WASHINGTON -- A loose coalition of beer brewers, automakers, Boeing and Coca-Cola is accusing big banks, including Goldman Sachs and JPMorgan Chase, of anti-competitive behavior in the aluminum market, fueling regulatory concerns and prompting a Senate probe as part of an international political battle over Wall Street's expansion into the commodities business.
The Senate Banking Committee next week will hear from MillerCoors and a pair of experts critical of banks' involvement in physical commodities activities and infrastructure assets involving businesses such as storage and transportation. The MillerCoors representative is expected to lash out at banks like Goldman and JPMorgan, which own large warehouses that store aluminum and trade derivatives contracts tied to commodity prices.
Representatives for Goldman and JPMorgan may be asked to testify as the banking panel scrutinizes their commodities businesses. Both companies, under fire in recent years due to a variety of controversies, are reported to be seeking buyers for their metals warehouses.
"When Wall Street banks control the supply of both commodities and financial products, there's a potential for anti-competitive behavior and manipulation," said Sen. Sherrod Brown (D-Ohio), a member of the banking committee. "It also exposes these megabanks -- and the entire financial system -- to undue risk."
The showdown over aluminum between industrial companies and Wall Street comes as some Federal Reserve officials worry about banks' involvement in activities like storing and transporting physical commodities. The debate has introduced the possibility that banks' highly profitable commodities businesses may face new restrictions. The Fed has broad authority over such activities by banks, and researchers at the Federal Reserve Bank of New York, citing news reports, have speculated that the Fed may crack down. Officials familiar with the Fed's supervision of financial groups also said the agency is struggling to figure out how to oversee such businesses, given that they are not a traditional banking activity.
A Fed spokesperson declined to comment.
It also highlights a looming issue at Goldman and Morgan Stanley. The Fed is examining the two financial groups’ commodities businesses ahead of a potential autumn deadline when the banks could be asked to shed or restructure lucrative units involving tankers and pipelines. The banks acquired the assets prior to converting into holding companies at the height of the financial crisis in September 2008. The companies maintain their activities are consistent with existing regulations.
JPMorgan, Goldman and Morgan Stanley last year were the top three ranked global banks in commodities revenue, according to Coalition, a financial data provider. The 10 largest banks generated some $6 billion in commodities revenue last year.
"Many more of our clients today have commodity exposure than they ever had before, or they ever realized they had," Gary Cohn, Goldman president and chief operating officer, said in May. "It's important to our business."
Representatives for JPMorgan, Goldman and Morgan Stanley declined to comment beyond their securities filings.
The main dispute between industrial companies from the so-called real economy and Wall Street involves bank ownership of metals warehouses, where companies such as MillerCoors store commodities such as aluminum prior to its use in items such as beer cans.
In recent years, industrial companies have complained about long waits to move their aluminum out of warehouses to plants or to settle contracts with purchasers of the metal.
The London Metal Exchange sets the daily amount of aluminum that must be moved out of one of its approved warehouses. As aluminum owners wait for delivery, they are paying rent to the warehouse owners.
Goldman and JPMorgan are among a select group of companies that dominate the warehousing business. Goldman and Glencore, a Swiss trading house now part of Glencore Xstrata, the natural resources giant, house most of the aluminum that trades on the LME at their respective warehouses in Detroit and Vlissingen, a city in the Netherlands.
Aluminum stocks at LME warehouses stand at a near-record 5.4 million tons, according to LME data. About 2.2 million tons are awaiting delivery, most of it in lines at Goldman's Detroit warehouses and at Glencore's Vlissingen facilities. JPMorgan's warehouses, which operate under the Henry Bath name, have no waits anywhere in the world, according to a person familiar with JPMorgan's business.
Goldman’s Detroit warehouses, Metro International Trade Services, can charge customers up to 48 cents a day to store one ton of aluminum, according to the LME. Aluminum warehouses in Detroit contain more than 1.4 million tons, the vast majority of that at Metro's facilities. Goldman could be earning as much as $680,000 a day to store aluminum.
At current delivery rates, it could take up to two years for aluminum owners to get their metal out of the warehouses, while warehouse owners pocket rent the entire time. By contrast there is little, if any, wait to get aluminum into the facilities.
"I'm becoming increasingly concerned that prices are being impacted by warehousing bottlenecks," said Bart Chilton, a Democratic commissioner on the Commodity Futures Trading Commission. "We need to work to ensure that markets are fair and that prices are based on supply and demand fundamentals."
Chilton added, "These are global markets and regulators need to work together to ensure fair pricing, because it can impact people in other areas of the world."
Europe Economics, a consultancy, said in a 2011 report for the LME: "The queuing problem is most acute when a warehouse develops a level of stocks that, given the existing loading out rate, means that the warehouse's income reaches a level at which after all costs, capital is fully remunerated and there is still a sufficient surplus to make it possible to buy in metal at a rate equal to or in excess of the loading out rate."
Numerous complaints of long lines lodged with the LME "were regarded as damaging, on the grounds that they inhibited arbitrage between the LME and the physical market, increased physical premiums and damaged the reputation of the LME," Europe Economics said in its report.
Market participants argue that the practice has distorted prices for physical aluminum, hurting manufacturers and other aluminum users. The metal now trades at a steep premium to benchmark contracts at the LME. Contracts for aluminum are the most actively traded at the LME, data show.
Banks have piled into the warehouse business since 2009 in part to capitalize on these profits. Industry participants argue that through ownership of the warehouses, banks are manipulating prices by hoarding metal, then selling it on the London Metal Exchange, where they are guaranteed a steady stream of rent because of how long it takes to move metal out of bank-owned warehouses.
The Russian aluminum company Rusal, U.S. auto manufacturer General Motors and Novelis -- the world’s largest rolled aluminum producer, aluminum purchaser and recycler -- are among the industrial companies that have publicly criticized the warehouses, the banks that own them or the LME.
Aluminum owners have tried to persuade authorities to crack down on the alleged abuses, but have been rebuffed in London and in Washington.
Industrial groups that have complained to the LME about long waits at Goldman's Detroit warehouses say the LME ignores their concerns by claiming it doesn't have authority over the warehouses to compel a change in behavior. Rather, the LME directs critics to U.S. regulators such as the CFTC, market participants said.
Meanwhile, the CFTC has been telling industrial companies that it lacks jurisdiction because the metals are traded in London and stored at LME-authorized warehouses, according to people familiar with CFTC discussions.
The regulatory no-man’s land has driven companies to raise the issue with Congress. MillerCoors specifically identifies the issue in its lobbying records filed with the Senate. In addition to the banking committee, the Senate Agriculture Committee is examining the issue and hopes to address the perceived regulatory gap when it reauthorizes the Commodity Exchange Act in the coming months, Senate aides said.
"The CFTC allows the London Metal Exchange to have direct access to U.S. customers through a 'No-Action' letter, which provides this agency with not only interest, but responsibility to ensure that everyone's playing fair, and that the rules of the exchange don't result in price distortions," Chilton said.
Brown said, "Regulators need to take a long, hard look at the practice of banks holding physical commodities."
Chris Thorne, a lobbyist at the Beer Institute, a group representing brewers and their suppliers, said, "We seek greater transparency and other immediate changes that would bring the London Metal Exchange's warehousing practices in line with other global commodity exchanges."
Banks, including JPMorgan, have owned a major slice of LME for some years, which has enabled them to help set the rules governing warehouses. Last year, Hong Kong Exchanges and Clearing acquired the LME; banks still own shares in the exchange.
The LME declined to comment.
Rent-fueled profits, which could wane once the LME finalizes proposals meant to end the long waits, can be compounded by banks' bets on derivatives tied to commodities such as aluminum, according to experts including Saule Omarova, a law professor at the University of North Carolina at Chapel Hill.
Some banks are said to be offering customers derivatives to hedge against rental fees, according to market participants, creating a situation in which a customer can wager on how quickly aluminum is moved out of a warehouse owned by the same bank that is selling them derivatives based on rental fees.
Omarova and Joshua Rosner, managing director at independent research firm Graham Fisher & Co., argue that traders at banks that own physical commodities businesses have a natural incentive to use inside knowledge gleaned from their co-workers to reap profits from trades of derivatives tied to the underlying commodities.
"The temptation is so strong," said Omarova, who wrote a paper on the subject titled "The Merchants of Wall Street: Banking, Commerce and Commodities."
A derivative is a financial contract that derives its value from any number of items, such as interest rates, commodities or even weather.
"If banks own storage, distribution, transmission or generating assets, they have the ability to manipulate prices for the benefit of their own balance sheet, to the disadvantage of the public interest, which is why they were prohibited from such activities after the Great Depression to the passage of Gramm-Leach-Bliley in 1999," said Rosner, who will testify next week, referring to the deregulatory law that allowed commercial banks to merge with investment banks. "While the Fed has plenty of authority, they seem either not to care or to be ambivalent about the risks posed."
The banks argue that the build-up of aluminum at their warehouses is a result of relatively low economic activity. The U.S. recession and the general economic slowdown that has taken hold in other developed economies in recent years has reduced demand for aluminum, forcing owners to store their stocks. That in turn has led to long lines to move the metal out of warehouses.
The banks also argue that firm separations exist between their trading desks and physical commodities units, known in the industry as "Chinese walls," that prevent traders from capitalizing on inside knowledge gleaned from other parts of the bank.
The Securities and Exchange Commission has quizzed Morgan Stanley about whether the Fed may force the company to dump its holdings in TransMontaigne, a petroleum and chemicals storage and transportation company. TransMontaigne told investors in its latest annual report that a 2009 internal review at Morgan Stanley found that "all of our activities and investments" are allowed under banking laws.
Morgan Stanley, in its latest annual report, told investors that it continues to discuss its commodities businesses with the Fed, which may force the bank to curtail its activities in the coming months. "At this time, the company does not believe, based on its interpretation of applicable law, that any such required divestment would have a material adverse impact on its financial condition," the bank said.
Banks that accept federally insured deposits had long been barred from participating in nonfinancial endeavors by the Glass-Steagall Act of 1933, but big banks have wedged their way into the physical commodities business through a series of legislative and regulatory exemptions, including Gramm-Leach-Bliley and a group of letters from the Fed that enables banks, including JPMorgan and Citigroup, to engage in physical commodities activities.
In its letters to the banks, the Fed argued that part of the reason why it blessed their applications was due to the fact that insight into physical commodities activities could help the banks serve customers with derivatives based on those same commodities.
For example, in 2005 the Fed sent JPMorgan a letter approving the bank's move into more physical commodities businesses. That letter contained an explicit prohibition on activities the bank appears to be engaged in today.
"To minimize the exposure of JPM Chase to additional risks, including storage risk, transportation risk, and legal and environmental risks, JPM Chase would not be authorized (i) to own, operate, or invest in facilities for the extraction, transportation, storage, or distribution of commodities; or (ii) to process, refine, or otherwise alter commodities. In conducting its commodity trading activities, JPM Chase has committed to use appropriate storage and transportation facilities owned and operated by third parties," the Fed wrote in its letter.
JPMorgan has owned and continued to operate the Henry Bath warehouses as a result of its 2010 acquisition of Sempra Commodities from Royal Bank of Scotland. The Fed and JPMorgan declined to comment.
"The Fed has absolutely not been transparent," said Omarova. "The Fed is like the Kremlin: They do their magic and then tell people like me to go away. But this is one of those instances in which they can't afford to do that."
Lawmakers have begun to notice. Earlier this month, four House Democrats sent a letter to Ben Bernanke, Fed chairman, posing sharp questions about banks in the physical commodities business.
The lawmakers -- Reps. Alan Grayson (D-Fla.), John Conyers (D-Mich.), Raul Grijalva (D-Ariz.) and Keith Ellison (D-Minn.) -- asked whether regulators could feasibly track conflicts of interest or market manipulation across the financial and industrial sectors, and warned of "significant macro-economic risk" from having banks that accept deposits and issue loans involved in nonfinancial sectors of the economy. (Read the full letter here.)
The divide between industrial corporations and Wall Street banks has implications well beyond the rules governing the exchange of aluminum. The lobbying battle may fuel the debate over "too big to fail," as large and powerful banks are accused of manipulating markets, harming customers and branching out into ever more activities.
Last week, Sens. Elizabeth Warren (D-Mass.) and John McCain (R-Ariz.) introduced bipartisan legislation to bar banks that accept taxpayer-backed deposits from engaging in securities trading. It's unclear whether their bill also would affect banks' physical commodities businesses.
"I don't think anybody wants to live in a country in which JPMorgan Chase provides your house with heating oil, electricity, water; gives you credit; and supplies you with a mortgage," said Omarova. "They effectively own you at that point."
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