An activist stance among Washington lawmakers to remove banks from physical commodity markets is having an immediate impact on their commodities businesses. Following the publication of a story in the New York Times earlier this year about a congressional investigation into the behaviour of commercial banks in physical metals markets, federal regulators are now looking to revise rules that allow commercial banks to own and operate metals warehouses and other pieces of commodities infrastructure. The move is particularly relevant to JPMorgan, Goldman Sachs and Morgan Stanley, all of which have generated substantial profits from owning commodities infrastructure assets since converting to commercial bank status to benefit from emergency government protection during the financial crisis.
“The current investigation is part of a move to prohibit and remove commercial banks from these sorts of industrial areas; there are other similar actions happening intended to prevent commercial banks trading commodities. Some of these banks are now considering de-registering as commercial banks to avoid these moves,” says Jeffrey Christian, managing partner at CPM Group, a New York-based commodities research, consulting, financial advisory, asset management and commodities management firm.
Within days of the NYT story, JPMorgan announced that it was pursuing “strategic alternatives” for its physical commodities business, including its remaining holdings of both underlying commodities and physical trading operations, which contributed some $1 billion to its trading revenues in 2012, according to industry estimates. One estimate suggests that JPMorgan’s metals warehousing activities contributed around $250 million of revenue annually.
Although this seems a relatively trivial amount in the context of the bank’s $6.5 billion second-quarter revenue number, taken in the context of the $410 million Federal Energy Regulatory Commission fine for alleged power-market abuse it’s an indicator of the financial impact that re-regulation will have on the three banks’ bottom line.
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| David Barrosse, founder and managing partner of Capstone, a policy analysis and regulatory research firm based in Washington, DC |
“JPMorgan didn’t wait for the jury to come back on the warehousing issue, and they put their desk up for sale within days of the article. That may be a coincidence, but it’s probably not,” says David Barrosse, founder and managing partner of Capstone, a policy analysis and regulatory research firm based in Washington, DC, that provides expert advice to long-term investors. Although commodity-market controversy has recently focused on energy and food-price speculation, the debate has moved on to metals, specifically physical aluminium and the storage warehouses within the London Metal Exchange network owned by US financial institutions. The rapidly evolving situation shows that banker bashing remains an important political occupation for both sides of the aisle on Capitol Hill.
The public debate around aluminium prices has focused on Goldman Sachs, together with the LME, which faces a class action lawsuit alleging that it restricted aluminium supplies from its warehouses in Detroit and inflated US midwest aluminium premiums.
“The federal investigations are mostly populist politics, but there does seem to have been some strange behaviour at Goldman Sachs’s aluminium storage facilities,” says Christian. However, he adds that: “The warehouse delays pre-date Goldman’s involvement, and they relate to LME policies that the exchange imposed, as opposed to the actions of individual warehouse owners.”
For its part, LME flagged its knowledge of the warehouse delay issue in early July, perhaps to head off any potential consequences from the investigations in the US, and suggested that if there is a queue of more than 100 calendar days, the affected warehouse would be expected to deliver out additional metal based on a formula. An LME spokesperson says that the exchange would remain open to industry consultation until the end of September. “We expect that the proposal and consultation will be discussed at the LME Board meeting in October,” says Miriam Heywood, head of media relations at LME in London. “We encourage market users to contact us with their views. We have nothing to add until the conclusion of the consultation.”
However, the filing of eight class actions in the US by aluminium end-users against a range of defendants – including Goldman Sachs; JPMorgan; the Detroit-based aluminium warehouse at the centre of the storm, Metro Industrial Services; and other metals intermediaries in the US – suggests that the LME’s review will not make accusations of monopoly go away that easily. In one such anti-trust suit filed on August 16 in San Jose, California, Mag Instrument, the makers of the aluminium Maglite torch, alleges a conspiracy between Goldman Sachs, intermediaries and the warehouse company to artificially inflate the price of aluminium by decreasing the amount of aluminium available to the market through hoarding.
Goldman has since replied publicly that it will defend all class actions vigorously, pointing to the fact that aluminium prices have declined around 40% from the 2006 peak.
According to the Aluminium Association, the US aluminium supply totalled 18.3 billion pounds (8.3 billion tonnes) in 2009, with industry sources putting Goldman Sachs’s portion of that stock at around 25%.
Presumably a change in regulation preventing commercial banks from owning physical metals and warehouses would put pressure on prices as bank owners sought to exit positions.
“The aluminium owned by banks is a meaningful number; if something were to change forcing banks to liquidate those positions quickly, you could see significant near- and medium-term price pressure in that commodity,” says one source.