By Anna Louie Sussman and Emily Stephenson
NEW YORK/WASHINGTON Jan 14 The U.S. Federal
Reserve on Tuesday took a first formal step toward restricting
the role of Wall Street banks in trading physical commodities,
citing fears that a multibillion-dollar disaster could bring
down a bank and imperil the stability of the financial system.
The Fed board voted to publish its concerns and potential
remedies following months of growing public and political
pressure to check banks' decade-long expansion into the
commodities supply chain. The Fed also questioned the initial
rationale for allowing them to trade and invest in risky raw
materials and lease oil tanks or own power plants.
The Fed "expect(s) to engage in additional rulemaking in
this area," according to prepared remarks of Michael Gibson, the
Fed's director of bank supervision and regulation, to a U.S.
Senate banking committee hearing on Wednesday.
The new rules could include a cap on total assets or
revenues from such trading, increased capital or insurance, or
prohibitions on holding certain types of commodities "that pose
Facing a clearly uneasy regulator, some banks including
JPMorgan Chase & Co are already quitting the business, a
once-lucrative trading niche that has reaped billions of dollars
of revenue for Wall Street over the years but is now facing
diminished margins and stiffer capital rules.
But others, such as Goldman Sachs Group Inc, have
stood firm, defending an operation they say benefits customers.
Due to a grandfather provision in a 1999 banking law, the Fed
has less leeway to restrict the activities of former investment
banks Goldman and Morgan Stanley, Gibson said.
In a 19-page document that included two dozen questions, the
Fed offered a host of reasons for imposing new restrictions in
the interests of limiting potential conflicts of interest and
protecting the safety and soundness of the banking system. It
invoked disasters including BP's oil spill in the Gulf of
Mexico in 2010 and the derailment and explosion of an oil train
in Canada last year.
"The recent catastrophes accent that the costs of preventing
accidents are high and the costs and liability related to
physical commodity activities can be difficult to limit and
higher than expected," the Fed said in its notice.
The "advance notice of proposed rulemaking," which is an
optional initial step in the sometimes years-long process of
making new regulations, seeks comments until March 15.
To read the full notice click:
CONFLICTS, RISKS AND CAPITAL
It is the Fed's first detailed public comment since it
shocked the banking industry last July by announcing a "review"
of its 2003 authorization that first allowed commercial banks
such as Citigroup to handle physical commodities.
U.S. Senator Sherrod Brown of Ohio, who led the first
hearing last summer, said the measure was "overdue and
insufficient", warning that consumers and end-users risked
paying higher commodity prices until new curbs are imposed.
But others saw it as a likely prelude to tough action that
would curtail so-called "too big to fail" banks amid a wider
political move to restore the historical division between
commercial banking and riskier business. Eliminating that divide
15 years ago helped open the door to commodities trading.
"That was the Greenspan era, and it was anything goes as far
as activities. Now, we realize that we made a lot of mistakes
during the Greenspan era," said Cornelius Hurley, banking law
professor at Boston University and former assistant general
counsel to the Fed Board of Governors.
Beyond the financial risks, the Fed is also seeking comment
on potential conflicts of interest for banks, and the risks and
benefits of additional capital requirements or other
restrictions - measures that have been hinted at in the past.
The Fed said that new limits on the three ways in which
banks may deal in physical commodities were up for debate: the
authority to trade raw materials as "complementary" to
derivatives; the investment in commodity-related business as
arm's-length merchant banking deals; and the "grandfather"
clause that has allowed Morgan Stanley and Goldman Sachs
much wider latitude to invest in assets than their peers.
The Fed also questioned several previously cited
justifications for allowing banks to trade in physical
commodities such as crude oil cargoes and pipeline natural gas
-- markets in which some banks such as Goldman Sachs and Bank of
America's Merrill Lynch are still active.
It said, for instance, that although most banks are not
allowed to actually own infrastructure assets, those that lease
storage tanks or own physical commodities held by third parties
may nonetheless face a "sudden and severe" loss of public
confidence if they are involved in a catastrophe.
They also said that several banks' recent moves to sell all
or parts of their physical trading operations "may suggest that
the relationship between commodities derivatives and physical
commodities markets...may not be as close as previously claimed
While scoping out possible measures to tighten up commodity
trading and merchant investment, the Fed offered little insight
into how it might level the playing field by narrowing the
grandfather exemption that Goldman and Morgan enjoy.
"Our ability to address the broad scope of activities
specifically permitted by statute under the grandfather
provision...is more limited," Gibson will tell lawmakers.
Legal experts say the provision - which has long been a bone
of contention with other banks who had never been allowed to
invest in oil tanks and power plants - was widely written. It
may require Congressional action to crack down - a seemingly
unlikely outcome given the political divisions in Washington.
One legal expert at a private commodity trading firm said
the tone of the Fed's notice and mention of catastrophic risks
made it almost certain that some form of regulatory action would
"Given some of the things they've said, it would almost make
them look bad if they ultimately decided not to do anything,"
said the expert, who asked not to be identified because they
were not authorized to speak to the media.