Fed Is Reserved on Commodity Regulation Ahead of Senate Hearing

Federal Reserve

Source: http://www.flickr.com/photos/23165290@N00/

Another day brings another piece of information on what is not expected to happen at the Federal Reserve. In addition to not tapering, the Fed is unlikely to reveal its plans for regulating the commodity trading business on Wall Street this year. Speaking to Reuters on the condition of anonymity, a person with insight on the matter said: ”I was told … they would not make any determination by the end of the year, but maybe soon after that.” Some had expected the regulations to be outlined ahead of next month’s Senate hearing, the second on the matter.

The first hearing was held in July by the Senate Banking Committee and was called “Examining Financial Holding Companies: Should Banks Control Power Plants, Warehouses, and Oil Refineries?” As the title suggests, the hearing is an investigation into whether banks should be allowed to trade and hold commodities, particularly the rigging of the aluminum market.

Partnership for Progress, a government website, explains the various filings and how the process works. A bank holding company under The Bank Holding Company Act of 1956, in conjunction with the 1999 Gramm-Leach-Bliley Act, is allowed to engage in non-banking activities that are closely related to banking, like mortgages. A bank holding company can also invest in companies not closely related to banking, provided they do not comprise more than 5 percent of the company’s voting stock. If approval is granted, the bank holding company can become a financial holding company and engage in more financial investments.

In 2003, the Fed decided to allow Citigroup Inc. (NYSE: C) to expand its commodities trading sector. The decision granted the bank permission to expand into oil, agricultural products, or other non-financial commodities because they did ”not appear to pose a substantial risk to Citigroup, its subsidiary depository institutions, or the U.S. financial system generally.” JPMorgan Chase & Co. (NYSE: JPM) and Morgan Stanley (NYSE: MS) also expanded as a result.

Other major corporations take issue with the practice. Testifying before the Senate committee in July was Tim Weiner, MillerCoors LLC’s global risk manager for commodities and metals. Bank holding companies were manipulating the marketplace because “the aluminum we are purchasing is being held up in warehouses controlled and owned by U.S. bank holding companies,” Weiner said. “These bank holding companies are slowing the load-out of physical aluminum from these warehouses to ensure that they receive increased rent for an extended period time.”

Randall D. Guynn, who also testified at the July hearing, sees matters differently: “Section 4(0) of the BHC Act and the complementary powers orders that permit certain non-grandfathered financial holding companies to engage in trading physical and energy commodities were only incremental expansions of traditional banking powers rather than a radical departure,” he said. Guynn is partner at Davis Polk & Wardwell LLP, an international law firm.

It is a hotly contested practice. On the one side are those like Weiner who see the banks as unfairly manipulating the market and investments to suit investment and earnings needs to the detriment of other companies. The other side has people and groups like Guynn, who see the practice as an extension of traditional banking.

With the Fed delaying any announcement of regulations, a solution could instead be coming from the marketplace. Banks becoming invested in commodities is not as profitable as it was 10 years ago. Speaking to Reuters, David Silbert, head of commodities at Deutsche Bank AG (NYSE: DB), said: ”The total wallet back at the peak was about $14 billion for the banking sector in commodities trading. I’d imagine this year it’ll be about $7 billion. There were 10-14 banks when it was at $14 billion, now there are really five relevant ones.”

JPMorgan, long seen as a bellwether bank announced the potential sale of its commodities business in July, and the sale began in October. Other banks may follow suit,rather than face dwindling profits and tougher regulations.

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