Fed Governor Insists on Stricter Commodity Rules for Banks - Analyst Blog

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The Federal Reserve governor, Daniel Tarullo, is holding steadfastly to his opinion of tightening regulations pertaining to major U.S. banks' ownership in physical commodities assets. On Thursday, at a U.S. Senate committee hearing, Tarullo suggested revoking the rule that allows two former investment banks - The Goldman Sachs Group, Inc. GS and Morgan Stanley MS - trade in the commodities markets.

Without naming the banks, Tarullo said, "Those two firms are by statute allowed to engage in the extraction, transportation of potentially highly combustible materials with substantial risks associated with them, I think it would be very much worth considering treating those two firms the way we treat all other bank-holding companies."

Per the "grandfather" provision of the Gramm-Leach-Bliley Act in 1999, a company that was not a bank holding company and converted to a financial holding company after Nov 12, 1999, allows it to continue to conduct activities pertaining to the trading, sale, or investment in commodities that were not permitted for bank holding companies engaged in any of such activities as of Sep 30, 1997 in the United States.

The grandfathered firms are allowed to engage in the transportation, storage, extraction, and refining of commodities. Currently, only two financial holding companies qualify for these grandfather rights - Goldman and Morgan Stanley - that became bank holding companies during 2008.

In recent years, Wall Street banking giants have been surrounded by controversies owing to their ownership in commodities including coal, oil, gold and aluminum. Notably, a finding in a two-year Senate probe released last year, specifically mentioned Goldman, Morgan Stanley and JPMorgan Chase & Co. JPM as the companies that amassed huge stakes in the commodity market and hence such significant stakes are likely to affect prices and pose "catastrophic risks" to the banking system. (Read more: Senate Probe: Banks Exploit Commodity Market )

Since Jan 2014, the Fed has invited public comments through the Advance Notice of Proposed Rulemaking (ANPR) on physical commodities activities of the banks. Under the ANPR, the Fed is exploring additional restrictions and limitations regarding banks' commodity-related activities. These may include increased insurance or capital requirements, cutbacks in the maximum amount of assets or revenue generated from such activities and prohibitions on holding certain types of physical commodities that could lead to undue risk to the bank's stability.

The Fed is planning to issue a formal notice of public rulemaking related to the matters concerning banks' stakes in the commodity market by the end of first-quarter 2015.

Bottom Line

Amid heightened regulatory and political scrutiny on banks' ownership of the physical commodity business, several banks have reduced exposure in the commodity business including Bank of America Corp. BAC , Deutsche Bank AG DB and Barclays PLC BCS .

Notably in Dec 2014, Goldman sold its Detroit-based metals warehouse unit - Metro International Trade Services LLC. However, during the same month Morgan Stanley's deal to divest its Global Oil Merchanting unit to Russia-based Rosneft Oil Company's wholly owned subsidiary was terminated, as it failed to win all the necessary regulatory approvals.

While it is a matter of time to see how lawmakers actually respond to Tarullo's suggestion, we believe revenues of the two banking giants might be impacted to a certain extent in the event the 1999 grandfather provision is overturned.

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BANK OF AMER CP (BAC): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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