By David Sheppard and Josephine Mason
NEW YORK (Reuters) - The future of Goldman Sachs' and Morgan Stanley's commodity businesses faces even greater uncertainty after a key deadline for them to conform their physical trading to U.S. regulations expired at the weekend without word from the Federal Reserve.
The Fed's silence leaves the two banks even more unsure about whether they will be able to continue owning and operating physical commodity trading assets, from power plants to metal warehouses, and the banks questioning whether the long-running issue has now been swept into a broader Fed review of the role of Wall Street in physical markets.
The banks have been discussing the issue with the regulator behind closed doors for five years, since converting to Fed-regulated banks at the peak of the financial crisis in September 2008. Rival commercial banks are not allowed to own such assets.
But in July, Wall Street's role - including other banks - in physical commodity trading suddenly came under intense scrutiny in Washington amid a series of civil and criminal investigations, including accusations banks have artificially inflated prices in markets from electricity in California to aluminium, boosting the cost of aluminium drink cans.
That issue may come to a head at Senate Banking Committee hearings next month, where the Fed and the banks are expected to testify. The close nature of the two dates has led some to speculate that the Fed may make an announcement on its review soon, to get out in front of a grilling on the Hill.
Nevertheless, the Fed's silence on the expiry of the September 21 deadline came as a surprise to some.
"One would expect something similar to an order from the Fed unless the banks had a very strong indication - formally or informally - that it's okay for them to continue holding these assets," said Saule Omarova, a visiting law professor at Cornell University, on Saturday.
"Given the seriousness of the issue and the public attention it is surprising the Fed didn't announce they were folding it into the formal review they announced in July. The ambiguity persists."
NOT PERMITTED LAST SEPTEMBER
As recently as last September, the Fed told Goldman Sachs (NYS:GS), one of the largest traders of oil and metal on Wall Street, it had just 12 months to stop any impermissible commodity-related activities, according to a letter obtained by Reuters through a Freedom of Information Act request.
"Goldman Sachs continues to engage in commodity-related activities ... that the board has not permitted" for financial holding companies, said Robert Frierson, Secretary of the Board, in a letter dated September 19, 2012 approving a final one-year grace period for the former investment bank to comply with commercial banking regulations.
It appears little, if anything, has changed. In the last 12 months, Goldman has not sold any of its physical commodity businesses that were in dispute.
At the same time, the Federal Reserve has not given the banks a clear signal that they consider them now to be in compliance. The Federal Reserve declined to comment on the expiry of the deadline when contacted by Reuters on Friday. Spokesmen for Goldman Sachs and Morgan Stanley (NYS:MS) also declined to comment.
Earlier this year Goldman looked at selling its Metro International metal warehouses but now says it is keeping the unit as a "merchant" investment operated at arm's length.
Morgan Stanley has also been looking at a potential sale of its commodity arm since last year, although those efforts appear to have cooled as the bank awaits the Fed's verdict.
Morgan Stanley owns TransMontaigne, a large oil terminaling and logistics subsidiary. Forbes magazine estimated last year that TransMontaigne was the 17th-largest private company in the United States.
Both Goldman Sachs and Morgan Stanley became Fed-regulated banks in September 2008 at the peak of the financial crisis. Commercial banks are normally barred from owning physical trading assets, because of the long-standing separation of banking and industry.
The banks have argued that a "grandfathering" clause in the Bank Holding Company Act may allow them to continue owning physical assets due to their long history of operating in those markets, though the debate has never been clearly settled.
Morgan Stanley said in its 2012 annual report that it remained in discussions with the Fed on the issue.
"Nothing will happen unless the Fed decides to say something about the grandfathering provision or makes any changes to the review of the physical commodities," said one U.S. attorney who specializes in banking regulation.
The banks will now be waiting for the result of the Fed's broader review, with some expecting them to tighten restrictions on commercial banks' ability to ship crude oil in tankers and trade pallets of metal.
Regulators and politicians have questioned whether Wall Street's involvement in risky commercial activities could pose a threat to their financial soundness as they try to end the era of the 'too big to fail' banks.
"The Fed has been slapped around a bit and is now going back to its core view, which is that banking should be banking," said Karen Petrou, co-founder of consultancy Federal Financial Analytics.
(Additional reporting Anna Louie Sussman in New York and Douwe Miedema in Washington; Editing by James Dalgleish)