Fed commodities review said to cover Goldman, Morgan Stanley

Manipulation risk being assessed

Five Years

After the Fed granted Goldman Sachs and Morgan Stanley the right to convert into banks in September 2008, the firms got five years to divest any non-financial businesses that didn’t comply with the Bank Holding Company Act. That deadline raised questions about whether the companies will be allowed to keep their physical commodities businesses.

Saule T. Omarova, a law professor at the University of North Carolina at Chapel Hill, said the five-year grace period to convert non-financial operations “strongly implies the Fed has to make that determination.” She wrote a draft report last year on banks’ roles in commodities, sharing it with lawmakers.

“It would be really wise of the Federal Reserve to be more forthcoming on their thinking, their decision,” she said in an interview. “It is just frustrating that with all this public attention, the Fed feels impervious to that pressure, to just ignore.”

Regulators are set to testify before a Senate Banking subcommittee in October on the issue. It will be the panel’s second hearing on the topic.

‘Safety Net’

Senator Sherrod Brown, an Ohio Democrat and chairman of the subcommittee, said in a September interview that the Fed should clarify that banks’ “safety net applies to traditional banking, not trading, not other lines of business.”

Banks’ commodities businesses drew additional congressional scrutiny this year as aluminum users including beverage companies complained that Goldman Sachs, which warehouses the metal, had created delivery delays that drove up its price. Goldman Sachs has said it stores aluminum according to customers’ instructions and noted the price of aluminum has fallen in recent years.

Goldman Sachs divested some physical commodity assets last year when it sold Cogentrix Energy LLC to Carlyle Group LP. The sale included five coal and solar power facilities in Florida, Virginia, Colorado and California.

Morgan Stanley held talks last year with Qatar’s sovereign- wealth fund about selling a stake in its commodities division. The unit cut jobs and shut businesses including agricultural products and dry freight this year.

Business ‘Struggling’

The six months ended in March were among the worst for the unit’s performance since 1995, Morgan Stanley CEO James Gorman, 55, said earlier this year. The division had a return on equity of less than 5 percent in 2012, the lowest among the bank’s five largest fixed-income units.

“If we could find the right structure to help with our commodities business, we’d move on it,” Gorman said in a Bloomberg Television interview with Erik Schatzker in July. “But as you’ve noted, we’ve been talking about this for a year. We haven’t acted, which is a sense that we’re quite patient.”

Gorman said commodities has been a “tremendous business for Morgan Stanley, but it’s been struggling.”

Goldman Sachs CEO Lloyd C. Blankfein said the firm’s physical commodities unit is a “core” business that provides a crucial service to clients. The bank, whose top three executives trace their roots to commodities trading division J. Aron, has said it plans to remain active in the industry.

Banks’ Defense

“The role we play in that business is very, very important to users in the market,” Blankfein, 59, said in a September interview with CNBC. “Without us in that market, a good credit, a regulated company, the outcomes won’t be very good for the users of the market.”

Banks defended their commodities activities with a September report commissioned by the Securities Industry & Financial Markets Association, in which Goldman Sachs and Morgan Stanley are members. The firms’ ability to trade physical commodities and related financial derivatives helps airlines and natural gas power plants hedge against changes in commodity prices, according to the report from IHS Inc.

The Fed could pursue a variety of strategies for reining in commodities businesses at banks that are grandfathered, Davis Polk’s Guynn said.

“Even if the law says you are permitted to engage in a particular activity, if the Fed thinks you don’t have sufficient risk controls it can insist that you limit the activity until you have proper risk controls,” Guynn said.


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