Wall Street's biggest banks are locked in an increasingly frantic struggle with the Federal Reserve over the right to retain the jewels of their commodity trading empires: warehouses, storage tanks and other hard assets worth billions of dollars.
While the battle over proprietary trading and new derivatives regulations has taken place largely in public view since the 2008 financial crisis, the fight by JPMorgan Chase, Morgan Stanley and Goldman Sachs to retain or expand their prized physical commodity operations - most acquired in only the past six years - has remained hidden.
The debate is nearing an inflection point: Within 18 months, the Fed will likely either allow banks more freedom to invest in the physical commodity world than ever; or force them to sell off the assets that many banks are counting on to buttress their trading books at a time when they are already vulnerable because of intensifying competition and new trading curbs.
The banks are now locked in deep debate with the Fed, multiple sources involved in the discussions told Reuters. Goldman and Morgan Stanley argue the right to own such assets is 'grandfathered' in from their lightly-regulated investment banking days, or that at least they should be allowed to retain them as "merchant banking" investments, kept segregated from the trading desks.
But regulators and lawmakers may not be in the mood to give way. Banks are under pressure to reduce risk on their balance sheet; as commodity prices rise again, they may face more allegations that they could use these assets to drive prices higher or lower, squeezing them for trading profits.
"The Fed's not going to be terribly accommodating," said Oliver Ireland, a former associate counsel to the U.S. Federal Reserve and a partner with law firm Morrison Foerster in Washington, D.C. "There doesn't seem to be a lot of sentiment in this town for people doing new things and taking new risk."
Should these banks lose the debate, the result may be the biggest shake-up in commodity markets since the early 1980s, when Wall Street first discovered the potential profits to be made by wading deep into the murky world of crude oil cargoes, copper stockpiles and power plants.
"Adding large-scale, complex commodity market activities to "too-big-to-fail" bank portfolios, with dangerous potential ramifications to the real economy - as demonstrated in California by Enron - is not comforting," says John Fullerton, who ran JPMorgan's commodity business in the 1990s, and is now a markets activist at the Capital Institute in Connecticut.
The loss of their coveted assets would be a blow for the banks at the worst possible moment, with their proprietary trading desks shut down, commodity merchants trying to poach their top traders and new Basel III capital regulations requiring them to further build capital reserves.
Morgan Stanley's commodity trading revenues have fallen by some 60 percent over the past three years. Goldman Sachs' commodities business revenues fell from $4.6 billion in 2009 to $1.6 billion in each of the past two years.
The Fed declined to discuss specific companies directly or the likely final outcome of the talks. Spokespeople for Morgan Stanley, Goldman Sachs and JPMorgan declined to comment on detailed questions put to them by Reuters.
...
Yet it may be JPMorgan, which has eclipsed long-time market leaders Goldman and Morgan under commodities chief Blythe Masters, that will be first to feel its effects.
The bank has begun sounding out possible buyers for its small operation trading metal concentrates, according to one source who examined the business late last year. It acquired that business when it bought most of RBS Sempra in mid-2010, but because metal concentrates aren't traded on any exchange they were not covered by a 2008 Federal Reserve order that allowed RBS to begin trading physical commodities.
More importantly, the sale has also raised questions about JPMorgan's ownership of its global metals warehousing business Henry Bath, which had also been excluded from the RBS waiver. The Fed's rules give banks a two-year grace period in which to divest any non-compliant businesses they acquire; sources say it's not clear why JPMorgan would be exempt from this rule.
...
@ bolded part
