Banking-industry groups urged the Federal Reserve not to write new rules restricting their involvement in physical commodity businesses, arguing that the benefits they provide outweigh risks highlighted by lawmakers.
The Securities Industry and Financial Markets Association and four other groups representing lenders including Goldman Sachs Group Inc. (GS:US) pressed their case in a letter meant to counteract calls by Senators Sherrod Brown and Elizabeth Warren to bar bank ownership of “physical assets like warehouses, pipelines and tankers” because of safety, legal and reputation risks that could harm the financial system.
The comments came as the Fed closed a public comment period in which it sought input on the risks posed by financial company ownership and trading of commodities such as oil, gas and aluminum, and the possible benefits of imposing additional capital standards. The proposal and request for comment may lead to new rulemaking on the issue, though the central bank could choose to take no action.
“Having a small presence in the physical commodities market actually adds liquidity and efficiency to those markets for the benefit of the end-user consumer” because of the role financial institutions, bank affiliates and investment banks play in making markets, Sifma President and Chief Executive Officer Ken Bentsen said today in a telephone interview.
When those business activities are conducted in accordance with appropriate safeguards, the benefits outweigh the risks, Sifma and the other industry groups said in their letter.
In a separate letter to the Fed, Goldman Sachs estimated that 39 percent of the Standard & Poor’s 500 Index’s $17.2 trillion capitalization has “meaningful exposure” to commodities, and the companies often use banks to manage it, because there are few alternatives.
“We believe that the connection between physical and financial products continues to be meaningful, and that access to physical markets is important in facilitating our provision of a broad range of services to our clients,” the New York-based bank said in a letter signed by Chief of Staff John F.W. Rogers.
The Fed’s review of commodities activities at about a dozen large banks followed Senate hearings last year led by Brown, an Ohio Democrat. Senator Carl Levin, the Michigan Democrat who leads the Permanent Subcommittee on Investigations is investigating possible conflicts of interest and manipulation by banks in commodity markets.
Brown and Warren, a Massachusetts Democrat, said in their letter that financial holding companies should be prohibited from owning physical assets -- highlighting Goldman Sachs’s history with coal mines, pipelines and the bank’s stockpile of yellowcake uranium.
“Commodities activities present risks that are different from financial-market risks, are idiosyncratic, and have the potential to disrupt more than just the financial system,” they wrote. “Global supply chain disruptions can affect industries in the broader economy that rely upon raw materials.”
In his letter, Levin stopped short of calling for an outright ban, suggesting the Fed tighten criteria for banks’ allowable commodity-business holdings, limit the value of those investments and require “adequate insurance.”
Lawmakers have warned that a catastrophe involving a bank-owned supertanker or power plant could jeopardize a lender’s health and leave taxpayers on the hook for a bailout. Sifma’s letter included a memo from a group of banking and energy law firms arguing that banks don’t hold liability risk from operating in physical commodities. Any liability rests with the owner and operator of the commodity not the investor, according to the memo.
JPMorgan Chase (JPM:US) & Co., Morgan Stanley (MS:US) and Bank of America (BAC:US) Corp. have announced plans to sell parts of their commodities businesses. The Fed’s action could increase pressure on Goldman Sachs to exit the physical commodities business.
“This is an important business to us, because it’s important to our clients,” Goldman Sachs Chief Financial Officer Harvey Schwartz said today in a conference call on the bank’s financial results. “There just may be some benefit to those market participants that stay strong in commodities like us, by those that are deemphasizing or exiting, particularly when the market is volatile.”
Goldman Sachs reviewed its merchant banking practices and has decided it would hire an outside management firm instead of using its limited authority to take over front-line control of a company in the event intervention is needed, Rogers said in the letter. The bank also urged the Fed provide guidance to encourage the same from other companies, saying the step would limit industry liabilities.
Federal law restricts banks from owning a non-financial business unless they get special exemptions. Goldman and Morgan Stanley, the biggest U.S. securities firms until they became bank holding companies during the 2008 credit crisis, were granted exemptions for commodities operations under a 1999 law.
Fed Chair Janet Yellen said in a February House hearing that the central bank would review industry comments and pledged to make changes in its oversight of banks’ role.
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