(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, Nov 27 (Reuters) - December 2010 and the copper market was booming.
On the London Metal Exchange (LME), three-month metal was charging to the then all-time high of $9,550 per tonne, and front-month spreads were tightening.
LME reports at the time showed a single entity controlling over half of all eligible LME stocks, leading to a frenzy of speculation as to just who was squeezing the copper market.
JPMorgan was “outed” in the media as the controlling hand, which only fuelled further the whirl of speculation, given the same bank was proposing to launch an exchange-traded fund backed by physical copper.
As is always the way with such things, JPMorgan declined to confirm or deny its involvement.
Now, thanks to documents submitted to the U.S. Senate subcommittee investigating U.S. banks’ involvement in physical commodities, we know that it was indeed JPMorgan that was holding that dominant position.
The nature of its positioning was a lot more nuanced than the headlines of the time suggested.
But the subcommittee has highlighted one highly anomalous and curious fact about copper.
U.S. banks such as JPMorgan do not have to declare their holdings of copper to banking authorities in the same way they do for other physical commodities.
That’s because both the Federal Reserve and the Office of the Comptroller of the Currency (OCC) classify copper not as a base metal but as bullion.
There has been a long-running game of cat-and-mouse between the U.S. banks and authorities as to the amount of physical commodities the banks can hold.
There are two stand-out restrictions among the multiplicity of contested grey areas.
The OCC limits banks to settling no more than 5 percent of their derivative transactions by taking physical delivery of commodities. The Federal Reserve limits financial holding companies to conducting complementary physical commodity activities at no more than 5 percent of their Tier 1 capital.
But not included in the count are gold, silver, platinum, palladium and ... copper.
Historically, only gold and silver were classified as bullion by the U.S. authorities. But the definition was broadened in 1991 to include platinum, at the request of the National Bank of North Carolina, and again in 1995 to include palladium.
Copper was added to the list just months after palladium at the request of an unidentified bank because, according to the OCC, “copper, like platinum and palladium, has been used to mint legal-tender coins”.
It’s a curious interpretation, since as the subcommittee noted in its report, “the penny, the U.S. coin most closely associated with copper, has been composed of 97.5 percent zinc since 1984”.
But there it is. As far as the OCC and Fed are concerned, copper is officially “bullion”, which means that U.S. banks do not have to declare their holdings to either body.
Just as well for JPMorgan, because the documents it handed over to the subcommittee show that, even with some aggressive accounting techniques, staying within the Fed’s 5 percent Tier 1 limit in other commodities has been a continual headache.
It breached the limit in January 2012 thanks to a colossal aluminium position totalling 3,501,365 tonnes and worth around $7.48 billion. The bank was forced to lend 100,000 tonnes to the market and another 400,000 tonnes to an affiliate to get back below the threshold.
The task of complying with Fed and OCC rules would have been even more difficult were JPMorgan’s copper holdings included, given they reached a maximum of $1.65 billion in 2010, $2.72 billion in 2011 and $1.22 billion in 2012.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Graphic on JPMorgan's copper holdings in 2010 and 3-month prices: link.reuters.com/rup53w Graphic on JPMorgan's copper holdings and short-dated spreads: link.reuters.com/sup53w ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Which brings us back to the frenzied events in the copper market at the end of 2010 in the count-down to the LME’s Dec. 15 prime prompt date.
JPMorgan supplied detailed copper stock holdings figures to the subcommittee covering the period from Oct. 14, 2010 through March 30, 2011.
These show that the bank’s copper stocks peaked at 213,000 tonnes on Dec. 13, at which stage they amounted to 64.5 percent of LME non-cancelled stocks.
A large portion of that position was sold back to the market on Dec. 15, and the holdings dropped to 56,000 tonnes. But not before the position generated massive tension in the nearby structure of the LME market.
“Tom-next”, the shortest-dated spread in the LME’s arcane system, flared out to $13 backwardation on Dec. 14. That was the cost per tonne of rolling a short position for one day. The benchmark cash-to-three-months spread widened to $70 backwardation the day before.
So the market was right about who was squeezing the London copper market.
Or was it?
The LME market is a hall of mirrors, with big beasts such as JPMorgan dealing for themselves and/or for clients at any one time.
It turns out that the bank had not itself taken a massive punt on copper in the way both market and media proclaimed.
JPMorgan’s legal counsel wrote to the subcommittee that “in late 2010 JPMorgan’s copper warrant position on the LME reflected its ongoing and sustained trading activity, including trades involving more than 50 different JPMorgan clients”. (Letter from Steven Ross, Akin Gump, to Carl Levin, chairman of the subcommittee, dated Oct. 31, 2014)
“The trade data does not appear to support the theory that JPMorgan’s copper warrant position was the result of a single large trade,” it added.
And another thing.
“Finally, we note that JPMorgan’s copper holdings during this time frame and at all other times, were related to its customer business and not to the then-proposed JPM XF Physical Copper Trust”.
Ah yes. The proposed physical copper ETF that provoked so much outrage among copper consumers the world over.
JPMorgan was one of several financial players looking to replicate the success of physically backed ETFs in the gold market in industrial metals such as copper.
Or, if you’re reading this at either the U.S. Fed or OCC, that should read “replicate the success of physically backed ETFs in the gold market in other bullion markets.”
JPMorgan’s proposed ETF, with holdings of up to 61,800 tonnes, was put on ice in the face of a fierce rearguard action by U.S. copper consumers and Senator Carl Levin, chairman of the Senate subcommittee.
The fear was that the fund would fuel ever higher prices by removing metal from a market that was in palpable deficit.
There were also concerns about the inherent conflict of interest involved when the same entity runs high-volume positions in the copper market and offers an investment vehicle backed by the physical market.
It doesn’t matter that the ETF was the brain-child of the asset management arm of JPMorgan, not its trading arm. Nor that the December 2010 squeeze had nothing to do with the fund’s proposed launch. The timing was always wrong for that purported linkage to be anything other than conspiracy theory.
The problem is that the potential conflict of interest was hard-wired into the proposition because of the overlapping interests of JPMorgan in being fund promoter, trading facilitator and storer of the metal, the latter in the form of its Henry Bath warehousing operations.
There is an analogy with Goldman Sachs’ ownership of LME warehouser Metro and its role in the aluminium market.
“Chinese walls” can be proven to be effective to financial regulators, but they’ll never be effective in terms of outside perception.
Which is why Goldman Sachs has been fending off regulatory scrutiny, lawsuits and media criticism for the last couple of years.
GOOD-BYE TO ALL THAT?
Things have changed a lot at JPMorgan since those heady copper market times of 2010.
The company has this year disposed of its physical commodity assets, including the Henry Bath metals warehousing business, to Mercuria.
It will revert to being a “pure” broker in terms of LME metals trading.
But that doesn’t mean that it couldn’t amass client positions to the point of market dominance again. And if it does so in the copper market, it still won’t have to include those holdings in meeting the limits imposed by the Fed and the OCC.
Nor will any other U.S. bank as long as copper is deemed to be “bullion”.
And while it is, to quote the subcommittee’s report, “copper will continue to provide a loophole that can be used to circumvent otherwise applicable physical commodity safeguards important to protecting U.S. taxpayers from risks related to physical commodity activities”. (editing by Jane Baird)