Fed said to widen commodities review to Goldman, Morgan Stanley

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, aimed at minimizing potential risks to the financial system, has 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.

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