An Advance Notice of Proposed Rulemaking (ANPR) issued in mid-January by the Federal Reserve Board (the Board) seeks public comment on the scope of permissible physical commodities activities. Such activities have been under the Board’s microscope since 2013 for several reasons, including their riskiness and increased participation by financial holding companies (FHCs).

Under Section 4 of the Bank Holding Company Act (the BHC Act), an FHC can engage directly or indirectly, in physical commodities activities relying on any of the following:

  • As “complementary” to activities that are financial in nature
  • Through a merchant banking investment in a portfolio company
  • Grandfathered activities (subject to a cap of 5 percent of the FHC’s consolidated assets)

“Complementary” Activities

The Board’s orders authorizing physical commodities activities impose quantitative limitations on investments (usually 5 percent of consolidated Tier 1 capital) and revenues (e.g., 5 percent of total consolidated operating revenue). Such activities include trading as principal, advisory services to power plant owners, and entering into tolling agreements with power plant owners. The Board in the ANPR has identified concerns about financial risks with dangers of “market contagion” and about “tail risks” associated with some of these activities.

Noting further that recent environmental disasters have involved some of these physical commodities in the energy field and that most of the FHCs involved in these activities are global systemically important banks (G-SIBs), the Board has issued the ANPR as part of its obligation under the Dodd-Frank legislation to address systemic risks posed by large financial institutions.

Specifically, the Board is inviting comments on the risks associated with physical commodities activities as well as, among other things:

  • The adequacy of both the existing limits (capital- and revenues-based);
  • The efficacy, especially with respect to G-SIBs, of additional safeguards that could be imposed to mitigate legal, reputational, and environmental risks (e.g., enhanced capital requirements, increased insurance requirements, limitation on the percentage of assets and revenue attributable to “complementary” physical commodities activities);
  • Linking regulatory limitations to specific underlying physical commodities; and
  • Negative effects, if any, on a bank if the FHC were forbidden from engaging in these activities altogether.

Merchant Banking Authority

The existing merchant banking regime prohibits FHCs from routine management of portfolio companies (subject to a limited exception for emergency circumstances) and limits the holding period to 10 years. Refocusing the same environmental, financial, and reputation risks discussed above on portfolio companies themselves, the Board seeks comment on whether:

  • The rules on routine management and holding periods for merchant banking investments should be restricted further
  • Existing safeguards adequately protect FHCs against the risk of courts piercing the corporate veil
  • Raising capital-based limitations on specific merchant banking investments or on investments in all portfolio companies in the aggregate would be advisable
  • The risks between merchant banking investments and investments by insurance FHCs in nonfinancial firms should receive similar or disparate treatment

Grandfathered Investments

Finally, the Board seeks comment on whether additional safety and soundness, capital, liquidity, reporting, or disclosure requirements for grandfathered physical commodities activities by FHCs would be effective; how any such requirements should be formulated; and whether there are competitive equity or other issues that need to be considered.

The comment period on the ANPR will close on March 15, 2014. After reviewing the comments, the Board will consider what further action, including a rulemaking, is warranted.

Energy Industry Focus

If further restrictions affecting banking organizations that are involved in trading of physical commodities—especially those trading in electricity and natural gas markets—are ultimately adopted, these will add to the substantial regulatory scrutiny already focused on such banks from a different quarter. The Office of Enforcement of the Federal Energy Regulatory Commission (FERC) has remained focused on fraud and market manipulation in electricity markets in fiscal 2013. This has resulted in some substantial settlements—more than $304 million in civil penalties and disgorgement of almost $141 million in unjust profits that included the largest civil penalty ever assessed by FERC.

In addition to the settlements, on July 16, 2013, a major foreign banking organization and four traders were found to have violated FERC’s anti-manipulation rule. FERC assessed civil penalties of $435 million against Barclays and $18 million against the traders, and it directed a foreign bank to disgorge $34.9 million plus interest in unjust profits. The bank and the traders elected to challenge the penalty in federal court; the Office of Enforcement filed an action to affirm the assessments in the U.S. District Court for the Eastern District of California on October 9, 2013.

Also, in mid-2013, FERC approved a settlement with the energy affiliate of a major U.S. banking organization to resolve an investigation of the company’s bidding practices in California and the Midwest. The company admitted the facts set forth in the agreement, paid $285 million in civil penalties, and disgorged $125 million, but neither admitted nor denied the violations.

Ballard Spahr’s Bank Regulation and Supervision Group regularly advises banking clients on a variety of commodities-related issues and assists clients in preparing comments in rulemaking proceedings. The firm’s Energy and Project Finance Group counsels a variety of clients in their dealings with FERC.

For further information, please contact Keith R. Fisher in the Bank Regulation and Supervision Group at 202.661.2284 or


Copyright © 2014 by Ballard Spahr LLP.
(No claim to original U.S. government material.)

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

Related Practices

Bank Regulation and Supervision
Energy and Project Finance