The Fed Looks To Curb Banks’ Physical Commodities Businesses

by Trefis Team
Goldman Sachs
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The Federal Reserve is expected to release a set of guidelines limiting the involvement of bank holding companies in the trade of physical commodities as early as this month in what comes as the latest move by the financial watchdog to clamp down on risky businesses run by the country’s biggest banks. [1] The restrictions are not entirely unexpected given the ongoing investigations by regulators into the alleged manipulation of commodity prices by JPMorgan (NYSE:JPM) and Goldman Sachs (NYSE:GS). Besides these two banks, the proposed changes are also aimed at Morgan Stanley (NYSE:MS) and Citigroup (NYSE:C) – bank holding companies who have a significant presence in the physical commodities business.

In terms of impact, the Fed’s move does not matter much to JPMorgan as it is already in the process of getting rid of its physical commodities business (see Why JPMorgan Might Sell Its Physical Commodities Unit). But the other banks will be forced to follow suit and discontinue or sell their metal warehousing, oil shipping and power generation operations once the Fed goes ahead with its plan to impose the ban. And this represents a downside to its value in the near future – more for Goldman Sachs than the others.

See the full Trefis analysis for Goldman SachsJPMorganMorgan StanleyCitigroup

The role of banking giants in the physical commodities business has come under considerable scrutiny over the recent months after it was revealed that JPMorgan and Goldman Sachs are among several companies being investigated for manipulating the prices of aluminum. [2] JPMorgan has also been under the scanner of several regulatory authorities since last year for manipulating energy prices in the country. [3]

The series of events proved to be the push JPMorgan needed to beat a hasty retreat from the physical commodities business – a move it had been mulling for nearly a year. But others like Goldman Sachs and Morgan Stanley continue to hold the opinion that they should be allowed to continue trading in physical commodities. No doubt their affiliation to the business has a lot to do with the fact that global investment banks pocketed well over $12 billion in revenues through commodities trading in 2008. [1] Although these revenues shrunk to $6 billion for 2012, the industry has also seen considerable consolidation over the years with very few big players left standing – each one of them generating a chunk of this figure.

A better idea of the impact on the two biggest players here, Goldman Sach and Morgan Stanley, can be obtained from the fact that these banks disclosed the size of their physical commodities portfolio to be $11.7 billion and $7.3 billion respectively at the end of 2012. That’s roughly 4% of the total FICC trading assets for each of the banks at that time.

So how much will the Fed’s restrictions on physical commodities trading hurt the two banks? Well, by reducing the size of their respective FICC trading assets by 4% over the forecast horizon we estimate the effective loss in value for Goldman Sachs to be roughly $1.7 billion (or a 3% downside to our current estimated value) while the figure for Morgan Stanley is a much lower $400 million (representing a downside of under 1% to our current estimated value).

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  1. Banks Face Physical Commodity Curbs, The Wall Street Journal, Sep 10 2013 [] []
  2. JPMorgan Sued With Goldman in Aluminum Antitrust Case, Bloomberg, Aug 7 2013 []
  3. J.P. Morgan Faces New Probe on Energy Trades, The Wall Street Journal, Aug 19 2013 []
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  • tags: C JPM MS GS
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