NEW YORK The U.S. Federal Reserve has announced a consultation on the role of banks in physical commodities ahead of a second Senate hearing. If the comments the Fed receives are anything like those presented at a U.S. Senate hearing on the same topic in July, it could signal the forced exit of banks from physical commodities.
The results of the consultation, which ends March 15, will affect the activities of a dozen banks including Goldman Sachs Group Inc., JPMorgan Chase & Co., Morgan Stanley, Barclays Bank Plc, Société Générale SA and Deutsche Bank AG.
These banks have been granted the authority to engage in physical commodities activities and will be subject to the decision resulting from the Fed review.
Sen. Sherrod Brown (D., Ohio) criticized the Fed at the last hearing for failing to provide a time table for its bank review, which may have prompted the announcement the day before the Senates next hearing.
The Fed may completely force out the banks that are active in the market or allow exemptions to operate assets. It might decide to ban the ownership of assets, but allow trading activities. Alternatively, the Fed could decide to let the status quo remain.
The role of banks in physical commodities came under scrutiny in July, when former U.S. Commodity Futures Trading Commission Commissioner Bart Chilton led the charge against Goldman Sachs and its peers during a U.S. Senate hearing.
Chilton, who has since left the CFTC, was opposed to banks having any role in physical commodities.
In fact, Chilton was pushing the Senate to repeal the Gramm-Leach-Bliley Act of 1999, which granted banks the ability to engage in physical commodities in the first place.
His absence from the CFTC may temper those arguments and it remains to be seen whether anyone else within the regulator picks up the opposition mantle.
Some banks have already decided that its getting increasingly tricky to operate in physical commodities within the confines of new regulation and have opted to quit the business altogether.
New York-based JPMorgan plans to exit physical commodities trading as well as ownership of assets such as its warehousing company Henry Bath LLC. Bids were due last week, according to sources familiar with the matter, and a decision on the sale of at least part of the business could be imminent.
New York-based Morgan Stanley is selling its global oil merchanting unit to Moscow-based OAO Rosneft and is selling other physical commodities units as well.
Frankfurt, Germany-based Deutsche Bank has exited commodities entirely, while London-based Barclays took a step back from metals trading when it moved off the floor of the London Metal Exchange.
New York-based Goldman Sachs, however, said it is sticking with its physical commodities business.
But a world in which U.S. banks have no role to play in the ownership of some of the countrys key strategic assets such as power plants and oil storage facilities is something that will likely attract objections.
Banks absence from trading those assets also seems unlikely.
Perhaps a solution lies in capital requirements.
For instance, what are the advantages and disadvantages of imposing "additional safety and soundness, capital, liquidity, reporting, or disclosure requirements" for banks engaging in physical commodity activities, the Fed asks in its consultation.
Banks are required to limit the aggregate market value of commodities held as a result of physical commodity trading to no more than 5 percent of its consolidated Tier 1 capitalthe banks core capital, including equity capital and disclosed reserves.
The same 5-percent limit goes for capacity payments under energy tolling agreements, after taking into account investments due to physical trading, as well as revenue resulting from energy management services.
The Fed states quite clearly that current capital requirements may be lacking.
Increasing those requirements would potentially provide the increased layer of security the Fed is seeking for the financial system.
It would also allow banks to continue to play a yet-to-be-determined role in physical commodities.
The second U.S. Senate hearing on the matter will kick off the debate for 2014.