NEW YORK/WASHINGTON Jan 13 (Reuters) - The U.S. Federal Reserve is set to take its first formal step toward limiting the role of Wall Street banks in physical commodities markets this week by issuing a notice to seek public comment on the topic, sources familiar with the matter said on Monday.
The Fed will publish an "advance notice of proposed rulemaking" on Tuesday, laying out the issues it is considering, one day before a second Senate banking committee hearing on the matter, the sources said.
The notice and Wednesday's hearing will provide the first glimpse into the Fed's response to growing public and political outcry over the risks of allowing banks to trade physical commodities such as tankers of crude oil and pallets of copper.
It is not clear what measures the Fed may propose. The public is expected to have 60 to 90 days to submit comment letters, which the Fed can use to formulate its rules.
A Federal Reserve spokeswoman declined to comment.
Over the past year, lawmakers have pressed the Fed to examine whether Wall Street's biggest banks, including JPMorgan Chase & Co and Goldman Sachs Group Inc, should be allowed to own assets such as metals warehouses and oil tankers, and to trade physical commodities alongside commodity derivatives.
At a Senate hearing in July, witnesses testified that the activities pose a risk to the financial system in the event of a catastrophic accident. Metals consumers complained that banks' ownership of physical storage assets enabled them to inflate prices for commodities such as aluminum.
The notice by the Fed may touch on the issue of capital surcharges for certain activities, an issue that arose in media reports but was never clarified by the Fed.
SOME BANKS EXITING COMMODITIES
In July, the Fed said it would be reviewing the role of banks in physical commodities trading, something that it has allowed a range of banks to engage in since 2003.
Karen Shaw Petrou of Federal Financial Analytics in Washington said the notice would likely seek comment on how the risk varies by commodity, and would consider the systemic impact of various physical trading activities.
"This is hard, and the Fed is busy," Petrou said. "It is really complicated. If you want to have a simple capital rule, then you would have an across-the-board charge for certain commodities activities, but it's true that some of them are a lot riskier than others."
It is unclear whether the Fed will also address a related but distinct question: whether former investment banks Goldman and Morgan Stanley should be allowed to carry on owning commodity-related assets, such as metals warehouses and oil pipeline, due to a "grandfathering" clause in a 1999 law.
Regardless of the scope of the Fed's statements, they are certain to be scrutinized by industry executives and their lawyers, who have been frustrated by the lack of clarity over a possible crack-down that could further roil Wall Street's multibillion-dollar trading operations.
Some banks have not waited for a final word. JPMorgan is in the final stage of a months-long process to sell its entire physical commodity desk, and Morgan Stanley agreed last month to sell its physical oil trading operation to Rosneft.
"One thing I'd want to look at is their justifications for such a proposal. I think for it to be an appropriately reasoned rule-making, it should address how the charges address the risks," said a banking lawyer who declined to be named.
"I would also want to see what they said about their supervisory experience over the time they have allowed financial companies to do this."