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Industry Letters

Supplemental Guidance on Procedures For Review and/or Approval of Certain New Products

October 26, 2010

Activities of Banking Organizations Conducted on an Agency Basis

To Institutions Addressed


On January 10, 2007, the Department issued an All Institutions Letter attaching a Department All Examiner Memorandum (“AEM”), AEM 2006-10, concerning Department review/approval requirements for certain new complex banking products.

AEM 2006-10 dealt with the possible need for prior review and/or approval by the Department when banking institutions, including New York-licensed branches and agencies of foreign banks, issue or trade in certain new complex products, due to the fact that such activities could raise either legal permissibility or safety and soundness concerns.  Examples of such complex products include commodity- and equity-linked derivative products (e.g. swaps, forwards, futures, options, notes and related hedging activities), as well as other complex financing or loan structures, where such structures are tax-driven or involve the use of special purpose vehicles, for example.  AEM 2006-10 was primarily concerned with and written from the point of view of banking institutions engaging in such activities as principal.

Questions have arisen whether the procedures set forth in AEM 2006-10 are applicable when a banking institution proposes to conduct such activities only in an agency capacity, not involving booking of such assets or trades on the institution’s own books in New York. This has been a common inquiry particularly by New York licensed branches and agencies of foreign banks, which often propose to conduct certain trading activities on behalf of affiliates or non-New York offices of the foreign bank.

The Department has issued a supplemental AEM addressing the Department’s review process when such activities will be conducted by a banking institution, including a New York licensed branch or agency of a foreign bank, on an agency basis.

The supplemental AEM, AEM 2010-04, is attached for your information and guidance.  Any questions concerning this Industry Letter or the AEM may be directed to Deputy Superintendent Regina Stone, Foreign and Wholesale Banks Division, at (212) 709-1500, or Deputy General Counsel Rosanne Notaro, at (212) 709-1663.

Richard H. Neiman
Superintendent of Banks
New York State Banking Department

 

ALL EXAMINER MEMORANDUM 2010-04

SUPPLEMENTAL GUIDANCE ON PROCEDURES FOR REVIEW AND/OR APPROVAL OF CERTAIN NEW PRODUCTS/ACTIVITIES OF BANKING ORGANIZATIONS (AEM 2006-10 SUPPLEMENT)

Introduction

This AEM constitutes a supplement to AEM 2006-10, which was issued on December 29, 2006, relating to the requirement for Banking Department review and/or approval of certain new products of banking organizations.

AEM 2006-10 dealt with the possible need for prior review and/or approval by the Department when banking institutions, including New York-licensed branches and agencies of foreign banks, issue or trade in certain new complex products, due to the fact that such activities could raise either legal permissibility or safety and soundness concerns.  Examples of such complex products include commodity- and equity-linked derivative products (e.g. swaps, forwards, futures, options, notes and related hedging activities), as well as other complex financing or loan structures, where such structures are tax-driven or involve the use of special purpose vehicles, for example.  AEM 2006-10 was primarily concerned with and written from the point of view of  banking institutions engaging in such activities as principal.

Questions have arisen whether the procedures set forth in AEM 2006-10 are applicable when a banking institution proposes to conduct such activities only in an agency capacity, not involving booking of such assets or trades on the institution’s own books in New York. This has been a common inquiry particularly by New York licensed branches and agencies of foreign banks (“New York Offices”), which often propose to conduct certain trading activities on behalf of affiliates or non-New York offices of the foreign bank (“Affiliates” or “Offshore Offices”).

Banking Organizations Conducting Activities on an Agency Basis

For the reasons set forth below, with respect to such agency-only activities involving complex products of the type discussed in AEM-2006-10, the Department still would expect certain information to be submitted by the banking institution, in order to evaluate the proposal. 

Banking institutions engaged in offering and trading complex products such as derivatives, even only on an agency basis, still have substantial risk management challenges and can easily subject the institution to undue risks, including litigation or reputation risk.  Accordingly, the Department has an interest in evaluating whether a banking institution will be conducting such activities prudently, even if such trades or other products will not be booked in New York.  Further, by evaluating the arrangement between the New York Office and the Affiliate or Offshore Office, the Department is able to determine whether the New York Office is de facto conducting the activities as agent, or whether the New York Office is exercising too much discretion or decision-making authority for such activities to be viewed realistically as agency activities.

In connection with a proposal to engage in agency-only activities, an initial submission to the Banking Department should, at a minimum, include the following:

  1. the service level agreement between the New York Office and the Affiliate or Offshore Office

  2. transactional/ customer deal documentation; and

  3. description of risk management procedures for the activities, including policies and procedures

The foregoing information will assist the Department in assessing such aspects as

  1. whether it is clear from the customer’s perspective that the New York Office is acting only as agent

  2. whether it is clear that the New York Office has limited discretion in conducting the activities, and where decision-making concerning products, trades, position limits, etc. resides

  3. whether the activities will be prudently managed and conducted in a safe and sound manner, and the roles of personnel at the New York Office versus the Affiliate or Offshore Office in managing them

  4. whether the New York Office is engaging in activities indirectly that it might not be permitted to engage in directly and in effect booking such activities with another entity or offshore

As a general matter, when a banking institution is conducting activities only as agent, the legal issue of whether the activity is permissible for a New York banking institution (or branch or agency of a foreign bank) is not implicated because the activities do not involve the banking organization booking a position or owning an instrument, even if such product or instrument is based on an asset (such as commodities, equities or real property) that banking institutions generally are not permitted to trade or own in the U.S.  It should be noted that foreign banking corporations often have broader investment and trading powers in their country of domicile.  Therefore, booking or owning a certain product or security may be permitted for a foreign office but not for the New York office of a foreign banking corporation.  Thus, it usually will not be required for an agency-only proposal for the institution or its counsel to submit an analysis of the bank-permissible nature of the activity in order to demonstrate that the activity is within the authorized powers of New York banking institutions.  Nevertheless, as indicated above, the Department has an interest in reviewing the proposed agency activities and the terms on which they will be conducted in order to assure itself not only that the activities will be properly managed, but that the activities are in fact bona fide agency activities.

 

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