The Commodities Activities of Banks: Comments on the Federal Reserve’s Advance Notice of Proposed Rulemaking

April 28, 2014

On April 16, 2014, the public comment period for the Federal Reserve’s Advance Notice of Proposed Rulemaking (ANPR) relating to the physical commodities activities of U.S. and non-U.S. financial holding companies (FHCs) closed.[1]  The ANPR drew comments from a wide variety of interested parties, including Senators, several interest groups, the banking industry, and end-users of commodities and commodity-based derivatives.

A review of the public comments suggests that there still is little concrete evidence that, under the conditions previously imposed by the Federal Reserve, physical commodities activities present meaningfully different levels of risk than the other financial activities in which FHCs engage.  The adverse effects arising from such activities suggested by commenters, moreover, do appear to be constrained, or capable of constraint, by existing laws and regulations.[2]

Perhaps most striking is the fact that approximately two dozen comment letters were filed by end-users of commodities and commodity-based derivatives, including a letter from the National Association of Corporate Treasurers, on to which fifteen additional end-users signed.  Numerous comment letters from such end-users showed a distinct preference for transacting with FHCs as opposed to other available or potential counterparties.  But notwithstanding this end-user preference, and in the absence of additional regulation, the number of FHC counterparties continues to dwindle — on April 21st the Financial Times reported that Barclays plc would be retreating from large parts of its metals, agricultural, and energy businesses.[3]


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),[4] 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.[5]

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.[6]

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.”[7]

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.[8]

Following the Citigroup approval, other domestic and foreign FHCs received approval to engage in physical commodities trading activities in approvals from 2004 to 2011,[9] including many of the largest domestic and foreign FHCs.  In other orders, the Federal Reserve declared energy tolling and energy management activities to be complementary to financial activities.[10]

Finally, during the 2008 Financial Crisis, Morgan Stanley and Goldman Sachs became FHCs and subject to Federal Reserve 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 D.

The Federal Reserve’s ANPR

In July 2013, the Federal Reserve 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.[11]

In January of this year, the Federal Reserve issued its ANPR.  The ANPR is broad in scope:  it requests 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.  It then poses 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.

Comments on the ANPR were initially due on March 15, 2014, but the Board extended the deadline to April 16, 2014.[12]

Scope of Comments

As of the close of business on April 25, 2014, the Federal Reserve had posted 182 comment letters on its website.[13]

The comment letters are listed by the name of the submitting person or entity and can be found at this link.  The majority of the comments are relatively short emails from individuals.  There are, however, approximately 60 links on the web site to lengthier, letter comments, generally submitted on behalf of a company, trade association, interest group, or other entity.  A list of these commenters can be found in Appendix A.  In addition to individual filers, it appears that comments were filed in the following categories:

  • End-Users
    • 36 end-user companies either submitted their own letter or joined a trade association letter;
    • 38 municipal utility districts submitted their own or joint letters;
    • 12 end-user trade associations submitted their own or joint letters; and
    • 2 private equity firms with end-user operating companies submitted their own letter or a joint letter with end-users.
  • Financial Holding Companies
    • 3 FHCs submitted their own letters;
    • 10 trade associations from the financial services industry submitted their own or joint letters; and
    • 4 other financial companies submitted their own letters.
  • Others
    • 3 U.S. Senators submitted their own or joint letters;
    • 2 academics submitted their own letters; and
    • 8 public interest groups submitted their own letters.

We summarize below the key points made by end-users, banks, and their trade associations as well as the counterarguments raised by certain U.S. Senators, interest groups, and academics.  For a breakdown of certain key points raised in the comment letters, please see Appendix B.  For a thematic discussion of the comment letters, please see Appendix C.

Comments: Key Points

In their letters, individual FHCs and the banking industry made the following principal contentions:

  • There has been no change to the nature of complementary commodities activities, or to the financial activities that they support and complement, since 2003.
  • 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.
  • Such additional regulation is sufficient to protect against material conflicts of interest.
  • According to a study by four law firms, the corporate separateness doctrine generally shields FHCs from liability arising from their subsidiaries’ handling of environmentally sensitive commodities, as long as appropriate risk management guidelines are followed.
  • A study of operational risk loss data for U.S. and non-U.S. banking organizations found that losses relating to disasters and public safety from 2006 to 2011 threatened neither the banks themselves nor the financial system generally.
  • There was no evidence that merchant banking investments related to physical commodities activities presented materially different risks than other merchant banking investments.
  • When it enacted Section 4(o) of the BHC Act, Congress imposed its own prudential limitations on physical commodities activities permissible under that section.
  • A representative of the insurance industry stated its view that the environmental events that were most likely to result from the physical commodities activities in which FHCs were primarily engaged could be appropriately insured against.

The end-user community focused on the effects on the commodities markets themselves from further restrictions, which they feared would cause additional FHCs to exit such markets.  End-users pointed to the following consequences:

  • There would be fewer sophisticated market-making entities with the ability to offer customized products.
  • There would be fewer market-making entities able to provide bid and offer prices on multiple commodities.
  • 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 their operations were generally not available from non-FHCs.
  • Remaining market players would be less well-capitalized, less well-rated, and less financially transparent.
  • Non-FHC counterparties did not have as broad market knowledge and therefore could not price commodities-related products as efficiently.
  • The commodities markets generally would suffer from diminished liquidity and greater risk concentration.
  • Such concentration would result in increased costs for end-user businesses and consumers.
  • End-users would be denied the ability to trade with the counterparties of their choosing.

Senators Carl Levin, Elizabeth Warren, and Sherrod Brown, public interest groups like Public Citizen, The Other 98%, and Occupy the SEC, and certain academics advanced the following principal arguments in their letters:

  • The “complementary” authority contained in Section 4(k) of the BHC Act had been interpreted by the Federal Reserve in an expanded manner that did not accord with congressional intent.
  • In approving physical commodities activities for FHCs, the Federal Reserve had improperly determined that public benefits from the activities outweighed adverse effects.
  • Conflicts of interest in the commodities markets were different in kind from other markets, due to significant FHC information advantages.
  • Physical commodities activities presented risks that were wide-ranging and whose severity was unpredictable, therefore justifying an outright ban or substantial new prudential limitations on the Section 4(k), Section 4(o), and merchant banking authorities.
  • These risks were significant enough to threaten particular FHCs, and, as a result of contagion, the financial system generally.
  • There was not sufficient disclosure about the extent of FHC commodities activities for the Federal Reserve to regulate such activities adequately.
  • FHCs should not be permitted to use the BHC Act’s merchant banking authority to evade restrictions on physical commodities activities.
  • The Federal Reserve should narrowly construe the authority contained in Section 4(o) because of the risks posed by commodities activities.
  • Potentially adverse effects on the commodities markets were outweighed by the benefits of reducing risk to particular FHCs and to the financial system generally.
  • FHC market advantages were also due to subsidies deriving from their being Too Big To Fail.

Analysis of the Public Comments

From the foregoing, it is clear the ANPR succeeded in producing a vigorous debate on the role of FHCs in the physical commodities markets.  What is far less clear is whether the evidence offered by commenters justifies further Federal Reserve action.

First, on looking at the criticism of FHCs’ current commodities activities, a significant portion seems animated by a desire to narrow the activities of banks generally.  Many of the comment letters advocating for a prohibition on physical commodities activities view the GLB Act as a radical break from prior American bank regulatory practice, one that severely narrowed the historical conception of the separation of banking and commerce.

On this subject, however, the truth of the matter is more complicated.  As noted by the banking industry, it was only in 1970 when the principle of the separation of banking and commerce applied to bank holding companies that owned only one bank, and it still does not apply to grandfathered unitary thrift holding companies.  For a more vivid example, one needs go no further than the government office building in which the Federal Reserve’s view on FHC commodity activities will be determined, named after Marriner Eccles, Chairman of the Federal Reserve from 1934 to 1948:  before his appointment, Eccles was “president and owner of 26 banks and one trust company, vice president of one of the largest sugar companies in the United States, president of a multistate dairy concern, president of a significant construction company, and one of the builders of the Boulder Dam, among other enterprises.”[14]

Second, some key concerns of industry critics seem better addressed to Congress than to the Federal Reserve.  With respect to both Section 4(k) and 4(o), critical comment letters argue that members of Congress must have been unaware of what they were enacting, even though the best evidence of what Congress enacted was the actual language it used — Sections 4(k) and 4(o) themselves.  Some of the interpretive methodology used by industry critics — for example, the citation of a senior officer of J.P. Morgan as to his understanding of Section 4(k)’s complementary authority — has been criticized in other areas, and it is no less deserving of criticism here.  The fact that, even after the Financial Crisis, FHCs’ physical commodities activities were left wholly untouched by the almost 900 pages of the Dodd-Frank Act suggests that Congress believed that the scope of current regulation was appropriate.

Third, the public comments do not change the speculative nature of the “underappreciated tail risks” of FHC physical commodities activities.   With respect to these risks, a comment letter from the insurance industry suggests that the principal catastrophic risks can be insured against, and the banking industry’s study on veil piercing provides significant evidence — not rebutted by the other public comments — that liabilities under CERCLA and other environmental statutes likely would be limited to FHC subsidiaries actually engaging in the commodities activities, and not the FHC itself.  For this reason, the original Section 4(k) orders, and their limitation of “complementary” activities to 5% of an FHC’s Tier 1 capital, still appear correct in their view that physical commodities activities do not pose “a substantial risk to the safety or soundness of depository institutions or the financial system generally.”[15]

Fourth, it is clear that the customers of FHCs — the end-user community — are highly concerned that any additional restrictions on FHC commodity activities will have a significant negative effect on their businesses and customers.  Many end-users express the dual concern that restrictions on FHC commodities-related activities will both decrease liquidity in the commodities markets and potentially force end-users to choose between selecting new, unfamiliar, and less-regulated counterparties and changing the way they hedge and engage in business.  Moreover, notwithstanding the press reports cited by critics of the banking industry, end-user companies pointed only to one area of potential abuse, warehousing, principally with respect to the London Metals Exchange


In some ways, perhaps the most salient comment on the Federal Reserve’s ANPR is the continued retreat of FHCs from the physical commodities markets.  Contrary to the apparent position of the ANPR, these decisions do not reflect that physical commodities activities are less “complementary” than they were in 2003 — on this issue, the critical question is whether the fit between physical commodities activities and the financial activities that they support has changed in any material way.  Rather, these exits are persuasive evidence that the additional regulations imposed on FHCs after the Financial Crisis, as well as the potential for further regulation, are themselves materially affecting FHC decision-making in this area.

In addition, the recently announced Barclays exit lends credence to the comments made almost universally by the end-user community that any additional restrictions on FHC physical commodities activities will hasten the pace of FHC departures — a result that the end-user letters consistently state will lead to material adverse effects on their businesses, their customers, and the commodities markets themselves.

   [1]   See 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).

   [2]   In a previous Client Alert,  available at, we analyzed the historical justifications for bank commodity activities in light of the enhanced regulatory framework existing after the passage of the Dodd-Frank Act.

   [3]   Martin Arnold & Daniel Schafer, “Barclays to Pull Out of Commodity Trading:  Retreat Follows Stricter Regulation,” Financial Times, April 21, 2014.

   [4]   Pub. L. 106-102, 113 Stat. 1338 (Nov. 12, 1999).

   [5]   12 U.S.C. § 1843(k).

   [6]   Id. §§ 1843(j)-(k).  Under Section 4(k) of the BHC Act itself, making “merchant banking” investments in non-financial companies is an activity financial in nature.

   [7]   Id. § 1843(o).

   [8]   See Citigroup Inc., 89 Fed. Res. Bull. 508 (2003) (Citigroup Order).

   [9]   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.

  [10]   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.

  [11]   12 U.S.C. § 1851(h)(4) (definition of proprietary trading includes only commodity futures and derivatives).

  [12]   See 79 Fed. Reg. 12414.

  [13]   See (last viewed on April 25, 2014).  The Federal Reserve noted that it had also received more than 11,000 form letters that were not posted on its website.  These short form letters generally stated that FHCs should not be involved in the commodities markets at all.

  [14]   Larraine & Steve Blackham, “How Marriner Eccles Saved America,” The Salt Lake Tribune, January 15, 2011.

  [15]   12 U.S.C. § 1843(k). 

Appendix A – List of Commenters
(click below)

Appendix B – Summary of Key Points Raised by Commenters
(click below)

Appendix C – Thematic Discussion of ANPR Comment Letters
(click below)

Appendix D – Physical Commodities Legal Authorities
(click below)

Gibson, Dunn & Crutcher’s Financial Institutions Practice Group 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, or the following:

Michael D. BoppWashington, D.C. (+1 202-955-8256, [email protected])
Arthur S. Long – New York (+1 212-351-2426, [email protected])
Mark S. Shelton – New York (212-351-3889, [email protected])
Chuck Muckenfuss – Washington, D.C. (+1 202- 955-8514, [email protected])
Jeffrey L. Steiner – Washington, D.C. (+1 202-887-3632, [email protected])
Nicolas H.R. Dumont – New York (+1 212-351-3837, [email protected])
Asad Kudiya – Washington, D.C.  (202-955-8298, [email protected])
Jennifer C. Mansh – Washington, D.C. (202-955-8590, [email protected])
Colin Richard – Washington, D.C. (+1 202-887-3732, [email protected])

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