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May 5, 2005

Michael M. Wiseman, Esq.
Sullivan & Cromwell LLP
125 Broad Street
New York, New York 10004

Dear Mr. Wiseman:

This is in response to the request by The Bank of New York Company ("BNY Company"), New York, New York, for an exemption from section 23A of the Federal Reserve Act and the Board's Regulation W.1 The exemption would allow BNY Company's subsidiary bank, The Bank of New York ("BNY"), to make certain guarantees on behalf of, and extensions of credit to, its affiliate, BNY Capital Markets, Inc. ("CMI"), both also of New York, in connection with BNY's securities lending program.2

In BNY's securities lending program, the bank, as agent for a customer, lends securities in a customer's portfolio ("Borrowed Securities") to another company, typically a securities broker-dealer ("Borrower"). The Borrower may use the Borrowed Securities for its own purposes but must return the securities on demand by the bank's customer. The Borrower provides collateral to BNY, as agent for the customer, in the form of cash, U.S. government securities, or letters of credit. The value of the collateral slightly exceeds the value of the Borrowed Securities.3 BNY actively engages in securities lending transactions with a number of unaffiliated securities broker-dealers.

Three aspects of the program expose BNY to credit risk in a manner that raises section 23A and Regulation W issues when the Borrower is an affiliate of the bank. First, in the agreements between BNY and its customers, BNY undertakes to return the Borrowed Securities to the customer whether or not the securities are returned to the bank by the Borrower. This indemnity is limited, however, to the amount by which the value of the Borrowed Securities exceeds the value of the collateral posted by the Borrower. The bank limits its exposure on this indemnity by marking the Borrowed Securities and any securities collateral to market daily and by calling for additional collateral in the event that the value of the collateral posted by the Borrower drops below the value of the Borrowed Securities.

Second, during the term of a securities loan, the Borrower has an obligation promptly to transmit to BNY's customer any dividends, interest payments, or other similar distributions made by issuers on the Borrowed Securities. Under the typical agreement, the bank generally credits the customer's account with these distributions on the date the distributions are payable by the issuer, regardless of whether the Borrower has forwarded the distribution amounts to the bank for the account of the customer. Thus, the bank typically has a short-term credit exposure to the Borrower in the amount of any distributions that the bank has credited to a customer's account in advance of having received the distribution from the Borrower.

Third, during the term of a securities loan, BNY has discretion to advance funds to a Borrower, on behalf of a customer, to pay fees owed by the customer to the Borrower or to return excess collateral to the Borrower.

BNY proposes to engage in securities lending transactions with its broker-dealer affiliate, CMI, on the same terms and conditions, including lending limits, that the bank lends customer securities to unaffiliated broker-dealers. Because these transactions would involve guarantees by the bank on behalf of CMI, and extensions of credit by the bank to CMI, CMI's participation in the securities lending program would be subject to the quantitative, collateral, and other requirements in section 23A and Regulation W. BNY Company has requested an exemption from the statute and regulation for these covered transactions to allow BNY to conduct its securities lending program with CMI in the same manner as the bank conducts this program with unaffiliated securities broker-dealers.

Section 23A and Regulation W limit the amount of "covered transactions" between a bank and any single affiliate to 10 percent of the bank's capital stock and surplus, and limit the amount of covered transactions between a bank and all its affiliates to 20 percent of the bank's capital stock and surplus. "Covered transactions" include the purchase of assets by a bank from an affiliate, the extension of credit by a bank to an affiliate, the issuance of a guarantee by a bank on behalf of an affiliate, and certain other transactions. In addition, the statute and regulation require a bank to secure its extensions of credit to, and guarantees on behalf of, affiliates with prescribed amounts of collateral. The statute and the regulation also have an "attribution rule" that treats as a transaction between a bank and an affiliate any transaction between a bank and a nonaffiliate to the extent that the proceeds of the transaction are used for the benefit of, or transferred to, an affiliate.

Section 23A and Regulation W specifically authorize the Board to exempt, at its discretion, transactions or relationships from the requirements of the statute and regulation if it finds such exemptions to be in the public interest and consistent with the purposes of section 23A.4 Granting an exemption from the requirements of section 23A and Regulation W for the covered transactions generated by the inclusion of CMI as a Borrower in BNY's securities lending program would be appropriate and consistent with Board precedent.5

Under the indemnity given by BNY to its customers, the risk of loss to the bank does not appear to be substantial due to the daily mark-to-market and remargining procedures employed by the bank and the predominant use of cash and U.S. government securities as collateral to mitigate the bank's exposure to CMI on the indemnity. In addition, the risk of loss to the bank from advances by the bank to customers on behalf of CMI is small because, among other things, the advances are generally repaid on an intraday basis. Moreover, the advances by the bank to CMI on behalf of a customer are generally short-term and are secured by all the investment securities in the customer's accounts with the bank.

In light of the higher risks often associated with securities lending transactions collateralized by assets other than cash or U.S. government securities, and consistent with Board precedent, the Board believes that securities lending transactions between BNY and CMI that are secured by property other than cash or U.S. government securities should be exempt from section 23A and Regulation W only to the extent that the total market value of Borrowed Securities lent to CMI by BNY's customers against such collateral does not in the aggregate exceed the lesser of (i) 5 percent of the bank's capital stock and surplus or (ii) 5 percent of the total market value of Borrowed Securities lent to CMI by the bank's customers.6

In the case of each of the three types of exposure, as well as other aspects of the transaction that involve payments by BNY to or on behalf of CMI, the bank would continue to be subject to the market terms requirement of section 23B and Regulation W. Because numerous unaffiliated Borrowers participate in BNY's securities lending program, examiners would be able to verify on an ongoing basis whether the bank's covered transactions with CMI in the program are on substantially the same terms as those prevailing with nonaffiliates. Likewise, section 23B would prevent the bank from agreeing to indemnify or make an advance to a customer on behalf of CMI unless the bank would agree to make the same indemnity or advance on behalf of a nonaffiliate, and would prevent the bank from making an advance to CMI on behalf of a customer, unless the bank would make the advance to a nonaffiliate on behalf of the customer.7

For the reasons stated above, and in light of all the facts you have presented, the transactions appear to be consistent with safe and sound banking practices and the purposes of section 23A. Accordingly, the Board hereby grants the requested exemption (subject to the indicated conditions and limits on securities lending transactions collateralized by property other than cash or U.S. government securities). The Board also reserves the right to rescind this exemption if it is used by BNY to evade section 23A or Regulation W.

The Board also grants your request that any subsidiary bank of BNY Company, on the one hand, and any U.S. broker-dealer affiliate of such a bank, on the other hand, may rely on this exemption on the same terms and conditions as would apply were the transactions between BNY and CMI. This broader exemption is subject to the additional conditions that (i) the securities lending program of any other subsidiary bank is structured in a substantially identical manner as that of BNY (as determined by Federal Reserve staff); (ii) the other subsidiary bank engages, directly or indirectly, in securities lending transactions with a number of unaffiliated securities broker-dealers; and (iii) the other subsidiary bank, directly or indirectly, includes affiliated broker-dealers in its securities lending program on the same terms that apply to unaffiliated broker-dealers that participate in the program.

These determinations are specifically conditioned on compliance by BNY Company and BNY with all the commitments and representations they made to the Board in connection with the exemption request. These commitments and representations are deemed to be conditions imposed in writing by the Board in connection with granting the request and, as such, may be enforced in proceedings under applicable law. These determinations are based on the specific facts and circumstances of the securities lending program described in your correspondence and this letter. Any material change in those facts and circumstances or any failure by BNY Company, BNY, or any other company relying on the exemption granted in this letter to observe any of its commitments or representations may result in a different view or in a revocation of the exemption.

Sincerely yours,

[signed] Robert deV. Frierson

Robert deV. Frierson
Deputy Secretary of the Board

cc:Federal Reserve Bank of New York


Footnotes

1. 12 U.S.C. 371c; 12 CFR Part 223.  Return to text

2. BNY Company also has requested that the Board grant a broader exemption that would apply to securities lending transactions between any subsidiary bank of BNY Company, on the one hand, and any U.S. broker-dealer affiliate of such a bank, on the other hand, on the same terms and conditions as would apply were the transactions between BNY and CMI.  Return to text

3. The amount of collateral that a Borrower must post is generally 102 percent of the value of the Borrowed Securities.  Return to text

4. 12 U.S.C. 371c(f)(2); 12 CFR 223.43.  Return to text

5. See Letter dated October 31, 2001, from Jennifer J. Johnson, Secretary of the Board, to Marjorie Gross, J.P. Morgan Chase & Co.  Return to text

6. If the total market value of Borrowed Securities lent to CMI by the bank's customers against property other than cash or U.S. government securities exceeds this threshold, the marginal amount would be treated as a nonexempt guarantee by the bank on behalf of an affiliate under section 23A and Regulation W and, accordingly, would be subject to the quantitative limits and collateral and other requirements of the statute and the rule.  Return to text

7. BNY has represented that it periodically reviews the credit quality of Borrowers in its securities lending program and would reduce a Borrower's credit line or remove a Borrower from the program (including CMI) if the Borrower's credit quality so warranted.  Return to text

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