As JPMorgan Chase & Co (JPM.N) prepares to exit physical commodities trading, the spotlight is turning to the future of the two banks that have dominated Wall Street's involvement in the natural resources supply chain for 30 years.
Goldman Sachs (GS.N) and Morgan Stanley (MS.N) two decades ago became known as the 'Wall Street Refiners' for their mastery of both financial and physical commodities.
But since 2012 Morgan Stanley has looked at selling its commodity arm and Goldman has made moves to scale back its physical operations.
Letters between the banks and the Federal Reserve, received by Reuters under the Freedom of Information Act, show both banks are in discussions on conforming or divesting activities that fall outside the normal scope of commercial banks.
Goldman has been looking at selling its Metro International metals warehouses firm since at least March, but it has also publicly reaffirmed its commitment to its J. Aron commodities business, where CEO Lloyd Blankfein started his career.
Morgan Stanley has been looking at a possible spin-off or sale of its commodity arm since last summer, but with little success. Recent moves suggest it may try to refocus on its vast physical oil trading arm and exit peripheral markets like Australian electricity.
The question is, in part, whether they will be able to choose their own future, or will the Federal Reserve's decision to review the entire role of Wall Street in physical commodities markets see regulators make the choice for them?
The past 10 days has seen unprecedented scrutiny of Wall Street's commodity trade, with a Senate hearing questioning whether banks should be allowed to own pipelines, warehouses and other commercial assets.
U.S. regulators and the Department of Justice have launched initial investigations into the metals warehousing business of banks and other big commodity traders, which have been accused of driving up the price of aluminum by drink can manufacturers.
While JPMorgan cited the growing regulatory pressures as one of the reasons it has decided to exit physical commodities trading, it was not clear if it was influenced by the banks' discussions with the Federal Reserve.
One person familiar with the matter said on Friday the bank had decided the profits from commodities were too slight to be worth the regulatory and reputational risks.
CEO Jamie Dimon has been trying 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.
"I don't think it was any one thing, but a culmination of things, that drove (JPMorgan's) decision," said Craig Pirrong, a professor at the University of Houston and expert in commodity markets.
"The legal and reputational risks, the Fed's likely action to constrain - if not eliminate - this sort of trading, the increasing capital strains on banks, and especially the political heat being directed at the industry. In the scheme of things at JPMorgan, commodities just weren't big enough and profitable enough to be worth all this bother."
LETTERS FROM THE FED
Goldman Sachs and Morgan Stanley may hold one advantage over JPMorgan, as their long history of operating in physical commodities as less regulated banks may provide them with "grandfathered" ownership of assets like warehouses, pipelines and storage tanks that other commercial banks aren't allowed.
"I don't think there is a necessary or clear link between whatever the Fed's position is on JPMorgan's ownership of physical assets - if, in fact, it is the Fed that is pushing JPMorgan to divest - and the Fed's position on Goldman and Morgan Stanley," said Saule Omarova, associate professor of law at the University of North Carolina, who appeared at the Senate banking committee hearing last week....MORE
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