FED RETHINKS MOVE ALLOWING BANKS TO TRADE PHYSICAL COMMODITIES / REUTERS

UPDATE 2-Fed rethinks move allowing banks to trade physical commodities

Fri Jul 19, 2013 7:47pm EDT

By David Sheppard and Josephine Mason



NEW YORK, July 19 (Reuters) - The U.S. Federal Reserve is "reviewing" a landmark 2003 decision that first allowed regulated banks to trade in physical commodity markets, it said on Friday, a move that may send new shockwaves through Wall Street.
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While it is well known that the Fed is considering whether or not to allow banks including Morgan Stanley and JPMorgan to continue owning trading assets like oil storage tanks or metals warehouses, Friday's one-sentence statement suggests that it is also reconsidering the full scope of banks' activities in physical markets, which help generate billions in profits.
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"The Federal Reserve regularly monitors the commodity activities of supervised firms and is reviewing the 2003 determination that certain commodity activities are complementary to financial activities and thus permissible for bank holding companies," the Federal Reserve said in an emailed statement. A spokesperson declined to elaborate or provide any details on the scale or timing of the review.
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It is the Fed's first public statement on the issue since it first came to light in a Reuters report in 2012. (Full story:)
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The statement comes amid growing political and consumer scrutiny of Wall Street's role in commodity markets amid complaints about ownership of metals warehouses and record fines against Barclays and potentially JPMorgan over allegations that they manipulated U.S. power markets.
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On Tuesday the Senate Banking Committee is holding its first hearing on the issue, asking if banks should be allowed to control power plants, warehouses and oil refineries.
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"They must be feeling some pressure on this issue if they've felt compelled to issue a public statement," said Saule Omarova Associate Professor of Law at the University of North Carolina at Chapel Hill School of Law, who will appear at the hearing.
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"Are they using this opportunity to in fact review the entire position of banks in physical commodity markets?"
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Large industrial consumers of aluminum have accused banks of boosting prices of the metal through their control of London Metal Exchange warehouses, which have been slow to deliver metal to customers, boosting premiums for physical metal and earning big profits on rent for storing the metal.
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A Goldman Sachs spokesman declined to comment on the Fed statement. Spokesmen for JPMorgan and Morgan Stanley did not immediately respond to emails seeking comment.
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PHIBRO WAS FIRST IN
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The statement refers to a 2003 letter that the Federal Reserve issued to Citigroup, which was seeking permission from the Fed to allow its Phibro unit -- acquired in 1998 -- to continue trading in physical energy markets.
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It was the first bank to seek permission under the Bank Holding Company Act (BHC Act) -- which normally prohibits banks from engaging in non-financial activities -- to trade physical commodities rather than only paper derivatives. Another dozen banks followed suit, with the Fed giving more and more leeway about how, what and where they could trade.
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Sincé converting to bank holding companies at the height of the financial crisis, Goldman Sachs and Morgan Stanley have also been subject to the holding company rules -- but up until now, the Fed's focus was believed to be on their ownership of assets.
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Under the Gramm-Leach-Bliley amendment to the BHC, any non-regulated bank that converts to holding company status after 1999 would be allowed to continue to own and invest in assets, as long as they held them prior to 1997. The banks have argued that their activities are "grandfathered" in, or that they are simply merchant banking investments.
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It is not clear that argument will hold up under intensifying political pressure, with concerns that "Too Big to Fail" banks shouldn't be taking on additional risks like moving tankers of crude oil or operating power plants.
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"Reviewing Wall Street's expansion into commercial activities is essential," Senator Sherrod Brown, a Democrat from Ohio, said in a statement. "Congress, regulators, and the public need to understand what has happened in the 14 years since the financial floodgates were opened, and reconsider what we want banks to do,"
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Four U.S. Congressmen wrote to Federal Reserve Chairman Ben Bernanke on June 27 expressing their concern about the issue, and asking for more information on the Fed's position.
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GETTING PHYSICAL


As commodity prices surged over the past decade, a host of global investment banks piled into the market, pressuring the former duopoly of Goldman and Morgan. At their peak several years ago, revenues in the sector reached some $15 billion.
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"It's not clear yet how far this review is going to go," said Omarova. "Are they going to make a large change to what they're authorized to do, or will they say that the decision to let bank holding companies start trading in physical commodities over 10 years ago was the correct one?".
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But pressures have mounted over the past few years as regulators crack down on proprietary trading, new capital measures limit trading books and bonus caps shrink.
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Commodity revenue from the top investment banks fell to about $6 billion in 2012, consultants Coalition estimated.
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While banks generate much of that revenue from trading derivatives -- selling indexes to investors or hedging prices for an oil company -- many have delved deeply into physical markets in order to get better information on markets, leverage their positions or offer more options to customers.
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For instance many banks are involved in "supply and offtake" arrangements with refiners, providing crude oil to the plant and then selling gasoline or diesel in the market.
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The Federal Reserve has generally allowed banks to trade in most major commodity markets so long as there is a similar futures contract for the commodity, which means it is regulated by the Commodity Futures Trading Commission. Crude oil and gasoline, for instance, are allowed but iron ore is not.
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Friday's statement calls that into question.
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While some consumer groups have been critical of the sway that banks can exert on commodity markets by owning key pieces of infrastructure, it is unclear how many would support barring them from trading commercial markets entirely.
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"I want them to have physical business because they play a positive role in the business on balance by providing financing," said one senior executive in the metals market.