[heading]Big Banks Prepare To Exit Physical Commodities[/heading]
JPMorgan made headlines last month with an astonishing announcement that it would be getting out of physical commodities. This was shocking for everyone who had followed the contentions that the bank was in fact manipulating the commodities, like silver.
Then, revelations about how banks were manipulating the storage warehouses and aluminum markets of some commodities. All of the sudden, banks were coming under mainstream pressure for physical commodity manipulation. No explicit mentions in the mainstream regarding silver. After all, the SEC had already let JP Morgan off the hook.
Attention turned to a 2003 ruling, when the Federal Reserve broke with a hundred years tradition and made it okay for banks to dabble in physical assets. The controversy surrounding the issue has climaxed amid a bull market in precious metals.
July 19 2013 saw the US Federal Reserve board make public their review of a 2003 ruling that allowed financial holding companies – a division of firm that includes parent companies of most the US investment banks and many non-US banks – to trade physical commodities on markets.
The sudden announcement increased the possibility that FHCs, including companies like Citigroup, Barclays and JP Morgan, might scale back their trading of physical natural gas, electricity and crude oil.
The New York Times ran a long front-page article probing allegations that Metro International Trade Services, a Michigan-based subsidiary of Goldman Sachs that owns metals warehouses in the Detroit area, had artificially created shortages of aluminum, driving up the cost of the metal – allegations that Goldman has denied.
On July 23 came the attack of banks in physical markets by lauded senators and expert witnesses in a US Senate hearing devoted to bank control over assets such as metals warehouses, power plans and oil refineries.
Then, on July 26, JP Morgan announced it was investigating a possible detangling from its physical commodities business, citing burdensome regulation as a reason for its desire to spin-off this division.
On July 30, the bank paid out $410 million to settle allegations by the Federal Energy Regulatory Commission (Ferc) that its traders had manipulated power markets in California and the US midwest from 2010-2012. This on the heels that it had manipulated power markets in California.
JP Morgan pled the 5th. The settlement did however lead to critics say the banks’ involvement in physical commodities raises the risk their traders will engage in market manipulation.
In the US there is a long history of financiers cornering physical assets, like when financier John Pierpont Morgan dominated the US steel industry. “There tends to be a sensitivity bordering on irrationality whenever commodities and finance are discussed together,” said Craig Pirrong, a professor at the University of Houston’s Bauer College of Business.
For over one hundred years, the laws in the US made it clear banks could not dabble in physical assets. Banks were banks, while commercial companies were commercial companies.
At the center of the controversy are two US banks with the longest history in commodities: Goldman Sachs and Morgan Stanley.
In the 1980s, the two investment banks were not bank holding companies, and so were not regulated by the Fed. The Gramm-Leach-Bliley Act in 1999 allowed the banks to become FHCs so they could participate in activities like insurance and securities.
The 2008 bankruptcy of Lehman Brothers in September 2008 led to Goldman and Morgan Stanley becoming BHCs so they could gain access to Fed liquidity. But, this also means the Fed could scrutinize their practices to ensure they conform to the limitations on what FHCs may do.
Both Goldman Sachs and Morgan Stanley trade physical crude oil, refined products, natural gas and power, as well as financial derivatives linked to commodities.
Physical trading is a important line of business for the two banks, especially Morgan Stanley, which owns 100% of TransMontaigne, a major fuel supply and logistics firm based in Colorado, and 49% of Heidmar, a Connecticut-based firm that manages a fleet of over 100 oil tankers.
The banks argue that they can partake in such activities due to a “grandfather” provision in the Gramm-Leach-Bliley Act. According to this provision, any firm that becomes an FHC can continue “activities related to the trading, sale or investment in commodities and underlying physical properties” so long as it engaged in those activities as of September 1997.
precious metals bugs will notice a key restriction to the Act: that commodities activities only account for 5% of the firm’s total assets.
Morgan Stanley disclosed in US Securities and Exchange Comission filings that it could be forced to exit commodities by September 21, 2013, when the five year grace period comes to a close; that is if the Fed decides they do not conform to the bank’s status as an FHC
“If the Federal Reserve were to determine that any of the company’s commodities activities did not qualify for the… grandfather exemption, then the company would likely be required to divest any such activities that did not otherwise conform to the BHC Act by the end of any extensions of the grace period,” Morgan Stanley stated in the SEC filing from February 26.
Goldman Sachs has pointed towards the same: “The Federal Reserve Board… has the authority to limit our ability to conduct activities that would otherwise be permissible for a financial holding company, and will do so if we do not satisfactorily meet certain requirements,” the bank stated in a February 28 filing with the SEC.
The Federal Reserve, Goldman Sachs and Morgan Stanley have all declined to comment on the matter, though sources familiar with the Fed say that it is unlikely to force the two banks to make any dramatic exit from physical commodities.
They echoed the sentiment that the banks were likely protected by the grandfather provision, though the Fed could issue an interpretation that limits the scope of the provision. Should the Fed demand divestiture, the banks would likely have plenty of time to extricate themselves from the positions.
The banks maintain that their market making in physical commodities benefits clients, including firms like refiners, utilities, airlines and mining companies. They help business manage price volatility.
“We hold an inventory position in a particular physical commodity for the simple reason of meeting the needs of our clients or as a hedge for positions in commodity futures or derivatives we assume as a market-maker,” said a New York-based spokesman for Goldman Sachs.
“From the point of view of a trading organisation, combining physical and financial trading has definite benefits, primarily in terms of information flow,” said Vincent Kaminski, a professor at the Jones Graduate School of Business at Rice University in Houston.
“A lot of information in the commodity markets is not available purely in prices. It’s very important to receive, on a regular and timely basis, information about the conditions of the physical infrastructure, inventory levels, the backlog of orders, and all the other information that you can’t get just by watching prices on the screen,” he continued.
Opponents to the current arrangement argue that banks manipulate prices via speculation. Still others argue that market manipulation was around before the entry of banks into physical commodities, stating that plenty of non-bank firms have also been accused of market manipulation, like Enron.
“It’s not like banks are uniquely suited for manipulation while other market participants are not. If conditions in the marketplace make manipulation possible and profitable, there will be people who are tempted to seize those opportunities,” notes Pirrong at the University of Houston.
“Experience with physical commodities trading activities since 2003 suggests that the Federal Reserve’s original rationale for finding that the activities are permissible for FHCs is correct – physical commodities trading is complementary to financial activities, and it does not pose a substantial risk to depository institutions or the financial system generally. The Federal Reserve would therefore be required to overcome substantial evidence in order to demonstrate that its original conclusions… were mistaken,” stated Los Angeles-based law firm Gibson, Dunn & Crutcher.
For banks like JPMorgan, a spinoff of its physical commodities business would mark a dramatic departure. JPMorgan has pushed aggressively into physical commodities, like oil, metals, coal, power and natural gas assets from RBS Sempra Commodities in two tranches during 2010.
Blythe Master – the NY-based head of commodities – touted the bank’s physical commodity positions, saying that in the past year “we’ve transacted a number of large and important client transactions that could not have been done but for the broader franchise at JP Morgan, and could not have been done but for the very significant investment in expanding our commodities platform along the direction of both physical and financial capabilities – and really broad capabilities, rather than narrow or niche things.
An apparent off-the-whim “internal review” has led JPMorgan to want OUT of the commodities market. After years of protested silver manipulation, could this be the end? Is silver set to increase in price now that “the Morgue” is out of the picture?
One thing is for sure, some silverbugs are rejoicing. Others want to know the truth of JPMorgan’s silver position.
The message telegraphed to mainstream media, alternative media and blogs around the globe is that JPMorgan will no longer be able to manipulate silver, because they are getting out after much issue has been taken with their positions. They’ve gotten out gold and made headlines for their oligopoly over commodity warehousing. Another probe has been threatened, and an era has ended. Or has it?
JP Morgan is “fully committed to traditional banking activities,” but they are looking to sell, spin or ally with strategic partners to shed the position. Many assume that “physical commodities” means the company’s extensive inventories of tungsten and lesser gold and silver.
Just recently, JPMorgan was manipulating beer prices.
Since Fall-Winter of last year, we have heard much news – coming out of sources like Bix Weir – that Citigroup has entered the commodities market.
On November 1 Jose Cogolludo joined the corporate sales office at Citi with years of experience in commodities sales at JPMorgan and Goldman Sachs before that. The entrance of Citi into commodities, with their office based in London, is a new position as of last Fall and includes “all commodity products with corporate clients across the world.”
“I am delighted and proud to join Citi, where our client franchise is unrivaled by other institutions, in particular in emerging markets. Our plan is to systematically provide a full range of risk management products to Citi’s global client base, to better integrate our product offering with the rest of the organization, and to strengthen our position as a leading actor in the commodities space,” he said.
“With these important additions to our sales team, we have made significant strides in strengthening our commodities platform and connecting our complete suite of commodity products with a wider range of the bank’s clients than ever before,” said Stuart Staley, global head of commodities.
What, perhaps, has Citi inherited from JPMorgan? In JPMorgan’s own words:
Following the internal review, J.P. Morgan has also reaffirmed that it will remain fully committed to its traditional banking activities in the commodity markets, including financial derivatives and the vaulting and trading of precious metals. The firm will continue to make markets, provide liquidity and offer advice to global companies and institutions that have, for years, relied on J.P. Morgan’s global risk management expertise.
The decision regarding whether or not JPMorgan was manipulating the market came in the Fall of last year, as Citi was accumulating further positions. The CFTC would not investigate allegations that the silver price is manipulated by major financial powerhouses, in particular JPMorgan, whose death-by-a-thousand-cuts year might see their Too Big To Fail status tested and endure.