Fed to outline bank commodity policy early 2014 -source


By Douwe Miedema and David Sheppard

WASHINGTON/LONDON, Oct 28 (Reuters) - The U.S. FederalReserve may not unveil its plans for regulating Wall Street'scommodity trading business until early next year, a personbriefed on the matter said, deferring a decision on thepolitically fraught debate into 2014.

The timing confounds any expectations that the regulatorwould make its views known before a second Senate hearingexpected next month into the rigging of aluminum and othermarkets, at which Fed officials are due to testify.

"I was told ... they would not make any determination by theend of the year, but maybe soon after that," the person said,asking not to be named because the talks were private.

A spokeswoman for the Fed declined to comment.

The Fed is reviewing a decade-old decision that has allowedCitigroup, Barclays and other banks to engage inthe trading of physical commodities such as oil and metals, aswell as its wider policy on containing the risks from thecommodity business for banks. It has never publicly set a timeframe or deadline for the review.

The new scrutiny of Wall Street's multibillion-dollar rawmaterial trading operations has unsettled banks, which fear theFed may impose new constraints on a business that has alreadylost much of its luster and higher regulatory costs.

In July, JPMorgan Chase & Co. announced it wasputting its physical commodity desk up for sale.

One core concern the Fed may have is the potential peril toa bank's health from owning physical commodity assets such asoil tankers and drilling platforms, lawyers said, includinglitigation, contractual or criminal risk.

"The Fed is looking at the safety and soundness (of thebanks), and litigation risk is one aspect of that. They willdetermine ... whether capital and other prudential controlsproperly address it," said Karen Shaw Petrou, a co-founder ofFederal Financial Analytics, a consultancy firm.

The Fed may look at higher capital requirements for banksexposed to the physical commodity business, lawyers said, andthe law gives it ample leeway to adjust the rules and tell banksin more detail how to run the businesses.

"They've got a lot of discretion in that area," said onebanking lawyer in Washington, asking not to be named in order tospeak more freely. "Anywhere from suggesting you need morecapital ... to requiring other procedural protections or riskmanagement to be put in place."


The issue of banks' decade-long expansion into commoditieshit the mainstream this summer after big aluminum buyersrepresented by MillerCoors - the second largest U.S. brewer -complained in a Senate hearing that some banks drove up coststhrough their control of metal warehouses.

The Senate Banking Committee hearing was lead by SherrodBrown, an Ohio Democrat who is canvassing for a bill for banksto hold far more capital, a measure that could trigger thebreak-up of the largest Wall Street firms.

However, in examining banks' commodity business the Fed isunlikely to concern itself with market manipulation, lawyershave said, something that is the remit of two other regulators,the Commodity Futures Trading Commission (CFTC) and the FederalEnergy Regulatory Commission (FERC).

There also may be little the Fed can do about the fact thatMorgan Stanley and Goldman Sachs have far widerleeway to operate in commodity markets than their rivals,because of a quirk in the banking law.

"They may reconsider some of their orders, but they won'tseek a change in the law," the person said.

The two banks sought refuge with the Fed at the height ofthe financial crisis by changing their status to bank holdingcompanies, and the move enabled them to use a grandfatheringclause for their commodity activities.

The law allows investment banks who changed their status tobank holding company after 1999 to keep any activities theyalready engaged in, a provision written into the law toencourage banks to come under the Fed's wings.

Morgan Stanley and Goldman Sachs are now the only two majorWall Street banks benefiting from that authority to not onlyown, but also transport, store, distribute and refinecommodities, something that the other banks cannot do.

Other investment banks may be allowed to own physicalcommodity assets like power plants or oil terminals as so-calledmerchant banking investments, lawyers said, which could offerbetter protection from legal risk.

Merchant banking investments need to be sold after a periodof 10 years, however, and there are strict limits on how closelythe banks can be involved in running these businesses.

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