The Board of Governors of the Federal Reserve System recommended a further limiting of the non-core bank activities that financial holding companies may engage in, by proposing that Congress repeal the authority of FHCs to invest in non-financial companies as part of a bona fide merchant or investment banking activity (including the authority to make investments in portfolio companies engaged in physical commodity activities) and the grandfathered authority of two FHCs to engage in physical commodity activities directly. (FHCs include certain bank holding companies and foreign banking organizations that meet heightened regulatory standards imposed by the FRB.) According to the FRB, “commercial activities conducted by portfolio companies held by FHCs under merchant banking authority may cause, or may be affected by, catastrophic and environmental events that, in turn, could pose substantial legal and environmental risks.” Although the FRB acknowledged the significant constraints it currently imposes on FHC’s that engage in merchant banking activity to mitigate the risks imposed by such activities, it said a total ban is necessary to “maintain the basic tenet of separation of banking and commerce." The FRB, along with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, also made recommendations to restrict or to study the potential restriction of other non-core banking activities of FHCs, state-chartered insured banks, national banks, federal savings associations and federal branches and agencies of foreign banks. Among other things, the OCC indicated it is studying the risks to federal banking entities potentially incurred by membership in clearinghouses, “particularly clearinghouse with rules that do not cap members’ liability.” The three banking agencies issued their recommendations in response to a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act that required them to conduct a study of activities engaged in by banking entities, including the risks of such activities, and to propose additional measures to help mitigate any risks to the “safety and soundness” of such entities. The so-called "Volcker Rule" under the Dodd-Frank law (click here to access) already imposes strict restrictions on the authority of federal banking entities to engage in proprietary trading and certain asset management activities.
My View: I don’t pretend to be a banking regulation expert, but in fact, my return to the legal side from the business side in 1995, was prompted by my role in helping Fimat USA Inc. gain FRB approval to acquire the assets of my former employer, Brody White & Company, Inc., a futures commission merchant that brokered, among other things, exchange-traded commodity derivatives (I previously served as president of BWC). It is important to note that, in the first instance, bank holding companies and foreign banking organizations must be adjudged to be well-capitalized and well-managed to qualify as an FHC. Only FHCs may engage in certain non-core banking activities including merchant banking activities. However, to engage in merchant banking activities, FHCs are subject to another host of limitations, including restrictions on the holding period of such investments and restrictions on the routine management and operations of an underlying portfolio company, as well as limitations on cross-marketing and affiliate transactions. To engage in merchant banking activities, the FRB also imposes on FHCs requirements related to policies and procedures and risk monitoring systems, among a number of other specially crafted obligations. Notwithstanding, the FRB now concludes its restrictions on such activities and its monitoring of such activities are not good enough, and the only alternative is to ban such activities entirely. This seems as much a condemnation of the merchant banking activities performed by FHCs as well as of the FRB’s own supervisory oversight. Moreover, a very important element missing in the study issued by the three banking agencies is a cost benefit analysis of the implications of banning the proposed enumerated activities by banking entities. If eliminating more permissible activities by banking entities reduces competition in certain commercial activity (thus, potentially increasing prices to consumers), or if substantially less revenue opportunities might threaten the safety and soundness of banking entities, then perhaps the three banking agencies' recommendations should not have been issued “as is.”