Published July 26, 2013
JP Morgan Chase & Co (JPM) is exiting physical commodities trading, the bank said in a surprise statement on Friday, as Wall Street's role in the trading of raw materials comes under intense political and regulatory pressure.
Wall Street's biggest bank said an "internal review" had concluded it should pursue "strategic alternatives" for its physical commodities operations, which includes assets like its Henry Bath metals warehousing subsidiary and a vast global team trading everything from African crude to Canadian natural gas.
The firm will explore "a sale, spinoff or strategic partnership" for its physical arm, the statement said. It said the bank remained "fully committed" to its traditional financial commodity business, including trading derivatives and its activities in precious metals.
The bank's announcement follows a week of unprecedented scrutiny of Wall Street's commodity operations, after the U.S. Federal Reserve said last Friday it was reviewing a landmark 2003 decision that allowed commercial banks to trade in physical markets to "complement" their financial activity.
The move also comes as Chief Executive Jamie Dimon strives to put the bank back on course after a series of costly trading moves and regulatory run-ins, including a potential $410 million settlement over alleged power market manipulation.
The decision is a sharp reversal for the bank that had pushed aggressively into the sector since 2008, when it first acquired a host of physical trading assets and expertise through its acquisition of Bear Stearns during the financial crisis.
That was followed by the acquisition of RBS Sempra Commodities in 2010, allowing the bank to quickly challenge Goldman Sachs (GS) and Morgan Stanley (MS) for the title of largest commodity business on Wall Street.
A spokesman for JPMorgan did not immediately return a call seeking comment.
The move will also bring questions about the future for Blythe Masters, the architect of JPMorgan's growth in commodities and one of the most famous women on Wall Street.
The review had been under way since at least February, according to a person familiar with the matter.
The bank concluded that the profits from the business were too slight to be worth the risks and costs of dealing with regulators in multiple jurisdictions, the person said. Another reason for the exit: Unlike the bank's traditional commodities trading, this business does not provide services that the bank's usual corporate customers want.
Bank officials believe the physical business will be more valuable to another owner that is not coming under as much scrutiny as the banking giant, the person said.
At its peak, JPMorgan's global commodity operation was considered the largest on Wall Street, supplying crude oil to the biggest refinery on the East Coast and holding enough electricity contracts to light Indiana's 2.8 million homes. It was one of the 10 largest U.S. natural gas traders.
Although the division's $2.4 billion in reported revenue last year exceeded those of the commodities divisions of Goldman Sachs and Morgan Stanley combined, some have questioned its profitability given the costs involved in running a large logistical operation.
The about-face comes after a bumpy ride in the markets.
After the Sempra acquisition, the bank appeared to struggle integrating the entrepreneurial trading unit into a storied Wall Street institution, and a number of senior traders left. That same year a bad trade in coal markets lost hundreds of millions of dollars, which Masters called a "rookie error."
Already under pressure in Washington because of its size and for its $6.2 billion "London Whale" loss on derivatives trades last year, it suffered a fresh blow several months ago as the U.S. Federal Energy Regulatory Commission (FERC) prepared to charge its power traders with manipulating markets.
Most recently the group's investment in warehousing firm Henry Bath has been attacked by metals consumers for distorting markets and driving up prices. The Department of Justice and the U.S. Commodity Futures Trading Commission have also both launched probes into metal warehousing.
The bank has already scaled back its power business and sold off half of its power trading contracts, Reuters reported earlier this week. Earlier this month its longtime global oil trading head Jeff Frase left the bank.
"This could be good news for consumers and taxpayers," said Senator Sherrod Brown, the Chairman of the Senate Banking Subcommittee on Financial Institutions and Consumer Protection, after JPMorgan's announcement on Friday.
"Banks should focus on core banking activities. Our economy is strengthened when financial conflicts of interest and financial risk are reduced," he said.
Brown who held a hearing on banks and commodities this week.
Earlier this week, Deutsche Bank's (DB) bank stock analyst Matt O'Connor said that tougher regulation of physical commodities would only have a modest impact on the bank's earnings.
Following a meeting with JPMorgan CEO Jamie Dimon, he wrote that physical commodity trading might be around 5 to 10 percent of total fixed income, currency and commodity trading revenue (FICC). He estimated overall commodity trading at the bank at around 15 percent of FICC.
In sum, that would mean that trading in physical commodities probably generates less than 2 percent of JPMorgan's total revenue.
The decision to move out of the raw materials trade comes months after Dimon vowed to resolve multiple government investigations and correct problems that regulators have found.
Big banks are taking a more conciliatory stance in general with regulators who continue to impose new rules more than five years after the start of the financial crisis.
Calls for legislation to limit the scope of dealings by big banks or even break them up have increased this year and caught the attention of bank executives and investors.
JPMorgan shares ended down 0.8 percent at $56.05 on Friday.
CROWDED MARKET FOR TRADE HOUSES
The bank's commodity business will come enter an already crowded market.
Morgan Stanley, facing even tougher regulatory pressure over its vast oil division, has been trying to sell its commodities division without success since last year. Hetco, the physical trading shop half owned by Hess Corp (HES), is also in the midst of being sold as Hess is split up. And the energy trading unit of Omaha, Nebraska-based Gavilon may also be for sale after Marubeni Corp excluded it from its takeover of the grains trader this year.
Industry executives say that there are two likely types of buyers for these vast, capital-intensive businesses: private equity groups like Carlyle Group, which have recently moved into the space, and sovereign wealth funds like that of Qatar.
But the group could also be a target for one of several merchant traders looking to quickly expand into metals and energy markets.
Freepoint Commodities, a privately owned merchant founded by the original Sempra executives, bought back a metals concentrates business from JPMorgan last year. Australian bank Macquarie Group, which faces less regulatory pressure because it does not have commercial banking operations in the United States, has also become a large presence in U.S. energy markets.