staff Director and Chief Counsel of the U.S. Senate Permanent Subcommittee on Investigations, Elise J. Bean, and Former Senior Counsel of the U.S. Senate Permanent Subcommittee on Investigations, Tyler E. Gellasch (suggesting that the definition of “covered physical commodities” be clarified by making use of a straightforward list).  See, e.g., Comments submitted by Public Citizen, Inc. (“Given the critical role played by FHCs in the economy and in commodity trading markets, and considering the unique risks associated with energy infrastructure in our economy and national security, the public interest is best served by having the Board publically disclose limited aspects of FHC ownership and control over physical commodity assets such as pipelines, storage terminals and tankers.”); comments submitted by Professor Saule T. Omarova (“[T]the Board should require each FHC to provide a detailed qualitative narrative of the entire complex of its operations and assets involving, or related to, physical commodities. As part of this narrative, FHCs should be required to identify and discuss specific organizational, informational, and financial links and inter-dependencies between their specific physical commodities businesses and other business activities they conduct or seek to conduct.”).  See, e.g., Comments submitted by U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed (citing to the U.S. Senate Permanent Subcommittee on Investigations’ findings with relation to Goldman Sachs’ activities within the aluminum markets, the Senators reasoned that “because FHCs have been found to exercise a high level of control over physical commodity portfolio companies, the proposal’s strengthened restrictions are necessary and important.”).  See, e.g., Comments submitted by Americans for Financial Reform, U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed, and Professor Saule T. Omarova.  See, e.g., Comments submitted by U.S. Senators Sherrod Brown, Jeff Merkley, and Jack Reed (noting that “the Director of the Board’s Bank of Supervision and Regulation Division has acknowledged that ‘there are multiple possible interpretations of section 4(o) of the BHC Act.'”).  See, e.g., Comments submitted by Professor Saule T. Omarova.  See, e.g., Comments submitted by the Goldman Sachs Group, Inc. (“In enacting Section 4(o) Congress explicitly acknowledged the importance of the expertise and risk management provided by FHC intermediaries in the physical commodity markets.”).  See, e.g., Comments submitted by the Natural Gas Supply Association (crediting the growth in the natural gas industry in part to the “unique role in facilitating physical commodity and related financial market counterparty diversity.”).  See, e.g., Comments submitted on behalf of end-users and end-user trade associations by the National Association of Corporate Treasurers (“[W]e will likely find ourselves having to transact with less-resilient and less-regulated non-bank counterparties, who offer a less-sophisticated and less-customized array of products, and who are often located outside the United States.”).  Comments submitted by U.S. Representative Bradley Byrne; see also Comments submitted by the Securities Industry and Financial Markets Association and the Institute of International Bankers (“The Federal Reserve’s failure to take into account the public benefits of FHCs’ physical commodities activities that would be lost if the requirements of the Proposed Rule were to become effective fails to satisfy its obligation under the Administrative Procedures Act to engage in reasoned decision-making in its rulemaking.”).  See, e.g., Comments submitted by Professors Reid B. Stevens and Jeffery Y. Zhang (presenting their study of manipulation by financial entities of regional commodity markets); Comments submitted by Better Markets (FHC physical commodity activity “invites market manipulation and excessive commodity speculation.”); Comments submitted by Americans for Financial Reform (citing to federal studies noting market manipulation in the energy, aluminum, and copper markets).  See Comments submitted by Novelis, Inc. (noting that FHCs enable Novelis to (1) efficiently manage surplus inventory through short-term repo transactions and (2) lock-in favorable pricing in instances where its business demands do not correspond with current market pricing).  See, e.g., Comments submitted by the Securities Industry and Financial Markets Association and the Institute of International Bankers (“Despite the fact that Congress and the Federal Reserve have allowed FHCs to engage in physical commodity activities for over 15 years, the Federal Reserve has failed to point to a single instance where an FHC incurred a significant loss arising from environmental liability related to these activities.”).  Id. (“FHCs are already subject to existing capital charges for credit risk, market risk and operational risk, which are designed to address, among other risks, legal liability risk.”).  Id. (noting that associations attach a Joint Memorandum of Law, prepared by four law firms, which concludes that “appropriately limited investment and trading activities relating to environmentally sensitive commodities present limited environmental liability risk” to FHCs, and “well-established doctrines of corporate separateness protect FHC groups from liability for investments in enterprises that engage in environmentally sensitive activities”). Additionally, the Board acknowledged such safeguards in the Proposed Rule, stating that these laws “generally impose liability on owners and operators of facilities and vessels for the release of physical commodities. . . [and while] a company that directly owns an oil tanker or petroleum refinery that releases crude oil in a navigable waterway” may be liable for damages that result from a spill, the owner of the commodity often times is not liable except in instances where the underlying owner engages in activities in addition to mere ownership. 81 Fed. Reg. at 67221.  See, e.g., Comments submitted by Amazon Watch (“In 2013, Morgan Stanley reported trading aluminum, copper, gold, lead, palladium, platinum, silver, rhodium, zinc, coal, crude oil, heating oil, ethanol, fuel oil, gasoline, jet kerosene, naphtha, and natural gas. It also reported maintaining physical inventories in 2012 that included 1.7 million barrels of crude oil, 5.8 million barrels of heating oil, and 6.2 million barrels of gasoline.”).  See, e.g., Comments submitted by Amazon Watch (“As a new study from the Center for Biological Diversity shows, existing pipelines in North Dakota have spilled crude oil and other hazardous liquids at least 85 times since 1996—an average of four a year—and released over 3 million gallons into rivers, farmland, reservoirs, and more. Those 85 spills caused more than $40 million in property damage.”).  See Catherine Ngai and Olivia Oran, Barclays’ exit from energy trading stirs concerns over liquidity, Reuters, Dec. 6, 2016, available at http://www.reuters.com/article/us-usa-oil-barclays-bk-idUSKBN 13U2MW.  We note also that the Proposed Rule could face an uncertain future. Board Governor Daniel Tarullo, the de facto Governor for bank supervision and regulation, has announced his resignation, effective in less than a month. With two Board seats currently empty, the Trump Administration will be able to add at least three Governors to the Board. Aspects of the Proposed Rule seem in tension with several Administration priorities, including lessening regulatory burden, making clear the economic costs of agency rulemakings, and constraining administrative action to adhere more closely to the expressed will of Congress.  Trade associations and end-users that signed on to this letter include Accuride Corporation, Air Products and Chemicals, Inc., the American Investment Council, Apache Corporation, Ball Corporation, The Boeing Company, BP, Cummins Inc., FMC Corporation, General Electric Company, General Motors Company, Harley-Davidson, Inc., The Hershey Company, Honeywell International, NextEra Energy Resources LLC, Northern Virginia Electric Cooperative, Orbital ATK, Inc., and Southwest Airlines Co.  See Covington & Burling LLP, Davis Polk & Wardwell LLP, Sullivan & Cromwell LLP and Vinson & Elkins LLP, Joint Memorandum of Law Prepared for SIFMA In Response to the Notice of Proposed Rulemaking on Risk-Based Capital and Other Regulatory Requirements for Activities of Financial Holding Companies Related to Physical Commodities and Risk-Based Capital Requirements for Merchant Banking Investments (Docket No. R-11547; RIN 7100AE-58), available at https://www.federalreserve.gov/SECRS/2017/February/20170228/R-1547/R-1547_021717_131733_608227617620_1.pdf (Appendix A).  Aidenvironment was joined by Climate Advisers, Green Century Capital Management, and Profundo.  12 U.S.C. § 1843(a)(2), (c)(8).  12 C.F.R. § 225.28(b)(8)(ii). FHCs are also permitted to own commodities that state member banks are permitted to own, such as gold and silver bullion. Id. § 225.28(b)(8)(ii)(B)(1), (b)(8)(iii).  12 U.S.C. § 1843(j)(1)(A).  Id. § 1843(j)(3)-(4).  Id. § 1843(k)(1)(A).  Id. § 1843(k)(4)(H).  Id. § 1843(k)(4)(H)(ii)(II).  12 C.F.R. § 225.170(f).  Id. § 225.172(b).  Id. § 225.171(d)(1).  Id. § 225.171(d)(2).  Id. § 225.171(d)(3).  Id. § 225.171(a). The rule provides examples of what constitutes “routine management or operation” of a portfolio company. “Routine management or operation” generally includes when any FHC director, officer or employee serves as an executive officer or employee of a portfolio company or when any portfolio company officer or employee is supervised by a director, officer or employee of the FHC (other than in its role as director of the portfolio company). See id. § 225.171(b). See also Fed. Res. Interp. Ltr. from J. Mattingly, Esq. to P. Grauer (Credit Suisse First Boston) (Dec. 21, 2001) (available at http://www.federalreserve.gov/boarddocs/legalint/bhc_changeincontrol/2001/20011221/) (providing a list of example covenants that would not involve an FHC routinely managing or operating a portfolio company).  Citigroup Order; Barclays Order; RBS Order.  12 U.S.C. § 1843(k)(1)(B).  Id. § 1843(j)(1)(A), (j)(2).  After the Citigroup Order, the Board permitted FHCs to make and take delivery of physical commodities for which the CFTC had not approved derivatives for trading on a U.S. futures exchange. See RBS Order.  12 U.S.C. § 1843(o).  Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation & Office of the Comptroller of the Currency, Report to Congress and the Financial Stability Oversight Council Pursuant to Section 620 of the Dodd-Frank Act (September 2016), available at https://www.fdic.gov/news/news/press/2016/pr16079a.pdf, at 16. Former Governor Daniel K. Tarullo has also noted that “[i]n contrast to section 4(k) complementary authority, this authority is automatic–meaning no approval by or notice to the Board is required for a company to rely on this authority for its commodities activities. Also, unlike the firms conducting limited commodities activities found to be complementary to financial activities under section 4(k), the section 4(o) grandfathered firms are authorized to engage in the transportation, storage, extraction, and refining of commodities.” Speech: Former Governor Daniel K. Tarullo, Statement before the Permanent Subcommittee on Investigations, U.S. Senate, Washington, DC (Nov. 21, 2014), available at https://www.federalreserve.gov/newsevents/testimony/tarullo20141121a.htm.  12 U.S.C. § 1843(c)(6). Gibson Dunn’s lawyers are available to assist in addressing any questions you may have regarding these developments. Please contact any member of the Gibson Dunn team, the Gibson Dunn lawyer with whom you usually work, the authors, or any of the following: Michael D. Bopp – Washington, D.C. (+1 202-955-8256, email@example.com) Arthur S. Long – New York (+1 212-351-2426, firstname.lastname@example.org) Carl E. 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