Fed said to widen commodities review to Goldman, Morgan Stanley

October Hearing

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.

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.

Low ROE

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% 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.”

‘Core’ Business

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.

“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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