Banks Had Unfair Advantage From Commodity Units: Senator

By Cheyenne Hopkins, Silla Brush and Jesse Hamilton

Photographer: Drew Angerer/Bloomberg

Senator Carl Levin's new findings include details on clients who entered into... Read More

Wall Street’s biggest banks have used their ownership of metals warehouses, oil tankers and other commodities businesses to gain unfair trading advantages and dominate markets, according to a U.S. Senate investigation.
In a report on Goldman Sachs (GS) Group Inc., Morgan Stanley and JPMorgan Chase & Co., a Senate panel said the firms have eroded the line separating banking from commercial activities to the detriment of consumers and the financial system. The holdings give banks access to non-public information that could move markets and increase the likelihood that industrial accidents will spur taxpayer bailouts, the report said.
“We simply cannot allow a large, powerful Wall Street bank the power to
influence the price of a commodity essential to our economy,” Senator Carl Levin, who chairs the Permanent Subcommittee on Investigations, told reporters in Washington yesterday. He added that his staff “found substantial evidence that these activities expose major banks to catastrophic risks that are poorly understood.”
The scrutiny over banks’ involvement with commodities has spurred the Federal Reserve to consider tightening regulations and prompted some Wall Street firms to try to shed assets.

Photographer: Stephen Morton/Bloomberg

Aluminum billets.

Levin’s new findings include details on Deutsche Bank AG (DBK) and other clients who entered into controversial aluminum transactions with Goldman Sachs and reveal that a former employee questioned whether the New York-based bank had adequate safeguards to prevent market-moving data from being passed on to the firm’s traders.

Capital Shortfalls

The 400-page report also referenced a 2012 Fed study of four banks that found each had capital and insurance shortfalls for commodity units of as much as $15 billion. That meant that if each bank experienced a catastrophe on the scale of BP Plc’s 2010 oil spill in the Gulf of Mexico, they couldn’t cover the losses, the report said.
The investigation, which is the focus of a two-day public hearings that start today, is a swan song for retiring Levin, a Michigan Democrat who’s long been a scourge of the banking industry. His 2010 showcase of Goldman Sachs’s mortgage trades helped crystallize the financial crisis in the minds of the American public and left a stain on the bank that it has yet to fully erase.
The commodities probe, unlike some investigations done by the panel, doesn’t feature as many smoking-gun e-mails and instead points to circumstantial evidence. The report still highlights the breadth of Wall Street’s reach into non-banking businesses and the potential conflicts of interest that come with it.

Metro Aluminum Business

The investigation covers a broad range of commodity investments in recent years including Goldman Sachs’s ownership of Colombian coal mines as well as a uranium trading business; Morgan Stanley (MS)’s natural gas and oil transport operations; and JPMorgan’s electricity and metals businesses.
A focus of Levin’s examination is Goldman Sachs’s 2010 purchase of Metro International Trade Services LLC, an operator of warehouses that’s part of the London Metal Exchange system. The Senate report said the acquisition allowed the bank to have a major influence on aluminum trading.
With Goldman Sachs employees in control of Metro’s board of directors, the warehouse took steps to increase the amount of time it took to remove aluminum, which may have led to higher prices, according to the report. Soon after Goldman Sachs bought it, Metro began paying incentives to traders to store aluminum in the company’s warehouses.

‘Merry-Go-Round Deals’

In a series of private deals worked out in e-mails and unsigned contracts, Metro also gave special incentives to a small group of financial firms to keep metal in its Detroit warehouses by first loading it out and then back in. Six so-called “merry-go-round deals” from 2010, 2012 and 2013 were struck with Deutsche Bank; Red Kite Group, a London-based hedge fund; and Swiss-based commodity trader Glencore Plc, according to the report.
A Deutsche Bank spokeswoman declined to comment, while officials at Red Kite and Glencore didn’t respond to e-mails sent after regular European business hours.
The September 2010 deal with Deutsche Bank was suggested by senior executives at Metro and a board subcommittee composed of Goldman Sachs employees, the report said. The transaction wound up having an immediate impact on the queues at the warehouse and resulted in other users having to wait longer and pay more to store their aluminum. The transaction increased the wait in Detroit from about 20 days to almost 120 days, the report found.
The report alleged the long delays led to a surge in the price of aluminum, which Goldman Sachs was trading at the same time.

Consumer Prices

In a statement, Goldman Sachs said the transactions responded to client requests and weren’t improper. The bank said the deals had “no impact” on the final price consumers paid.
In July 2013, Goldman Sachs offered to speed up delivery of aluminum to users of the metal, and said no client accepted the offer to swap their metal stuck in queues for immediately available aluminum. In August, a district judge dismissed a suit against the firm and others brought by aluminum consumers, saying that an increase in a price component of aluminum was “an unintended consequence of rational profit maximizing behavior rather than the product of conspiratorial design.”

‘Chinese Wall Policy’

Goldman Sachs’s ownership of Metro also raises conflicts of interest and potential unfair trading advantages, Levin said. While Goldman Sachs said it had policies against the misuse of warehouse information, the Senate investigators found that confidential Metro data was made available to dozens of bank employees, including those active in trading commodities.
The report included a 2013 e-mail from a resigning Metro employee who expressed concerns that market-moving information could be shared with Goldman Sachs’s traders.
Michael Whelan, the former Metro vice president of business development, expressed “questions and concerns regarding the Chinese Wall Policy that is in place” regulating the interaction between the warehousing unit and Goldman Sachs’s primary commodities trading subsidiary, J. Aron.
Goldman Sachs told the Senate investigators there was no breach of information barriers required by the LME. Executives from the bank plan to reiterate that point at a hearing today.
“Regular reviews by Goldman Sachs personnel have not found a single instance where confidential Metro information went to the metals-trading personnel of Goldman Sachs,” Jacques Gabillon, head of the bank’s global commodities principal investments group, said in prepared remarks. An outside auditor reviewed the information barriers at Metro and found “no issues,” Gabillon said.

Gamed Limits

The Senate report was critical of regulators’ inconsistent attempts to rein in the growth of banks’ commodities businesses.
A memorandum from the Federal Reserve Bank of New York said JPMorgan “pushed regulatory limits and their interpretation” as it integrated commodity businesses with its trading units, the Senate investigation found. The largest U.S. bank by assets allegedly gamed the limits on commodities activities, and the report said regulators at one point realized JPMorgan had breached the cap.
JPMorgan (JPM) exceeded the limit only once in an incident that took place in 2011, according to a statement yesterday from the bank. It has been selling off large portions of its physical-commodities business and will focus on derivatives in the future, the bank said.

‘Case Study’

On Morgan Stanley, the Senate report said the firm presents a “case study of banking mixed with commerce” that poses conflicts over trading “financial and physical oil products.”
“Morgan Stanley is proud of its comprehensive approach to risk management, which has enabled the firm to manage its commodities business prudently and effectively over the last three decades,” saidMark Lake, a spokesman for the New York-based bank.
Wall Street commodity units first drew criticism in 2013 after beer makers complained that long wait times for metal deliveries from bank-owned warehouses had led to price spikes. The Fed, facing calls from lawmakers to bar lenders from owning physical commodities, responded by seeking input from banks and the public on the risk posed by financial companies owning and trading oil, gas and aluminum.
Levin’s investigation adds pressure on the central bank and other regulators to toughen rules. The Senate report urged the Fed to impose a “clear” limit on how much banks can participate in physical commodities and “reaffirm” the separation between lending and other businesses. Fed Governor Daniel Tarullo is among those set to testify before the panel.