WASHINGTON/NEW YORK - Wall Street's multibillion-dollar commodity trading operations will be put under the political spotlight on Tuesday as a powerful US Senate committee questions whether commercial banks should control oil pipelines, power plants and metals warehouses.
The Senate Banking Committee hearing comes as Goldman Sachs, Morgan Stanley and JPMorgan Chase - which generated an estimated $4 billion in commodity revenues last year - face growing pressure from a number of investigations into their operations, and as the Federal Reserve reviews Wall Street's right to operate in raw material markets.
Big aluminium consumers like MillerCoors are set to tell the committee that the banks' control of metal warehousing firms has driven up industry costs by as much as $3 billion. The banks will not speak at the hearing, with their views represented by a lawyer who often works with Wall Street.
The threat to Wall Street's physical commodity trading divisions has escalated abruptly across multiple fronts, putting an uncomfortable spotlight on a lucrative side of their business that has thus far fallen largely outside of regulators' sights.
Last Friday, the Fed raised the stakes dramatically, issuing a surprise statement to say it was reviewing a landmark 2003 ruling that first allowed commercial banks to trade physical commodities such as gasoline barges and coffee beans. Until now the Fed had been thought only to be debating whether or not certain banks could own assets, not trade the raw materials.
"Since 2003, our government and central bank have allowed an unprecedented mixing of banking and commerce," Joshua Rosner, managing director of independent research firm Graham Fisher & Co, said in prepared remarks.
"So far, that grand experiment has gone better for the banks than it has for consumers."
At issue is not whether banks should be allowed to trade derivatives like corn futures or oil options, but whether they should be allowed to invest in infrastructure such as tankers and warehouses that can be integrated with their trading operations - and more broadly whether they should be allowed to continue holding title to the underlying physical commodities.
Goldman, Morgan Stanley and JP Morgan declined to comment in detail on their physical commodity trading.
WALL ST FRUSTRATIONS
The Fed statement was the latest in a series of setbacks for banks at a time of growing frustration in Washington over the failure to complete reforms meant to prevent "Too Big to Fail" banks from endangering the wider economy.
Last week the Commodity Futures Trading Commission (CFTC) also launched the opening salvo of a possible enquiry into the lucrative but controversial business of metals warehousing, which has become a potent political lightning rod.
"Large investment banks should not be allowed to warehouse physical commodities like fuel or building materials, inflating prices for consumers and small businesses and profits for Wall Street," Senator Ed Markey of Massachusettes said on Monday.
JP Morgan and Goldman both purchased major London Metals Exchange (LME) warehouse operators in 2010.
Over the following years, a glut of aluminium and other metals piled up in these storage sheds, forcing companies to wait as long as 18 months to take delivery of physical supplies, Tim Weiner, Global Risk Manager of commodities and metals at MillerCoors LLC, is set to tell the committee.
"What's happening is that the aluminium we are purchasing is being held up in warehouses controlled and owned by US bank holding companies," he will say, according to advance testimony. He says the rules that have caused the queues and inflated premiums cost companies $3 billion last year.
JP Morgan is also reportedly close to a more than $400 million settlement with the Federal Energy Regulatory Commission (FERC), as the bank tries to put to rest allegations that its traders manipulated power markets in the Midwest and California.
The bank's alleged activity in those markets was linked to its control over real power plants and energy supplies, a fact likely to sharpen questions over the rules for ownership.
The hearing is the first to address the oversight of banks in physical commodity markets since a Reuters report last year revealed that Goldman and Morgan Stanley were still awaiting a Federal Reserve decision on whether they can still own physical assets after becoming bank holding companies in 2008.
Commercial banks are prohibited from owning trading assets, but the two former investment banks argued that their commodity activities are permitted under a "grandfathering" clause in a 1997 law that effectively scrapped much of the Glass-Steagel act separating the commercial and investment banks.
The Fed has until mid-September deadline to make that decision, and has never commented on the issue. The central bank's reluctance to address the issue publicly may also come under scrutiny at the hearing.
Separately, JP Morgan - which as a commercial bank has never been allowed to own assets - is believed to have reconfigured its Liverpool, UK-based Henry Bath metal warehousing business in order to qualify it as a "merchant banking" investment with the Fed, sources have said.
It is unclear whether that effort, which would require the warehouses to be managed at arm's length from the bank and divested within 10 years, was successful. JP Morgan has also floated a possible sale of Henry Bath, sources have said. The bank has declined to comment on the status of the unit.
Randall D. Guynn, a partner and head of the Financial Institutions Group at law firm Davis Polk & Wardwell, says the Federal Reserve's original 2003 decision to allow Citigroup to trade physical commodities should not be lightly dismissed.
"Both Congress and the Federal Reserve have previously found that the public benefits of these activities outweigh their potential adverse effects," he will say, according to testimony.