The Federal Reserve Board (the Board) recently issued an advance notice of proposed rulemaking (the ANPR)1 seeking public comment on issues related to physical commodity activities conducted by financial holding companies (FHCs) and the restrictions imposed on these activities to ensure they are conducted in a safe and sound manner and do not pose a threat to financial stability. The commodities activities on which the Board is seeking comment are activities authorized under the “complementary” authority in Section 4(k)(1)(B) of the Bank Holding Company Act of 1956 (the BHCA) and grandfathered authority in Section 4(o) of the BHCA. The ANPR also seeks comment on merchant banking activities permitted under Section 4(k)(4)(H) of the BHCA.

The ANPR poses 24 questions on which it seeks comment by March 15, 2014.


The BHCA contains three principal authorities that allow an FHC and its subsidiaries to engage in, or invest in companies engaged in, certain physical commodities activities.

  • Section 4(k)(1)(B) permits an FHC, with Board approval, to engage in physical commodities trading and certain other activities that the Board determines to be complementary to a financial activity and not to pose a substantial risk to the safety and soundness of depository institutions or the financial system generally.
  • Section 4(k)(4)(H) permits an FHC to engage in merchant banking investments in nonfinancial companies as part of a bona fide securities underwriting or merchant or investment banking activity, including in a company that engages in physical commodities activities; and
  • Section 4(o) grandfathers certain physical commodities activities engaged in by a company that became an FHC after November 12, 1999, so long as the grandfathered activities do not exceed 5% of the FHC’s total consolidated assets.

Physical Commodities Activities

Currently, FHCs are permitted to engage in three types of physical commodities activities, subject to a number of conditions and restrictions designed to limit the level of such activities and the associated risks:

  • physical commodities trading involving the purchase and sale of commodities in the spot market and taking and making delivery of physical commodities to settle commodity derivatives;
  • paying power plant owners fixed periodic payments that compensate the owner for its fixed costs in exchange for the right to all or part of the plant’s power output; and
  • providing transactions and advisory services to power plant owners (collectively, Complementary Commodities Activities).

In the ANPR, the Board states that recent environmental disasters involving physical commodities (e.g., explosions of natural gas pipelines, oil spills, leaking of radioactive water from the Fukushima Daiichi nuclear power plant) make it “prudent to determine [the limits on Complementary Commodities Activities’] adequacy in protecting safety and soundness and financial stability.” The Board notes that “the cost of preventing accidents are high and the costs and liability related to physical commodity activities can be difficult to limit and higher than expected.” Another concern is that 11 of the 12 FHCs that engage in Complementary Commodities Activities are designated as global systemically important banks and their involvement in a disaster involving such activities could lead to market contagion, as highlighted by the financial crisis.

The Board is seeking comment on each aspect of the FHCs’ physical commodities activities, including the risks associated with these activities and the adequacy of the limitations currently being imposed on these activities. The questions posed provide insight into the types of measures the Board is considering taking with respect to Complementary Commodities Activities, including (i) increased insurance and capital requirements and (ii) reducing the amount of assets and revenue attributable to such activities, including absolute dollar limits and caps based on a percentage of an FHC’s regulatory capital or revenue.

The Board also questions whether the authority for FHCs to engage in Complementary Commodities Activities is still necessary to ensure competitive equality between FHCs and competitors that conduct commodities derivatives and other related activities, noting that fewer than 20 FHCs have sought authority to conduct Complementary Commodities Activities and that two of the 12 FHCs that currently conduct physical commodities activities under Complementary Authority recently have publicly reported that they intend to cease such activities while continuing to engage in related financial activities, including commodities derivatives activities.

Merchant Banking Authority

As noted above, the BHCA permits an FHC, subject to certain limitation, to engage in merchant banking investments in nonfinancial companies. The Board is considering various actions to address the potential risks associated with merchant banking investments, including (i) more restrictive merchant banking investment holding periods, (ii) additional restrictions on the routine management of merchant banking investments, (iii) additional capital requirements on some or all merchant banking investments and (iv) enhanced reporting to the Federal Reserve of public disclosures regarding merchant banking investments.

The Board’s review of merchant banking activities is not limited to physical commodities activities, but extends to all merchant banking activities. There is limited reference to an FHC’s risks related to physical commodities activities, and the Board appears more concerned with the risk to an FHC if a court were to pierce the corporate veil, notwithstanding the requirement that an FHC establish policies and procedures designed to ensure corporate separateness between itself and its merchant banking portfolio companies to protect the FHC and its subsidiary insured depository institutions from legal liability from the operations and financial obligations of its merchant banking portfolio companies.

Grandfather Authority

Section 4(o) of the BHCA permits a company that was not a bank holding company and becomes an FHC after November 12, 1999, to continue to engage in activities related to the trading, sale or investment in commodities that were not permissible for bank holding companies as of September 30, 1997, if the company was lawfully engaged in such activities in the United States. This statutory grandfathering permits certain bank holding companies to engage in a potentially broader set of physical commodities activities than FHCs may conduct under the complementary authority. The Board seeks comment on whether additional prudential requirements could help ensure that activities conducted under Section 4(o) of the BHCA do not pose undue risks to safety and soundness or to financial stability and is considering how to address potential risks to safety and soundness and financial stability.