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Senators Question the Fed’s Review of Banks’ Commodities Units

U.S. Senate Democrats said the Federal Reserve’s decision to weigh further restrictions on banks’ trading and warehousing of physical commodities is insufficient and too late.

The Fed yesterday sought comment on the risks posed by bank ownership and trading of commodities such as oil, gas and aluminum by deposit-taking banks and the possible benefits of imposing additional capital standards.

The Fed’s review was quickly criticized by Democratic Senators on the Banking Committee. At a subcommittee hearing today on the issue, Senator Sherrod Brown of Ohio and Elizabeth Warren of Massachusetts said the action didn’t go far enough.

“The Fed’s proposal yesterday is a timid step, it was too slow in coming, and there is still too much that we do not know about these activities and investments” said Brown, who led the hearing.

The Fed said yesterday that it is considering whether additional restrictions are needed to ensure physical commodities activities by banks are conducted in a safe and sound manner. The central bank said it will consider whether further rules are needed after the public comment period ends on March 15.

The Fed’s decision was “certainly a step forward but a meager one,” Warren said. “I think we already have ample evidence that the Fed needs to place additional restrictions on how banks trade and warehouse physical commodities to reduce systemic risk and protect consumers from market manipulation.”

Recent Catastrophes

In its notice, the Fed cited a list of recent accidents and natural disasters, including the 2010 Deepwater Horizon drilling rig explosion that cost BP Plc more than $42 billion through the end of 2012, as examples of catastrophic events posing risk to exposed institutions.

“There has been a substantial increase since 2008 in the amount and types of commodities activities conducted by the firms we supervise,” Michael Gibson, the Fed’s director of bank supervision, said in testimony for the hearing. “Moreover, recent catastrophic events involving physical commodities have increased concerns regarding the ability of companies to mitigate potentially extraordinary tail and other risks.”

The Fed’s action could increase pressure on Goldman Sachs Group Inc. and Morgan Stanley to sell commodities businesses. Although the Fed generally forbids bank holding companies to own or trade physical commodities, the two Wall Street firms were permitted to retain units after they converted into banks during the 2008 financial crisis.

Revenue Down

Commodity trading revenue at the 10 largest global investment banks fell 18 percent in the first nine months of 2013 to $4 billion, industry analytics firm Coalition Ltd. said in a report this month.

Senators Brown and Carl Levin of Michigan, both Democrats, have raised concerns that financial companies’ involvement in physical commodity markets could lead to abuses that harm consumers. Levin’s Permanent Subcommittee on Investigations is investigating the issue.

Brown held his first hearing on banks’ ownership of physical commodities in July after beer distributors complained that companies such as Goldman Sachs were manipulating aluminum prices. The Commodity Futures Trading Commission issued subpoenas to Goldman Sachs, JPMorgan Chase & Co. and other operators of metal warehouses after brewer MillerCoors LLC and others complained of long waits for materials.

Timing Questioned

Brown questioned the timing of the Fed’s release the day before a hearing. He said he has not yet decided whether to have further hearings on the issue.

JPMorgan agreed to pay $410 million in July to settle Federal Energy Regulatory Commission allegations that the bank manipulated power markets in California and the Midwest from 2010 to 2012.

Gibson, along with officials from the CFTC and FERC, testified on the issue at today’s hearing. Gibson said in testimony that the Fed could take additional restrictions including reductions in the maximum amount of assets or revenue for such activities, increased capital or insurance requirements, and prohibitions on holding specific types of physical commodities.

“I suspect, with over a decade to address complementary activities and merchant banking, and five years to address grandfathering, this will continue to be a slow process,” Joshua Rosner, managing director at Graham Fisher & Co., said in an e-mail after the Fed’s announcement. “This release is more focused on placating legislators than affirmatively restricting activities of the bank holding companies.”

Comment Requested

The Fed requested comment on whether physical commodities businesses pose catastrophic or safety and soundness risks. The central bank also asked whether additional capital, liquidity, reporting or disclosure requirements would be necessary.

Soliciting comment doesn’t bind the Fed to issuing a rule at a later date. The central bank has issued such preliminary notices before, including for a credit-ratings rule in 2010 and capital rules in 2003. After gathering outside views, the Fed could then propose a rule and open that for comments before issuing a final version.

“The open-ended tone of this release, combined with the lack of specifics on any possible capital charges, means it’s clear sailing for current physical-commodity operations,” said Karen Shaw Petrou, managing partner at Federal Financial Analytics, a Washington regulatory research firm.

‘As Is’

“New entrants –- if any -– are on hold, but the lack of specifics combined with the amount of time it will take the Fed to finalize anything it might ultimately choose to do means that this business is as is for now at Morgan Stanley, Goldman Sachs and other big bank holding companies,” Petrou said.

Federal law restricts banks from owning non-financial businesses unless they get special exemptions. Goldman Sachs and Morgan Stanley, the biggest U.S. securities firms until they became bank holding companies during the 2008 credit crisis, had grandfather exemptions for commodities operations under a 1999 law.

Bart Chilton, a Democratic member of the CFTC, suggested in a letter to Brown today that Congress consider requiring data sharing between the Fed and his agency over banks’ commodities ownership information.

“I have no issue with banks making boatloads of cash, just not owning the boats (and some apparently do, in the form of oil tankers),” Chilton wrote.

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