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Board Interpretations of Regulation K

3-689

“AGENCY”—Status of Certain Offices for Purposes of the International Banking Act Restrictions on Interstate Banking Operations

See Board interpretation 12 CFR 211.601 at 3-690.
3-690

“BRANCH”—Status of Certain Offices for Purposes of the International Banking Act Restrictions on Interstate Banking Operations

The Board has considered the question of whether a foreign bank’s California office that may accept deposits from certain foreign sources (e.g., a United States citizen residing abroad) is a branch or an agency for the purposes of the grandfather provisions of section 5 of the International Banking Act of 1978 (12 USC 3103(b)). The question has arisen as a result of the definitions in the International Banking Act of “branch” and “agency” and the limited deposit-taking capabilities of certain California offices of foreign banks.
The International Banking Act defines “agency” as “any office . . . at which deposits may not be accepted from citizens or residents of the United States,” and defines “branch” as “any office . . . of a foreign bank . . . at which deposits are received” (12 USC 3101(1) and (3)). Offices of foreign banks in California prior to the International Banking Act were generally prohibited from accepting deposits by the requirement of state law that such offices obtain federal deposit insurance (Cal. Fin. Code § 1756); until the passage of the International Banking Act an office of a foreign bank could not obtain such insurance. California law, however, permits offices of foreign banks, with the approval of the Banking Department, to accept deposits from any person that resides, is domiciled, and maintains its principal place of business in a foreign country (Cal. Fin. Code § 1756.2). Thus, under a literal reading of the definitions of “branch” and “agency” contained in the International Banking Act, a foreign bank’s California office that accepts deposits from certain foreign sources (e.g., a U.S. citizen residing abroad), is a branch rather than an agency.
Section 5 of the International Banking Act establishes certain limitations on the expansion of the domestic deposit-taking capabilities of a foreign bank outside its home state. It also grandfathers offices established or applied for prior to July 27, 1978, and permits a foreign bank to select its home state from among the states in which it operated branches and agencies on the grandfather date. If a foreign bank’s office that was established or applied for prior to June 27, 1978, is a “branch,” as defined in the International Banking Act, then it is grandfathered as a branch. Accordingly, a foreign bank could designate a state other than California as its home state and subsequently convert its California office to a full domestic deposit-taking facility by obtaining federal deposit insurance. If, however, the office is determined to be an agency, then it is grandfathered as such and the foreign bank may not expand its deposit-taking capabilities in California without declaring California its home state.
In the Board’s view, it would be inconsistent with the purposes and the legislative history of the International Banking Act to enable a foreign bank to expand its domestic interstate deposit-taking capabilities by grandfathering these California offices as branches because of their ability to receive certain foreign source deposits. The Board also notes that such deposits are of the same general type that may be received by an Edge corporation and, hence, in accordance with section 5(a) of the International Banking Act, by branches established and operated outside a foreign bank’s home state. It would be inconsistent with the structure of the interstate banking provisions of the International Banking Act to grandfather as full deposit-taking offices those facilities whose activities have been determined by Congress to be appropriate for a foreign bank’s out-of-home-state branches.
Accordingly, the Board, in administering the interstate banking provisions of the IBA, regards as agencies those offices of foreign banks that do not accept domestic deposits but that may accept deposits from any person that resides, is domiciled, and maintains its principal place of business in a foreign country. 1980 Fed. Res. Bull. 902; 12 CFR 211.601.
3-693

FOREIGN BANKING ORGANIZATIONS—Permissible Underwriting Activities

Introduction. A number of foreign banks that are subject to the Bank Holding Company Act (BHC Act) have participated as co-managers in the underwriting of securities to be distributed in the United States despite the fact that the foreign banks in question do not have authority to engage in underwriting activity in the United States under either the Gramm-Leach-Bliley Act (GLB Act) or section 4(c)(8) of the BHC Act (12 USC 1843(c)(8)). This interpretation clarifies the scope of existing restrictions on underwriting by such foreign banks with respect to securities that are distributed in the United States.
Underwriting transactions engaged in by foreign banks. In the transactions in question, a foreign bank typically becomes a member of the underwriting syndicate for securities that are registered and intended to be distributed in the United States. The lead underwriter, usually a registered U.S. broker-dealer not affiliated with the foreign bank, agrees to be responsible for distributing the securities being underwritten. The underwriting obligation is assumed by a foreign office or affiliate of the foreign bank.
The foreign banks have used their U.S. offices or affiliates to act as liaison with the U.S. issuer and the lead underwriter in the United States, to prepare documentation and to provide other services in connection with the underwriting. In some cases, the U.S. offices or affiliates that assisted the foreign bank with the underwriting receive a substantial portion of the revenue generated by the foreign bank’s participation in the underwriting. In other cases, the U.S. offices receive “credit” from the head office of the foreign bank for their assistance in generating profits arising from the underwriting.
By assuming the underwriting risk and booking the underwriting fees in their foreign offices or affiliates, the foreign banks are able to take advantage of an exemption under U.S. securities laws; a foreign underwriter is not required to register in the United States if the underwriter either does not distribute any of the securities in the United States or distributes them only through a registered broker-dealer.
Permissible scope of underwriting activities. A foreign bank that is subject to the BHC Act may engage in underwriting activities in the United States only if it has been authorized under section 4 of the Act. The foreign banks in question have argued that they are not engaged in underwriting activity in the United States because the underwriting activity takes place only outside the United States where the transaction is booked. The foreign banks refer to Regulation K, which defines “engaged in business” or “engaged in activities” to mean conducting an activity through an office or subsidiary in the United States. Because the underwriting is not booked in a U.S. office or subsidiary, the banks assert that the activity cannot be considered conducted in the United States.
The Board believes that the position taken by the foreign banks is not supported by the Board’s regulations or policies. Section 225.124 of the Board’s Regulation Y (12 CFR 225.124(d)) states that a foreign bank will not be considered to be engaged in the activity of underwriting in the United States if the shares to be underwritten are distributed outside the United States. In the transactions in question, all of the securities to be underwritten by the foreign banks are distributed in the United States.
Regulation K (12 CFR 211) was amended in 1985 to provide clarification that a foreign bank may not own or control voting shares of a foreign company that directly underwrites, sells, or distributes securities in the United States (emphasis added) (12 CFR 211.23(f)(5)(ii)). In proposing this latter provision, the Board clarified that no part of the prohibited underwriting process may take place in the United States and that the prohibition on the activity does not depend on the activity being conducted through an office or subsidiary in the United States. Moreover, in the transactions in question, there was significant participation by U.S. offices and affiliates of the foreign banks in the underwriting process. In some transactions, the foreign office at which the transactions were booked did not have any documentation on the particular transactions; all documentation was maintained in the United States office. In all cases, the U.S. offices or affiliates provided virtually all technical support for participation in the underwriting process and benefitted from profits generated by the activity.
The fact that some technological and regulatory constraints on the delivery of cross-border services into the United States have been eliminated since the Regulation K definition of “engaged in business” was adopted in 1979 creates greater scope for banking organizations to deal with customers outside the U.S. bank regulatory framework. The definition in Regulation K, however, does not authorize foreign banking organizations to evade regulatory restrictions on securities activities in the United States by directly underwriting securities to be distributed in the United States or by using U.S. offices and affiliates to facilitate the prohibited activity. In the GLB Act, Congress established a framework within which both domestic and foreign banking organizations may underwrite and deal in securities in the United States. The GLB Act requires that banking organizations meet certain financial and managerial requirements in order to be able to engage in these activities in the United States. The Board believes the practices described above undermine this legislative framework and constitute an evasion of the requirements of the GLB Act and the Board’s Regulation K. Foreign banking organizations that wish to conduct securities underwriting activity in the United States have long had the option of obtaining section 20 authority and now have the option of obtaining financial holding company status.
Conclusion. The Board finds that the underwriting of securities to be distributed in the United States is an activity conducted in the United States, regardless of the location at which the underwriting risk is assumed and the underwriting fees are booked. Consequently, any banking organization that wishes to engage in such activity must either be a financial holding company under the GLB Act or have authority to engage in underwriting activity under section 4(c)(8) of the BHC Act (so-called section 20 authority). Revenue generated by underwriting bank-ineligible securities in such transactions should be attributed to the section 20 company for those foreign banks that operate under section 20 authority. 12 CFR 211.605.
3-695

FOREIGN BRANCHES—Joint

The provisions of section 25 of the Federal Reserve Act, while authorizing any national bank to establish an individual foreign branch, do not authorize the national bank to operate a joint branch with another national bank. Digest of 1915 Fed. Res. Bull. 308.
3-696

FOREIGN BRANCHES—Relationship with Parent Corporation

A foreign branch established by a national bank is not an independent corporation and the creditors of the branch are general creditors of the parent bank. (A full discussion of the relationship between a foreign branch and its parent corporation.) Digest of 1917 Fed. Res. Bull. 198.
3-697

FOREIGN BRANCHES—Reserves

Section 19 of the Federal Reserve Act, which prescribes the reserves to be carried by member banks, does not apply to foreign branches of national banks; but, under the special power vested in the Federal Reserve Board by section 25 of such act to prescribe conditions and regulations under which foreign branches may be established, the Board is authorized to prescribe the amount, character, and location of reserves to be maintained against deposits received in such branches. Digest of 1918 Fed. Res. Bull. 1123.
3-699

FOREIGN BRANCHES—Reserves Against Credit to Domestic Subsidiaries of Edge Corporations

The Board of Governors recently considered the applicability of section 213.7 of [old] Regulation M* to credit extended by a foreign branch of a member bank to a domestically chartered financing subsidiary of the member bank’s subsidiary Edge Act corporation. The financing subsidiary proposed to use the credit to make loans and investments abroad. Such loans would not be to United States residents; such investments would not involve the acquisition of assets from the member bank (other than assets described in clause (2) of footnote 7 to section 213.7).
Section 213.7 is designed to affect the flow of foreign funds into the domestic banking system. Section 213.7(b)(2) exempts from reserve requirements credit extended to enable the borrower to comply with requirements of the Office of Foreign Direct Investments, Department of Commerce. The justification for that exemption is that the borrowing does not directly affect the availability of credit for use in the United States.
Consistent with the purpose of section 213.7 and the exemption for credits under the OFDI program, the Board concluded that a foreign branch of a member bank need not maintain reserves against credit extended to a domestically chartered financing subsidiary of any of the member bank’s Edge Act corporations on any portion of the credit that is used by the financing subsidiary to make loans and investments abroad of the type proposed. 1971 Fed. Res. Bull. 1001.
*
The Regulation M referred to here has since been incorporated into Regulation K. This does not refer to the Board’s current Regulation M, “Consumer Leasing.”

FOREIGN BRANCHES—Deposits in Guaranteed by U.S. Office

See Board interpretation at 2-260.55.
3-705

FOREIGN SUBSIDIARIES—Operations

In a previous interpretation, the Board determined that a state member bank would not violate the “stock-purchase prohibition” of section 5136 of the Revised Statutes (12 USC 24 ¶ 7) by purchasing and holding the shares of a corporation which performs “at locations at which the bank is authorized to engage in business, functions that the bank is empowered to perform directly”1 (1968 Fed. Res. Bull. 681, 12 CFR 250.141). The Board of Governors has been asked by a state member bank whether, under that interpretation, the bank may establish such a so-called “operations subsidiary” outside the United States.
In the above interpretation the Board viewed the creation of a wholly owned subsidiary which engaged in activities that the bank itself could perform directly as an alternative organizational arrangement that would be permissible for member banks unless “its use would be inconsistent with other federal law, either statutory or judicial”.
In the Board’s judgment, the use by a member bank of operations subsidiaries outside the United States would be clearly inconsistent with the statutory scheme of the Federal Reserve Act governing the foreign investments and operations of member banks. It is clear that Congress has given member banks the authority to conduct operations and make investments outside the United States only through gradually adopting a series of specific statutory amendments to the Federal Reserve Act, each of which has been carefully drawn to give the Board approval, supervisory, and regulatory authority over those operations and investments.
As part of the original Federal Reserve Act, national banks were, with the Board’s permission, given the power to establish foreign branches.2 In 1916, Congress amended the Federal Reserve Act to permit national banks to invest in international or foreign banking corporations know as “agreement” corporations, because such corporations were required to enter into an agreement or understanding with the Board to restrict their operations. Subject to such limitations or restrictions as the Board may prescribe, such agreement corporations may principally engage in international or foreign banking, or banking in a dependency or insular possession of the United States, either directly or through the agency, ownership or control of local institutions in foreign countries, or in such dependencies or insular possessions of the United States. In 1919 the enactment of section 25(a) of the Federal Reserve Act (the “Edge Act”) permitted national banks to invest in federally chartered international or foreign banking corporations (so-called Edge corporations) which may engage in international or foreign banking or other international or foreign financial operations, or in banking or other financial operations in a dependency or insular possession of the United States, either directly or through the ownership or control of local institutions in foreign countries, or in such dependencies or insular possessions. Edge corporations may only purchase and hold stock in certain foreign subsidiaries with the consent of the Board. And in 1966, Congress amended section 25 of the Federal Reserve Act to allow national banks to invest directly in the shares of a foreign bank. In the Board’s judgment, the above statutory scheme of the Federal Reserve Act evidences a clear congressional intent that member banks may only purchase and hold stock in subsidiaries located outside the United States through the prescribed statutory provisions of sections 25 and 25(a) of the Federal Reserve Act. It is through these statutorily prescribed forms of organization that member banks must conduct their operations outside the United States.
To summarize, the Board has concluded that a member bank may only organize and operate “operations subsidiaries” at locations in the United States. Investments by member banks in foreign subsidiaries must be made either with the Board’s permission under section 25 of the Federal Reserve Act or, with the Board’s consent, though an Edge corporation subsidiary under section 25(a) of the Federal Reserve Act or through an agreement corporation subsidiary under section 25 of the Federal Reserve Act. In addition, it should be noted that bank holding companies may acquire the shares of certain foreign subsidiaries with the Board’s approval under section 4(c)(13) of the Bank Holding Company Act. These statutory sections taken together already give member banks a great deal of organizational flexibility in conducting their operations abroad. 1975 Fed. Res. Bull. 169; 12 CFR 250.143.
1
National banking associations are prohibited by section 5136 of the Revised Statutes from purchasing and holding shares of any corporation except those corporations whose shares are specifically made eligible by statute. This prohibition is made applicable to state member banks by section 9, paragraph 20 of the Federal Reserve Act (12 USC 335).
2
Under section 9 of the Federal Reserve Act, state member banks, subject, of course, to any necessary approval from their state banking authority, may establish foreign branches on the same terms and subject to the same limitations and restrictions as are applicable to the establishment of branches by national banks (12 USC 321). State member banks may also purchase and hold shares of stock in Edge or agreement corporations and foreign banks because national banks, as a result of specific statutory exceptions to the stock purchase prohibitions of section 5136, can purchase and hold stock in these corporations or banks.
3-706

FOREIGN SUBSIDIARIES—Use of to Sell Long-Term Debt Obligations

In a request for an interpretation filed with the Board by a member bank and its parent bank holding company, the issue arose whether it would be a permissible activity for one of their existing foreign subsidiary corporations, subject to the provisions of either sections 25 or 25(a) of the Federal Reserve Act or section 4(c)(13) of the Bank Holding Company Act, to sell long-term debt obligations in foreign markets and to transfer the proceeds of these obligations to its United States parent(s) for domestic purposes.
Under the specific proposal put forward, a foreign subsidiary of the parent bank holding company would sell debt obligations in foreign markets, which obligations would have initial maturities in excess of seven years and may or may not be supported by the guaranty of its parent bank holding company. The foreign subsidiary in question would have substantial other international or foreign business and would be performing an activity that its parent bank holding company could perform directly, i.e., raising capital funds through the sale of long-term debt obligations.
Under the eighth paragraph of section 25(a) of the Federal Reserve Act (12 USC 615), an Edge corporation may, with the prior consent of the Board, purchase and hold stock of a corporation that is “not engaged in the general business of buying or selling goods, wares, merchandise or commodities in the United States, and not transacting any business in the United States except such as in the judgment of the Board . . . may be incidental to its international or foreign business.” Similarly, under the tenth paragraph of the same section, an Edge corporation shall not “carry on any part of its business in the United States except such as in the judgment of the Board .  . . may be incidental to its international or foreign business.” Pursuant to the third paragraph of section 25 of the Federal Reserve Act, a national banking association1 may acquire and hold, directly or indirectly, stock or other evidences of ownership in a foreign bank as long as such foreign bank is “not engaged, directly or indirectly, in any activity in the United States except as, in the judgment of the Board . . . shall be incidental to the international or foreign business of such foreign bank.” Finally, section 4(c)(13) of the Bank Holding Company Act exempts from the nonbanking prohibitions of section 4 of the act “shares of, or activities conducted by, any company which does no business in the United States except as an incident to its international or foreign business.”
In the Board’s judgment, the slight wording differences between the quoted portions of the above statutes were not intended by Congress to bear any meaningful significance. Accordingly, the Board has interpreted these provisions in the past as being synonymous2 and this interpretation applies to each of the above statutory provisions.
To the extent that the foreign subsidiary in question is involved in the issuance of long-term debt obligations in foreign markets, there is no legal issue raised since that subsidiary would clearly be engaging in permissible foreign activities. However, an issue is raised whether the transfer of the proceeds of those obligations to its parent institution causes such foreign subsidiary to be “doing” or transacting business within the United States in violation of the statutory provisions set forth above.
The Board has determined that the foreign subsidiary in question is not “transacting” or “doing” business in the United States by the mere transfer of proceeds of its long-term foreign debt obligations to its parent corporation. In the Board’s judgment, the foreign subsidiary is essentially providing a service to its parent in that it is serving as its parent’s alter ego for the limited purpose of obtaining long-term funds that the parent could otherwise obtain directly.3 The transfer of borrowing proceeds between a United States parent and its foreign subsidiary in this situation can thus be viewed as not more than an intraorganizational transaction for the parent’s benefit. In the Board’s view, such a transaction is distinguishable from a commercial loan to a third-party United States resident by a foreign subsidiary, which loan would bring a foreign subsidiary into direct lending competition with domestic banking organizations.
In the Board’s judgment, this interpretation applies only to a situation where a foreign subsidiary, acting on behalf of its parent organization, issues debt obligations abroad for the sole and express purpose of supplying funds to its parent organization. To meet this test, the board believes three conditions must be satisfied: (1) the foreign subsidiary should be wholly owned (except for director’s qualifying shares, if any) by its United States parent organization(s); (2) the proceeds repatriated should be no greater in amount than the amount of debt issued abroad; and (3) the proceeds should be repatriated on approximately the same terms and conditions as the obligations issued by the foreign subsidiary. 1977 Fed. Res. Bull. 59; formerly designated 12 CFR 211.112 and 225.136.
1
Paragraph 20 of section 9 of the Federal Reserve Act (12 USC 335) makes the provisions of section 25 applicable to state member banks.
2
See section 225.4(f)(1) of Regulation Y, wherein the Board has by regulation applied to foreign subsidiaries of domestic bank holding companies the Edge Act limitations on activities in the United States.
3
While such a foreign subsidiary may be viewed as providing a service to its parent bank holding company, the Board nevertheless believes that any bank holding company that plans to acquire shares of a foreign corporation to engage solely in the activities described herein will have to file an application under section 4(c)(13) of the Bank Holding Company Act and section 225.4(f) of Regulation Y. (See in this regard the Board’s prior ruling on foreign operations subsidiaries, 12 CFR 250.143 at 3-705).
3-707

FOREIGN SUBSIDIARIES—Data Processing Activities

Introduction
As a result of a recent proposal by a bank holding company to engage in data processing activities abroad, the Board has considered the scope of permissible data processing activities under Regulation K (12 CFR 211). This question has arisen as a result of the fact that section 211.5(d)(10) of Regulation K does not specifically indicate the scope of data processing as a permissible activity abroad.
Scope of Data Processing Activities
Prior to 1979, the Board authorized specific banking organizations to engage in data processing activities abroad with the expectation that such activity would be primarily related to financial activities. When Regulation K was issued in 1979, data processing was included as a permissible activity abroad. Although the regulation did not provide specific guidance on the scope of this authority, the Board has considered such authority to be coextensive with the authority granted in specific cases prior to the issuance of Regulation K, which relied on the fact that most of the activity would relate to financial data. Regulation K does not address related activities such as the manufacture of hardware or the provision of software or related or incidental services.
In 1979, when the activity was included in Regulation K for the first time, the data processing authority in Regulation K was somewhat broader than that permissible in the United States under Regulation Y (12 CFR 225) at that time, as the Regulation K authority permitted limited nonfinancial data processing. In 1979, Regulation Y authorized only financial data processing activities for third parties, with very limited exceptions. By 1997, however, the scope of data processing activities under Regulation Y was expanded such that bank holding companies are permitted to derive up to 30 percent of their data processing revenues from processing data that is not financial, banking, or economic. Moreover, in other respects, the Regulation Y provision is broader than the data processing provision in Regulation K.
In light of the fact that the permissible scope of data processing activities under Regulation Y is now equal to, and in some respects broader than, the activity originally authorized under Regulation K, the Board believes that section 211.5(d)(10) should be read to encompass all of the activities permissible under section 225.28(b)(14) of Regulation Y. In addition, the limitations of that section would also apply to section 211.5(d)(10).
Applications
If a U.S. banking organization wishes to engage abroad in data processing or data transmission activities beyond those described in Regulation Y, it must apply for the Board’s prior consent under section 211.5(d)(20) of Regulation K. In addition, if any investor has commenced activities beyond those permitted under section 225.28(b)(14) of Regulation Y in reliance on Regulation K, it should consult with staff of the Board to determine whether such activities have been properly authorized under Regulation K. 12 CFR 211.604.
3-710

INVESTMENTS—In Edge Corporations and International Banking Corporations Organized Under State Law

The Board has ruled heretofore that any national bank which desires to invest in the stock of a corporation organized under the provisions of section 25(a) of the Federal Reserve Act must make application to the Board for permission to subscribe to such stock. That ruling was not intended as an interpretation of the law but was promulgated as a matter of regulation based upon practical considerations. Upon careful consideration of the practical value of this requirement in the light of experience, the Board has decided to withdraw this ruling and will no longer require national banks to obtain the board’s permission before purchasing stock in Edge corporations. It should be remembered, however, that national banks are required by the terms of section 25 to apply for and obtain permission of the Federal Reserve Board before investing in the stock of international banking or financial corporations organized under state law; and that the aggregate amount of stock held by any national bank in all corporations engaged in business of the kind described in sections 25 and 25(a) of the Federal Reserve Act must not exceed 10 percent of the subscribing bank’s capital and surplus. X-3195; Sept. 8, 1921.
3-711

INVESTMENTS—By Edge Corporation in Combination Export Manager

The Board of Governors has been presented with the question whether a corporation organized under section 25(a) of the Federal Reserve Act (an “Edge corporation”) may acquire and hold a noncontrolling stock interest in a company engaged in the United States in the business of combination export manager.
The company and the clients for which it acts as export sales manager are located in the United States. Through designated agents and distributors abroad, the company obtains foreign orders for its clients in the United States or, against firm orders from abroad, itself purchases merchandise from them and reinvoices it for export. In no case does the company maintain inventories of unsold merchandise, nor does it make any sales in the United States.
The eighth paragraph of section 25(a) of the Federal Reserve Act (12 USC 615) authorizes an Edge corporation, with the consent of the Board, “to purchase and hold stock or other certificates of ownership in any other corporation organized . . . under the laws of any foreign country or a colony or dependency thereof, or under the laws of any state, dependency, or insular possession of the United States but not engaged in the general business of buying or selling goods, wares, merchandise or commodities in the United States, and not transacting any business in the United States except such as in the judgment of the Board . . . may be incidental to its international or foreign business.”
The Board recognized the closeness of the question whether the company is engaged in the general business of buying or selling goods in the United States. It concluded, however, that the activities of the company in acting as agent or broker for foreign clients where there is no market risk on the part of the company, or in acting as principal where there are offsetting firm orders for foreign clients, would not cause it to be “engaged in the general business of buying or selling goods, wares, merchandise or commodities in the United States.  . . .”
While the activities of the company are closely related to those of companies engaged in a commercial business in the United States, the sole business of the company is to act as an intermediary between domestic manufacturers and foreign consumers. Moreover, the company is exclusively concerned with the effecting of international transactions, and its activities in the United States are entirely directed to that end. Accordingly, it was the judgment of the Board that the activities of the company in the United States are “incidental to its international or foreign business.”
Inasmuch as the activities of the company in the United States conform to the requirements contained in the eighth paragraph of section 25(a) of the Federal Reserve Act, and the acquisition of a stock interest therein by an Edge corporation would otherwise be likely to further the foreign commerce of the United States, the Board concluded that such an acquisition and holding would be permissible and appropriate.
In view of the serious and difficult questions presented by the foregoing application, the Board emphasized that its decision was based on the particular facts of this case, and that applications by Edge corporations for permission to make similar acquisitions will necessarily be decided on their own merits. Because of the closeness of this case, the Board also stated that Edge corporations may wish to obtain the prior specific consent of the Board before making investments of the kind described herein, even though a proposed investment technically might fall within the general-consent provisions of section 211.8(a)* of Regulation K. 1967 Fed. Res. Bull. 752; formerly designated 12 CFR 211.103.
*
Now § 211.5(c)(1).
3-712

INVESTMENTS—In Special-Purpose Corporations

A question has been raised with the board as to whether a corporation organized under section 25(a) of the Federal Reserve Act (an “Edge corporation”) that is directly or indirectly engaged in the general business of leasing personal property and equipment is required under paragraph 8 of section 25(a) and section 211.8(b)† of this part (Regulation K) to obtain the Board’s prior approval for investments in special-purpose leasing corporations that are formed as vehicles for specific leasing transactions (or the functional equivalent thereof) with a single customer, rather than to engage in the general business of leasing. In the Board’s opinion, such special-purpose corporations represent credit facilities provided by the parent financial institution, either alone or in participation with others, and should be regarded as activities of the parent financial institution and not as investments requiring Board approval.
It is common practice for certain types of lease financings to be structured in such a way that legal title to the personal property or equipment rests in a separately incorporated entity, as, for example, in the leasing of commercial aircraft or vessels. Such a corporation, herein referred to as a “special-purpose corporation,” may be used to reduce the potential exposure of the parent financial institution to tort liability arising in connection with the operation of an aircraft or vessel, to comply with the laws of the various countries relating to registration of aircraft or vessels or perfecting liens on equipment, or to minimize taxes upon rental payments received under the lease.
The distinguishing feature of special-purpose corporations is that they are formed for the purpose of engaging in a particular transaction involving the financing of one or more items of personal property or equipment and a single customer, rather than a general business. In the Board’s judgment, no regulatory purpose associated with paragraph 8 of section 25(a) and section 211.8(b) of Regulation K would be served by having the Board screen in advance each transaction entered into in this manner.
The Board understands that, in most cases, these special-purpose corporations are established under an arrangement whereby the creditors who have made loans to such corporations do not have recourse to the parent Edge corporation, or its subsidiary engaged in the general business of leasing or financing, for the repayment of such loans. In those instances where the financing arrangement contemplates that creditors of the special-purpose corporation shall have recourse to the parent Edge corporation or its leasing or financing subsidiary, borrowings by the special-purpose leasing corporation of the type described in section 211.4 of Regulation K shall be regarded as if the borrowings were those of the guarantor and shall not cause the borrowings of the latter to exceed the amount previously approved by the Board. All assets and liabilities of special-purpose corporations shall be fully reflected in consolidated financial statements of their parent institution(s) filed with federal bank regulatory authorities.
The parent Edge corporation shall furnish the Board with such information regarding the activities of each special-purpose corporation as it may require from time to time and maintain full information on such subsidiaries at its head office. By reference this interpretation also applies to investments made directly or indirectly by bank holding companies in special-purpose corporations of the type described above which do no business in the United States except as may be incidental to their international or foreign business. 1973 Fed. Res. Bull. 104; formerly designated 12 CFR 211.108.
†
Now § 211.5(c).
3-713

INVESTMENTS—Policy Statement on Joint Ventures

Before approving a proposed international joint venture, such as a jointly owned Edge corporation or foreign bank, the Board of Governors will consider the possible competitive effects thereof on U.S. domestic and foreign commerce and consult with the Department of Justice regarding any antitrust issues. Applicants shall submit all relevant material relating thereto. Formerly designated 12 CFR 211.51.
3-714

INVESTMENTS—In Foreign Joint Ventures; Policy Statement

In general, when a member bank or a corporation organized under section 25(a) of the Federal Reserve Act (an “Edge” corporation), or operating pursuant to an agreement with the Board under section 25 thereof (an “agreement” corporation), or a bank holding company requests the Board’s specific consent to acquire the stock or other certificates of ownership of a foreign corporation that will be jointly owned by the U.S. banking organization and other foreign or domestic participants (hereinafter referred to as a “foreign joint venture”1), the Board considers, among other factors, the degree of legal and practical business responsibility the U.S. banking organization will bear for the financial condition and operations of the foreign joint venture in foreign and international financial markets. In the Board’s judgment, this factor, among others, is relevant in assessing what effects the proposed investment may have on the financial and managerial resources of the applying U.S. banking organization.
Based on the recent experience of certain foreign joint ventures in foreign and international financial markets, the Board has found that a U.S. banking organization may, in certain circumstances, feel impelled for business reasons to provide financial support2 to a foreign joint venture in which it has an equity interest in the event the venture has liquidity or other financial needs. This support may be substantially in excess of the U.S. banking organization’s original equity investment and may, in some situations, be well in excess of its pro rata share. This has seemed most likely to occur in situations where (1) the foreign joint venture has included in its name a reference to the U.S. banking organization, (2) the U.S. banking organization or its affiliates have consistently provided financial support to the foreign corporation in amounts significantly beyond the usual commercial limits or significantly disproportionate to its pro rata stock interest, or (3) as the result of substantial managerial support furnished by the U.S. banking organization under a contract or other arrangement, the foreign corporation has been publicly identified as or considered to be, sometimes with the active encouragement of the U.S. banking organization, an integral part of the U.S. banking organization’s international operations.
Accordingly, the Board, in considering applications by U.S. banking organizations to invest in foreign joint ventures, will, as a matter of policy, take into account the possibility that the applicant may feel impelled for business reasons to provide financial support for such foreign joint venture in the event the venture has liquidity or other financial needs, and that such support could be significantly greater than the amount of its proposed equity investment. The Board will, therefore, consider such application in light of the relative ability of the applicant to meet the demands that such potential support could place on its financial and managerial resources. In doing so, the Board will take into consideration the risks associated with the total assets and liabilities of the foreign joint venture and its projected expansion, and not merely the size of the proposed equity investment by the applicant. In particular, the Board will give great weight to these potential risks and their implications for the applicant in cases where the applicant proposes (1) to include a reference to its name in that of the foreign joint venture, (2) to provide general funding support to the foreign joint venture in amounts disproportionate to its pro rata stock interest, or (3) to provide virtually all of the management for such foreign joint venture.
If, however, in the case of any such proposed joint venture investment, the U.S. banking organization can establish in the record of its application that it has reached an agreement or arrangement whereby its support of the proposed joint venture in the event of liquidity or other financial needs will be limited to its initial equity investment or to some fixed amount, or will be shared pro rata or otherwise with the other shareholders, or will otherwise be limited, the Board will consider the application and the risks associated therewith on the basis of this additional information. In this regard, the Board will also consider the identity and financial strength of other partners and investors in the venture and their respective ability to provide support to the venture, if needed.
This statement of policy is not intended to prohibit or discourage investments by U.S. banking organizations in foreign joint ventures, which can be a useful form of corporate organization in appropriate circumstances; rather, due to the difficulty of ascertaining the precise risks undertaken in joint venture investments, its primary purpose is to clarify for all parties concerned the probable dimensions of risks assumed in any particular investment. Thus, even if an applicant proposes to assume a disproportionate share of the risks in any joint venture, e.g., agrees to stand behind more than its pro rata share of the joint venture’s obligations, the Board might be willing to approve the investment if the applicant’s financial and managerial resources could bear this additional risk and if other factors indicated that approval would be consistent with the public interest.
The Board further notes that any action that it might take on an application should not be viewed or relied upon by the applying U.S. banking organization, other participants in the venture, or any third party as constituting approval or disapproval, or ratification or rejection of any agreement or arrangement that may have been entered into by the shareholders of a foreign joint venture; specifically, any Board action should not be viewed as constituting any expression of judgment as to the validity or enforceability of any such agreement or arrangement. Any agreement or arrangement will, rather, be merely one among many factors considered by the Board in deciding on an application.
This statement is intended to apply primarily to proposed investments by U.S. banking organizations in the stock of foreign corporations in which they do not already have an equity investment. Applications involving an additional investment in an ongoing foreign joint venture will continue to be considered by the Board on the basis of outstanding facts and circumstances. In the case of any ongoing foreign joint venture the Board will, of course, continue to consider carefully the amount of support, if any, that is being provided by the application to the venture and any agreement or arrangement among the joint ventures for the provision of any future support. 1976 Fed. Res. Bull. 249; formerly designated 12 CFR 211.52.
1
The term “foreign joint venture” is used to describe a situation in which a U.S. banking organization with a minority share interest participates, directly or indirectly, in the overall management of the corporation and thus has an active operating interest. A purely passive minority investment in a foreign corporation will not be deemed a “joint venture” investment for purposes of this statement of policy. This “joint venture” determination will be made on the basis of the facts and circumstances of each case.
2
As used herein, the term “support” includes, without limitation, contributions to capital, purchase (or causing the purchase) from the foreign corporation of loans or securities, making (or causing the making) of loans to the foreign corporation, and the making (or causing the making) of deposits in the foreign corporation.
3-715

INVESTMENTS—By U.S. Banking Organizations in Foreign Companies That Transact Business in the United States

Section 25(a) of the Federal Reserve Act (12 USC 611, the “Edge Act”) provides for the establishment of corporations to engage in international or foreign banking or other international or foreign financial operations (“Edge corporations”). Congress has declared that Edge corporations are to serve the purpose of stimulating the provision of international banking and financing services throughout the United States and are to have powers sufficiently broad to enable them to compete effectively with foreign-owned institutions in the United States and abroad. The Board was directed by the International Banking Act of 1978 (12 USC 3101) to revise its regulations governing Edge corporations in order to accomplish these and other objectives and was further directed to modify or eliminate any interpretations that impede the attainment of these purposes.
One of the powers of Edge corporations is that of investing in foreign companies. Under the relevant statutes, however, an Edge corporation is prohibited from investing in foreign companies that engage in the general business of buying or selling goods, wares, merchandise or commodities in the United States. In addition, an Edge corporation may not invest in foreign companies that transact any business in the United States that is not, in the Board’s judgment, “incidental” to its international or foreign business. The latter limitation also applies to investments by bank holding companies (12 USC 1843(c)(13)) and member banks (12 USC 601).
The Board has been asked to determine whether an Edge corporation’s minority investment (involving less than 25 percent of the voting shares) in a foreign company would continue to be permissible after the foreign company establishes or acquires a United States subsidiary that engages in domestic activities that are closely related to banking. The Board has also been asked to determine whether an Edge corporation’s minority investment in a foreign bank would continue to be permissible after the foreign bank establishes a branch in the United States that engages in domestic banking activities. In the latter case, the branch would be located outside the state in which the Edge corporation and its parent bank are located.
In the past the Board, in exercising its discretionary authority to determine those activities that are permissible in the United States, has followed the policy that an Edge corporation could not hold even a minority interest in a foreign company that engaged, directly or indirectly, in any purely domestic business in the United States. The United States activities considered permissible were those internationally related activities that Edge corporations may engage in directly. If this policy were applied to the subject requests, the Edge corporations would be required to divest their interests in the foreign companies notwithstanding the fact that, in each case, the Edge corporation, as a minority investor, did not control the decision to undertake activities in the United States, and that even after the United States activities are undertaken the business of the foreign company will remain predominantly outside the United States.
International banking and finance have undergone considerable growth and change in recent years. It is increasingly common, for example, for United States institutions to have direct or indirect offices in foreign countries and to engage in activities at those offices that are domestically as well as internationally oriented. In this climate, United States banking organizations would be placed at a competitive disadvantage if their minority investments in foreign companies were limited to those companies that do no domestic business in the United States. Moreover, continued adherence to the existing policy would be contrary to the declaration in the International Banking Act of 1978 that Edge corporations’ powers are to be sufficiently broad to enable them to compete effectively in the United States and abroad. Furthermore, where the activities to be conducted in the United States by the foreign company are banking or closely related to banking, it does not appear that any regulatory or supervisory purpose would be served by prohibiting a minority investment in the foreign firm by a United States banking organization.
In view of these considerations, the Board has reviewed its policy relating to the activities that may be engaged in in the United States by foreign companies (including foreign banks) in which Edge corporations, member banks, and bank holding companies invest. As a result of that review, the Board has determined that it would be appropriate to interpret sections 25 and 25(a) of the Federal Reserve Act (12 USC 601, 611) and section 4(c)(13) of the Bank Holding Company Act (12 USC 1843(c)(13)) generally to allow United States banking organizations, with the prior consent of the Board, to acquire and hold investments in foreign companies that do business in the United States subject to the following conditions: (1) the foreign company is engaged predominantly in business outside the United States or in internationally related activities in the United States;* (2) the direct or indirect activities of the foreign company in the United States are either banking or closely related to banking; and (3) the United States banking organization does not own 25 percent or more of the voting stock of, or otherwise control, the foreign company. In considering whether to grant its consent for such investments, the Board would also review the proposals to ensure that they are consistent with the purposes of the Bank Holding Company Act and the Federal Reserve Act. 1981 Fed. Res. Bull. 145; 12 CFR 211.602.
*
This condition would ordinarily not be met where a foreign company merely maintains a majority of its business in international activities. Each case will be scrutinized to ensure that the activities in the United States do not alter substantially the international orientation of the foreign company’s business.

INVESTMENTS—Data Processing Activities

See 3-707.
3-720

SUPERVISION—On-Site Examinations of Foreign Branches

It has been the policy of the Board for a number of years not to conduct on-site examinations of foreign branches of state member banks. Until recently, the number of such branches was small and their activities sufficiently limited as not to warrant the expense and the commitment of manpower resources that would have been involved. Rather, reliance was placed on annual surveys conducted at head offices as a means of supervising foreign branches.
There are now 24 state member banks operating 49 branches abroad, including 11 banks operating only limited service branches in the Bahamas. In addition to the increased number of branches, the volume and nature of their activities have expanded enormously and now occupy a significant place in the overall operations of the banks involved.
In the circumstances, consideration has been given to a program of on-site examinations of foreign branches where feasible. To assist in the development of such a program, pilot examinations of selected branches were conducted in the fall of 1969 and the spring of 1971.
The Division of Supervision and Regulation recently requested the comments of the Officer in charge of Examinations at each Reserve Bank on a proposed program for on-site examinations and head office surveys. In the light of those comments and in view of existing System capabilities and budget considerations, the following minimum program has been adopted subject to modification and expansion as circumstances permit:
  • 1.
    Each full-service branch in countries permitting examinations will be examined on-site approximately every four years. Initial emphasis will be placed on European branches.
  • 2.
    The head office survey of each full-service branch will ordinarily be conducted in each year in which an on-site examination is not conducted. Some deviation in frequency or variation in scope may be appropriate in specific cases, as determined in consultation with the Division of Supervision and Regulation.
  • 3.
    Annual surveys of “limited operations” branches will continue to be made in connection with examinations of their head offices.
The early part of each year, and before the end of March if at all possible, seems the best time to undertake the overseas examinations contemplated, but examinations may occasionally be scheduled at other times for operational reasons and to enhance the element of surprise in the program.
Only four Federal Reserve Districts presently domicile state member banks with fullservice branches to be examined under this program. However, with the increasing spread of international banking activities in State member banks, the establishment of such branches by banks in other districts must be anticipated. For this reason and because of the desirability of strengthening examiner capabilities in the international area in all districts, the on-site examination program is viewed as offering a means of providing training and experience to examiners throughout the System. Individual Reserve banks will be contacted about periodic participation of their examinational personnel in overseas branch examinations, with priority in the early phases of the program to those Banks with the greatest existing or potential needs for examiners with international banking backgrounds.
Those Reserve Banks in Districts domiciling branches subject to on-site examination under this program may wish to discuss the program with interested state banking departments, which may wish to consider joining in the examinations. S-2187; Jan. 26, 1972.
3-721

SUPERVISION—Policy Statement on Availability of Information Concerning Foreign Operations of Member Banks

For the guidance of member banks having foreign operations, the Board publishes the following statement of policy regarding availability of information pertaining to member banks’ foreign branches and subsidiaries to enable proper supervision of those operations:
The Board of Governors of the Federal Reserve System, as a central bank, is properly concerned with the preservation and promotion of a sound banking system in the United States. The Board of Governors and other federal banking supervisory authorities have been given specific statutory responsibilities to assure that banking institutions are operated in a safe and prudent manner affording protection to depositors and providing adequate and efficient banking services to the public on a continuing basis. These responsibilities and concerns are shared by central banks and bank supervisors the world over.
Under sections 25 and 25(a) of the Federal Reserve Act, the Board has particular responsibilities to supervise the international operations of member banks in the public interest. In carrying out these responsibilities, the Board has sought to assure that the international operations of member banks would not only foster the foreign commerce of the United States but that they would also be conducted so as not to encroach on the maintenance of a sound and effective banking structure in the United States. In keeping with the latter consideration, the Board believes it incumbent upon member banks to supervise and administer their foreign branches and subsidiaries in such a manner as to assure that their operations are conducted at all times in accordance with high standards of banking and financial prudence.
Proper administration and supervision of foreign branches and subsidiaries require the use of effective systems of records, controls, and reports that will keep the bank’s management informed of the activities and condition of its branches and subsidiaries. At a minimum, such systems should provide the following:
  • 1.
    Risk assets. To permit assessment of exposure to loss, information furnished or available to head office should be sufficient to permit periodic and systematic appraisal of the quality of loans and other extensions of credit. Coverage should extend to a substantial proportion of risk assets in the branch or subsidiary, and include the status of all large credit lines and of credits to customers also borrowing from other offices of the bank. Information on credit extensions should include (i) a recent financial statement of the borrower and current information on his financial condition; (ii) credit terms, conditions, and collateral; (iii) data on any guarantors; (iv) payment history; and (v) status of corrective measures employed.
  • 2.
    Liquidity. To enable assessment of local management’s ability to meet its obligations from available resources, reports should identify the general sources and character of the deposits, borrowings, etc., employed in the branch or subsidiary with special reference to their terms and volatility. Information should be available on sources of liquidity—cash, balances with banks, marketable securities, and repayment flows—such as will reveal their accessibility in time and any risk elements involved.
  • 3.
    Contingencies. Data on the volume and nature of contingent items such as loan commitments and guaranties or their equivalents that permit analysis of potential risk exposure and liquidity requirements.
  • 4.
    Controls. Reports on the internal and external audits of the branch or subsidiary in sufficient detail to permit determination of conformance to auditing guidelines. Such reports should cover (i) verification and identification of entries on financial statements; (ii) income and expense accounts, including descriptions of significant charge-offs and recoveries; (iii) operation of dual-control procedures and other internal controls; (iv) conformance to head office guidelines on loans, deposits, foreign exchange activities, proper accounting procedures, and discretionary authority of local management; (v) compliance with local laws and regulations; and (vi) compliance with applicable U.S. laws and regulations.
1973 Fed. Res. Bull. 449; formerly 12 CFR 211.110.
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