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Tags: Wall Street | Commodities | Business | Regulation

Wall Street Reshapes Commodities Business to Fend Off Regulation

Monday, 22 July 2013 08:57 AM EDT

Wall Street's most powerful banks have accelerated efforts to transform the structure and focus of their commodity trading desks to preserve their multibillion-dollar empires from tightening regulation.

Scrutiny of their activities in electricity markets, metals warehousing and oil trading is reaching fever pitch ahead of a Federal Reserve decision in September that may decide how deeply banks can delve into the world of gasoline tankers, piles of copper and power plants.

Mounting regulatory and political pressure has already forced Morgan Stanley, Goldman Sachs Group Inc., and JPMorgan Chase & Co., the three Wall Street banks known for their commodities trading prowess in the past decade, to openly consider exiting key businesses.

Editor's Note: Save, shop and invest like an insider! Our experts lead the way each month in The Franklin Prosperity Report. Click here to learn more.

Morgan Stanley explored selling its vaunted commodities trading desk last year; Goldman Sachs has already sold off its power plant division, and both Goldman and JPMorgan Chase are now considering a sale of their metal warehousing firms, sources said.

Wall Street firms have also adopted more subtle maneuvers, reconfiguring operations to placate regulators, expanding into new markets, and trying to find ways to preserve the value of their investments if they are forced to sell or spin them off, according to a Reuters review of regulatory filings and more than a dozen interviews with top traders and bankers.

The three banks declined to comment on their plans for this article.

Among the maneuvers that have not been reported previously: JPMorgan reshuffled the board of its Henry Bath metals warehousing company last year in an attempt to qualify it as a "merchant banking" investment, sources say.

That designation could allow it to keep the assets for up to 10 years if it cannot find a buyer, although it is unclear whether that effort has been persuasive with regulators.

Goldman Sachs has pressed, so far without success, to get the green light from regulators to move into the growing physical iron ore business, sources familiar with the talks say.

Morgan Stanley, which has the biggest presence of any bank in physical commodity markets, last week tied itself even more closely to its vast logistics subsidiary, TransMontaigne, extending the majority of its oil terminal leases with the firm indefinitely, according to a filing.

Brad Hintz, a Wall Street analyst at Sanford Bernstein & Co. in New York and a former treasurer of Morgan Stanley, said Wall Street was seeking ways to preserve its commodities business role.

"The banks have essentially been told by the Federal Reserve they're allowed a certain number of sins," Hintz said. "Just not as many as there used to be."

At the same time, various investigations — ranging from probes of alleged U.S. electricity price manipulation to aluminum hoarding — have led to more political scrutiny of the banks' commodities dealings than at any time since 2008. In that year, Wall Street faced accusations of helping to stoke oil prices to a record peak of almost $150 a barrel in the lead up to the financial crisis.

On Tuesday, the Senate banking committee holds its first hearing on Wall Street's role in the trillion-dollar physical market for oil and other commodities. It is responding to complaints from aluminum consumers such as brewer MillerCoors that say banks are boosting prices through their control of international metals warehouses.

The U.S. Commodity Futures Trading Commission last week put all the major warehouse operators on notice of a possible probe, Reuters reported on Sunday.

And on Friday the Fed shocked the industry by saying it was reconsidering its decade-old decision that first allowed banks to participate in physical commodity markets, threatening an even deeper blow to Wall Street than had been anticipated.

The short statement marked the Fed's first comments on an issue that had been largely hidden from public view until a Reuters report last year.

"It's not clear yet how far the (Fed) review is going to go," said Saule Omarova, associate professor of law at the University of North Carolina at Chapel Hill School of Law, who will appear at the Senate banking committee hearing.

"Are they going to change what they're authorized to do, or will they say the decision to let bank holding companies start trading in physical commodities 10 years ago was the correct one?" Omarovo said.

The Fed declined to discuss specific companies or the likely final outcome of the review. Spokespeople for Morgan Stanley, Goldman Sachs and JPMorgan declined to comment.


For much of the past five years, Goldman, Morgan Stanley and JPMorgan quietly hoped to persuade the Federal Reserve to let them keep owning power plants, storage facilities and other trading assets before a five-year grace period expires in September, according to interviews with people familiar with the businesses.

Morgan Stanley and Goldman Sachs had became known as the 'Wall Street refiners' after they grew out of the New York and Chicago trading pits to become full-scale merchant commodity houses, owning fleets of oil tankers, buying up refineries, and even operating regional electricity plants.

At their peak between 2007 and 2009, commodities trading accounted for as much as a fifth of their overall annual revenues, at times touching as much as $8 billion between them.

But since converting to bank holding companies in 2008, to get access to emergency Fed funding, they have faced a host of new regulations that have cut into their profits.

While other commercial banks have long been barred from owning such assets, Goldman and Morgan Stanley have argued that their commodities activities were "grandfathered" under a 1999 law, citing an amendment allowing non-regulated banks to carry on activities they engaged in prior to 1997.

While the Federal Reserve has not made a final decision, the banks are preparing increasingly for the worst as the Fed itself comes under pressure to explain why it allows any so-called "Too Big to Fail" bank to participate in risky commercial markets.

Four Democratic congressmen wrote to Fed Chairman Ben Bernanke on June 27 expressing their concern about banks exposing their balance sheets to the risks of disasters such as power plant explosions or oil spills.


Goldman Sachs, once the most powerful financial commodity trader on Wall Street, has said it has no plans to sell or scale back its commodities business. CEO Lloyd Blankfein and COO Gary Cohn both have close ties to the business given they started at the bank's J. Aron commodities arm.

"We got into that business in 1981 and have invested a huge amount in being a market leader," Goldman CFO Harvey Schwartz said in April. "We are very committed to that business."

But in the past three years Goldman's revenues from commodities have suffered, and were down 90 percent last year compared with the peak in 2009.

The bank has sold its power plant development group, Cogentrix, to private equity firm Carlyle Group, sharply reducing its physical footprint in electricity markets, and has explored a possible sale of its Metro International metals warehousing business.

If Metro is sold, the bank that was once a powerhouse in the physical markets will have disposed of much of its physical trading assets.

In newer markets where a physical presence is critical, such as iron ore, the bank has so far been rebuffed by regulators.


In April, Morgan Stanley CEO James Gorman told investors that he believed the banks already faced more restrictions in commodities than ever before. Once a major profit engine for the bank, commodity revenue fell 77 percent in the first quarter, according to filings with the Securities and Exchange Commission.

"The ability to continue to acquire real assets and trade around those real assets is restricted for us and for the industry," Gorman said in a presentation laying out the future of the bank's fixed income, currencies and commodities business.

The bank's oil business continued to falter between April and June, Chief Financial Officer Ruth Porat told analysts last week.

Despite the uncertainty hanging over its commodities unit, Morgan Stanley is pushing ahead with one of its biggest physical asset investments ever, a 42.5 percent stake in a $485 million oil terminal near Houston being built by its logistics subsidiary TransMontaigne Inc.

The unit, ranked by Forbes magazine as the 17th largest private company in the United States, with revenues of more than $14 billion last year, is a cornerstone of Morgan Stanley's oil division, providing storage and transportation for millions of barrels of crude, gasoline and diesel shipped by the bank's traders.


JPMorgan's position in this debate is different: As a commercial bank, it had always been subject to the Fed's rules, but in 2008 inherited power plants from the takeover of Bear Stearns, and absorbed the Henry Bath warehouses in the 2010 purchase of Sempra Commodities.

The long-term status of those assets has remained unclear, as the Fed normally gives banks three years to comply with regulations. For Henry Bath, one of the world's biggest metal storage firms, the deadline expired on July 1.

But JPMorgan has argued that the operations are still allowed under rules governing merchant banking investments, which are allowed by the Fed so long as the assets are held at arm's length from the bank and are sold within 10 years.

While those familiar with the business say it is operated as an asset separate from the bank's metals trading team, in keeping with the guidelines of the London Metal Exchange (LME), it is not clear who now ultimately controls the franchise.

Last year, JPMorgan added commodity chief Blythe Masters and other JPMorgan executives to Henry Bath's board, according to filings with Britain's Companies House.

It is unclear whether the metals warehouses are the money-spinners they once were. Profits at Henry Bath fell to $28 million 2011, a quarter of what they were in 2009, according to Companies House filings. Results for last year have not yet been filed.

JPMorgan Chief Executive Jamie Dimon is under intensifying pressure over the bank's role in energy markets. JPMorgan is negotiating a potential $410 million settlement with federal regulators over allegations it used power plants in California and Michigan to manipulate markets, according to media reports last week.

In May the bank sold three power marketing agreements in California.

Editor's Note: Save, shop and invest like an insider! Our experts lead the way each month in The Franklin Prosperity Report. Click here to learn more.

© 2024 Thomson/Reuters. All rights reserved.

Wall Street's most powerful banks have accelerated efforts to transform the structure and focus of their commodity trading desks to preserve their multibillion-dollar empires from tightening regulation.
Wall Street,Commodities,Business,Regulation
Monday, 22 July 2013 08:57 AM
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