WASHINGTON Wall Street banks face the prospect of increased scrutiny of their commodity businesses as U.S. regulators and lawmakers on Tuesday pressed for a closer look at their roles in owning warehouses and in trading everything from oil to metals
Under pressure from a handful of lawmakers to explain why banks including JPMorgan Chase & Co. and Goldman Sachs have been allowed to own warehouses and trade physical commodities, regulators have scrambled this month to demonstrate that they are tackling the issue.
On Tuesday, Securities and Exchange Commission Chairwoman Mary Jo White said for the first time that the SEC was looking into the question of insider trading, a concept that has never been formally applied to the broad commodity markets.
Meanwhile a leading lawmaker called on the Commodity Futures Trading Commission (CFTC) to explain what kind of oversight it had of metals warehouses within the London Metals Exchange (LME) network, many now owned by big banks and traders. Metals users testified before a Senate panel last week that the owners are driving up costs by moving slowly to deliver the metal.
The scrutiny of banks' commodity desks, which has been apparent since last year, abruptly intensified this month, raising the possibility that banks may have to spin off or shut down their multibillion-dollar operations.
JPMorgan moved first last week, saying it would quit physical trading. Earlier on Tuesday it also paid $410 million (269 million pounds) to settle a long-running dispute with U.S. power regulators over alleged market manipulation, a penalty likely to increase calls for better oversight.
Senator Sherrod Brown, an Ohio Democrat and banking critic, at a senate hearing asked top regulators including White whether banks should be allowed to own oil tankers and metal warehouses while at the same time trading in related commodities.
"It's a subject matter that once it came to my attention, and that's fairly recently, I've actually asked the staff to examine that question, or a series of questions," White told the U.S. Senate Banking Committee.
She also said that "a range of possible disclosures ... could be involved," but gave no further details.
The European Union has just agreed to overhaul its market abuse law to include stricter rules on commodity trading and tougher sanctions generally for insider dealing, and bring offences like rigging of market benchmarks like Libor within the scope of the EU law for the first time. The revised law is expected to take effect by November.
A spokesman for the SEC later said that White had asked staff to provide her with a briefing on the subjects raised, because of the recent attention on the issue.
The pressure on banks has ratcheted up in the past few weeks, particularly after the Federal Reserve shocked the industry by saying it was "reviewing" a landmark 2003 decision that first allowed banks to trade in physical markets.
But some degree of inquiry has been underway since the end of last year, when the Senate's Permanent Subcommittee on Investigations first began questioning some large banks about their commodity businesses, according to two sources. The inquiry was earlier reported by the Wall Street Journal.
Sen. Carl Levin, who heads the committee, declined to comment on or confirm the initial inquiry, but said he too had "real concerns" about the involvement of banks in this area.
"There's great potential there for conflicts and I think there's great potential there for speculation, which banks should not be engaged in," Levin told reporters.
The stakes went up last week, when big aluminium buyers represented by MillerCoors - America's second-largest brewer - told senators that banks' control of metals warehouses drove up the brewers' costs by as much as $3 billion last year.
A few days later, JP Morgan said it was exiting physical commodities trading, as the profits were too slight for the risks and costs of dealing with regulators in a slew of different countries.
It was a sharp and unexpected reversal for a bank that has pushed aggressively into the sector since 2008, when it first inherited a host of power trading assets through its acquisition of Bear Stearns during the financial crisis.
Such moves reflect a wider and growing unease of combining banking and commodities trading, with both the Department of Justice and the U.S. Commodity Futures Trading Commission having launched probes into metal warehousing.
Sen. Debbie Stabenow, who heads the Senate Agriculture Committee, also weighed in on the issue in a letter to Gary Gensler, who heads the Commodity Futures Trading Commission, the derivatives regulator Stabenow's committee oversees.
"I am writing to encourage you to further review this issue and clarify the role and responsibility of the Commodity Futures Trading Commission," Stabenow said.
One question Stabenow said she wanted answered is what jurisdiction the CFTC has in overseeing the London Metals Exchange, the operator that oversees most the metals warehouses owned by the largest banks.
Gensler, also testifying in the Tuesday hearing, stressed that his agency, while not directly overseeing physical commodity markets, had a clear authority to police derivatives for fraud, manipulation, and other abuses.
The rules for insider trading in commodity markets are far lighter than in securities markets, and have traditionally been much less of a concern because of the fragmented nature of trading, market participants said.
Rich Feltes, an analyst at futures broker RJ O'Brien, said the authors of the 2010 Dodd-Frank overhaul of Wall Street - designed to prevent a repeat of the financial crisis - refrained from tightening the rules for that reason.
"Any rule was significantly scaled back because commodity information is so diverse and so broad based... it was just seen as unworkable," Feltes said.
(Additional reporting by Emily Stephenson in Washington, Christine Stebbins and Tom Polansek in Chicago, Josephine Mason in New York and Huw Jones in London; Editing by Gerald E. McCormick, Carol Bishopric and Bob Burgdorfer)