Fed commodities review said to cover Goldman, Morgan Stanley

Manipulation risk being assessed

The Federal Reserve has expanded its scrutiny of banks’ physical commodities operations to encompass businesses run by Goldman Sachs Group Inc. and Morgan Stanley that Congress had previously authorized.

The Fed is examining all legal and regulatory exemptions that allow banks to participate in the commodities markets, said a person briefed on the process who asked not to be named because the review is confidential. The appraisal, intended to minimize potential risks to the financial system, widened since the Fed said in July that it’s reconsidering its landmark 2003 decision to grant some lenders, such as Citigroup Inc. and JPMorgan Chase & Co., permission to expand into raw materials.

U.S. law restricts banks from owning non-financial businesses unless they get special exemptions. Goldman Sachs and Morgan Stanley were the two biggest U.S. securities firms until they converted into banks in 2008. A 1999 law “grandfathers” any commodities operations they had before Sept. 30, 1997.

“The way I read the statute, all commodities activities are grandfathered forever, subject to appropriate risk-management controls,” said Randy Guynn, head of the financial institutions group at law firm Davis Polk & Wardwell LLP, whose clients include Morgan Stanley and Goldman Sachs.

Merchant Banking

The breadth of the Fed’s review indicates the central bank could narrow its interpretation of what’s grandfathered, potentially limiting Goldman Sachs and Morgan Stanley’s commodities operations to exactly what was held in 1997. Some of their commodity activities, such as Goldman Sachs’s Metro International Trade Services LLC aluminum warehousing business, fall under a separate exemption for “merchant banking” investments. Those can only be held for 10 years.

The Fed is “trying to clear up grandfathering and how it fits merchant banking and the broader context,” said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics, which advises companies on how policies may affect their businesses. Leeway allowed to banks is vague, she said.

Banks trade derivatives related to commodities from oil to corn to gold. To support that business, they often accept delivery of those assets to settle trades, and even store the materials. Many banks have moved beyond trading to owning physical operations such as shipping companies and power plants.

Boeing’s Concern

The U.S. Chamber of Commerce and companies including Boeing Co. and United Parcel Service Inc. sent a letter today to Fed Chairman Ben S. Bernanke, saying they would face difficulties if banks are forced out of commodities.

“Our ability to manage our risk would be seriously impeded” if banks disappear as counterparties for physical commodities hedges, the group said. “We likely would be forced to tie up our own capital in holding physical inventories and the related infrastructure to manage those inventories, and may find our options for hedging shrink, become less useful, or more expensive.”

Unlike Goldman Sachs and Morgan Stanley, banks such as JPMorgan and Citigroup had to seek an exemption from the Fed that deemed their physical commodities units complementary to their financial operations. That exemption, granted in 2003, was the first to come under the central bank’s review.

Trading Platforms

The Fed is conducting the review while U.S. lawmakers and regulators raise concerns that banks might abuse their various roles in commodities markets, such as by coordinating their trading platforms and ownership of materials or energy firms to influence prices and profit. Lawmakers and regulators also have questioned whether large banks integral to financial markets should own commodities businesses, such as oil tankers, in which accidents could undermine the firms’ stability.

“There’s a lot of problems with banks engaging in commodities and taking proprietary positions in commodities,” Senator Carl Levin, a Michigan Democrat, said in an interview. The Permanent Subcommittee on Investigations, which he leads, is reviewing banks’ involvement in commodities.

“Congress should reject the policies that allow for bank ownership and reverse the law,” Bart Chilton, a Democratic member of the Commodity Futures Trading Commission, said in an interview.

JPMorgan, whose commodities units are overseen by Blythe Masters, said in July it may exit businesses. The largest U.S. bank could sell or spin off holdings including warehouses, stakes in power plants and trading in materials such as gas and coal. The New York-based firm said it will continue trading commodity derivatives as well as storing and trading precious metals.

Goldman’s Mines

Morgan Stanley, whose commodities business is run by Simon Greenshields and Colin Bryce, owns electricity-generating facilities in the U.S. and Europe and markets electric power in the U.S. It also owns Denver-based TransMontaigne Inc., a petroleum and chemical transportation and storage company, and a stake in Heidmar Inc., based in Norwalk, Connecticut, which manages about 100 oil and chemical tankers.

Goldman Sachs, whose commodities trading unit is led by Gregory A. Agran in New York and Magid N. Shenouda in London, owns coal mines in Colombia, a stake in the railroad that transports the coal to port and part of an oil field off the coast of Angola. Spokesmen for both firms declined to comment.

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