Wall Street's multibillion-dollar commodity trading operations came under the political spotlight on Tuesday as a powerful U.S. Senate committee questioned 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 aluminum buyers like MillerCoors, the second largest brewer in the U.S., told the packed hearing that the banks' control of metal warehouses that are part of the London Metal Exchange network has driven up their costs by as much as $3 billion last year by distorting supplies.
"U.S. bank holding companies have effective control of the LME and they have created a bottleneck which limits the supply of aluminum," Tim Weiner, global risk manager for the brewer, the combined U.S. operations of Molson Coors and SABMiller, said in a prepared statement to the U.S. Senate banking committee.
The banks were not present at the hearing, but as it got underway Goldman Sachs issued its first public rebuttal of mounting criticism of its metals warehousing unit, denying that Metro International Trade Services has deliberately caused aluminum shortages and inflated prices.
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 then, the Fed had been thought to be only 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."
Sherrod Brown, Democrat for Ohio and a member of the committee said they may ask the Fed to give testimony at another hearing in September.
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.
WALL ST FRUSTRATIONS
The Senate hearing will increase pressure on the banks commodities businesses 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 Massachusetts said on Monday.
JP Morgan and Goldman both purchased major LME warehouse operators in 2010.
Over the following years, a glut of aluminum and other metals piled up in these storage sheds, forcing companies to wait as long as 18 months to take delivery of physical supplies, MillerCoors' Weiner said in the advance testimony.
"What's happening is that the aluminum we are purchasing is being held up in warehouses controlled and owned by U.S. bank holding companies," Weiner said. He said 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 was 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 Fed 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 a 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, British-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 Fed's original 2003 decision to allow Citigroup Inc 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 said, according to his written testimony.