New Wall Street model may curb commodity flows

By Jane Merriman and Pratima Desai - Analysis

LONDON (Reuters) - The demise of Wall Street's stand-alone investment banking model could drain more liquidity from commodity markets that have already seen a mass exodus of speculative cash.

Goldman Sachs (GS.N) and Morgan Stanley (MS.N), the two biggest investment bank players in the energy markets, have agreed to tighter commercial bank-style regulation by the U.S. Federal Reserve as part of plans to restore calm to the financial sector.

The Fed's action is the latest move toward reduction of risk across the finance industry that will, at least in the short term, mean participants in the markets, including commodities and oil, will have less money to play with.

"Liquidity is going to diminish in all areas of financial markets, including commodities. There's no doubt about that," said Ian Morley, director at British-based fund manager Quantum.

However, Goldman Sachs and Morgan Stanley's change of status will not bar them from commodities trading. Commercial banks, such as J.P. Morgan Chase (JPM.N), regulated by the Fed, are active in these markets.

"Our decision to become a bank holding company will have no impact on our commitment to our commodities and energy business," Goldman Sachs spokesman Lucas van Praag said.

A Morgan Stanley spokesman said: "Morgan Stanley has been an active participant in the commodities markets for over two decades. We remain fully committed to our commodities franchise."

GREATER SCRUTINY

But the banks' activities will face greater scrutiny under the Federal Reserve's regulatory regime.

"It means that the regulators are going to take a much closer look at these banks, what they do, what risk they are running, their liquidity and capital positions," David Williams, head of European banks research at Fox-Pitt, Kelton, said.

"I think that is going to restrain them somewhat in terms of the activities and risks they undertake."

Commodities will have to compete aggressively for capital, which will be in heavy demand in a new lower-risk world and this will have knock-on effects.

"If you reduce the amount of investment or speculative capital you will get a little less volatility in the price, and you reduce the chances of getting bubbles," Simon Wardell, analyst for Global Insight in London, said.

Oil, industrial metals, gold and agricultural commodities have seen an inflow of money from banks' proprietary desks, institutional investors such as pension funds and hedge funds over the past year that contributed to what some said was a "price bubble."

Gold hit a record high of $1,030.80 an ounce on March 17 and slipped to below $740 an ounce earlier this month, while oil hit a record of nearly $150 a barrel in July and dipped back below $100 this month.