United States: OCC Reaffirms the Ability of National Banks to Become Clearing Corporation Members

Originally published April/May 2005

The OCC was responding to a request by FICC that it clarify the ability of national banks to become netting members of its clearing corporation divisions and through such membership effectively guarantee third-party obligations. FICC is a clearing agency registered with and supervised by the Securities and Exchange Commission. FICC has two divisions: the Government Securities Division ("GSD"), which clears transactions in government securities, and the Mortgage-Backed Securities Division, which clears transactions in mortgage-backed securities. The GSD, which clears, nets, settles and manages other risks from government securities transactions, includes national banks as netting members. Netting members benefit from significant risk reduction from their membership in FICC, as FICC matches two proposed counterparties in a securities transaction and then will become the "counterparty" to each transaction, taking onto itself the risk that a counterparty will fail to settle.

GSD’s rules provide for several risk protection devices, which if all unsuccessful end in a loss allocation arrangement where GSD netting members could be allocated a portion of a loss unrelated to any of their transactions. While the GSD has had this loss allocation system in place for several years, a recent OCC interpretive letter raised some issues relating to the ability of national banks to remain as members of GSD so long as such a loss allocation system was in place. In Interpretive Letter No. 929 (Feb. 11, 2002), the OCC stated that the provision of default contributions by the London branch of a national bank to a default fund of the London Clearinghouse as a necessary precondition to engaging in bank permissible clearing and execution activities was a permissible guarantee, so long as the activity was conducted in a safe and sound manner. FICC requested that the OCC determine that the GSD loss allocation process was also a permissible guarantee for national banks.

While national banks have long been permitted to engage in clearing and execution activities, they have limited powers to issue third party guaranties. Although the National Bank Act ("NBA") is silent on the authority of national banks to issue thirdparty guaranties, the Supreme Court and other federal courts have interpreted the NBA to implicitly place limits on the issuance of such guaranties. OCC Interpretive Ruling 7.017 (12 C.F.R. 7.017) states that a national bank can issue a guarantee, but only if the bank had a "substantial interest" in the performance of the transaction involved. The OCC further determined that a substantial interest existed for national banks if the guarantee provided by the national bank was incidental to one of its authorized activities. Finally, the OCC found that the closer the relation between the incidental activity of the bank and the authorized activity, the more "substantial" was its interest in issuing the guarantee.

The OCC has applied Interpretive Ruling 7.017 to numerous national bank activities. Most recently, in a letter dated September 7, 2004, the Chief Counsel of the OCC stated that a national bank and its wholly-owned operating subsidiary could issue financial warranties to purchasers of a specified mutual fund. The OCC reasoned that the bank’s involvement in the structuring and performance of the overall fund product—where the bank had acted as the financial product consultant and adviser—satisfied the "substantial interest" test.

The OCC’s guidance in Interpretive Letter No. 1014 relies upon a similar analysis. In Interpretive Letter No. 1014, the OCC found that a national bank had a substantial interest in providing the guaranties required by the GSD rules in order to engage in such bank permissible activities as clearing and execution services. This finding held that such guaranties were therefore incidental to banking and permissible for national banks.

Interpretive Letter No. 1014 is an important interpretation for national banks (and through State law "wild card" statutes, many State chartered banks) because it permits them to become members of clearing corporations that mutualize loss. These clearing corporations provide significant risk reduction to their members, and help banks manage the risks that arise from their banking and trading activities. 

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