BANKS AND COMMODITIES
Major Banks Gradually Begin to Exit Commodity Trading
We’ve written before on the difference between good and bad regulation — good regulation which can reduce systemic risks through judicious oversight, and bad regulation which can smother productivity and growth and create opportunities for cronyism. We believe moderation is the key, and where we see moderate, intelligent regulation, we see one more support for growth. The reduction of regulation could be good, or could be bad — depending on what kind of regulations are being removed. As investors, we stay aware of regulatory developments in the sectors that currently interest us the most. This is one set of data points among many that shape our view of emerging trends.
Banks & Non-Financial Businesses For most of the past century, banking regulations kept a barrier between
finance and commerce. That changed after the erosion and final repeal of Depression-era legislation in 1999. Since then, there have been even more regulatory changes which have weakened the historical restrictions on banks’ commodity trading activities. Fed regulations currently allow banks and other financial institutions to engage in commodity trading under several different authorizations made over the past decade. Some institutions that reorganized during the financial crisis (so that they could gain access to stabilizing liquidity from the Federal Reserve) were permitted specific “grandfathered” exceptions — including Morgan Stanley and Goldman Sachs. For almost a year now, regulators — including both the Federal Reserve
and the Commodities Futures Trading Commission (CFTC) — have been discussing banks and bank holding companies who trade in physical commodities, and wondering about the risks this may pose to consumers and to the stability of the wider economy.
Regulators Look for Stability Risks Last year, the discussion was mainly about the potential for price manipulation. But now the questions have widened to include various ways in which banks’ trading in commodities could expose the financial system to unexpected and destabilizing risks. The focus on stability makes sense given the experience of 2008.
Regulators want to make sure that banks aren’t exposed to some “black swan” event that will embroil them in another systemic crisis. The Fed drew particular attention to the BP Deepwater Horizon oil spill as one example of catastrophic risk connected to commodities trading. The Fed also points out that financial institutions have been voluntarily
curtailing their commodity activities over the past year. This undermines the argument that banks need to be able to trade in commodities if they are to compete with non-financial competitors who “find innovative ways to combine financial and non-financial activities.” In any event, regardless of the interplay among the various regulatory bodies (Congress, the Fed, and the CFTC), it looks like banks will eventually face more limits on their ability to engage in commodity trading. We think that with the profitability of their commodity operations already down, and the regulatory writing on the wall, banks are already beginning to curb their trading. We are confident that the profits of many big banks will continue to be robust, and we’re pleased to see that they’re shedding potentially risky activities outside their central competencies — whether driven by the market, by regulators, or by both.
Tony Danaher , Guild Investment Management [
www.guildinvestment.com] 26 March 2014
even
operations
commodities sector, usually mimicking the models of those who had been successful historically [including owning physical assets]. It is as much bad luck as anything else, because by the time they got there the rules had changed – the future looks very different now,” Stuart Staley, global head of commodities at Citi recently told the FT.3 Others are staying true to the sector, expanding –
their especially some of
commodity the
smaller players and those that fall outside the regulatory gaze. GF Securities, one of China’s largest
securities brokers last year acquired the commodities division of French bank Natixis. Bank of China has become a member of the London Metal Exchange. The Industrial and Commercial Bank of China (ICBC) has bought into Standard Bank Group’s global markets business, which covers commodities, fixed income, currencies. Australia’s Macquarie Group has expanded its commodity trading business through a handful of small acquisitions in the US. Many other examples can be searched on our website.
... sweeping changes to any
established market run the risk of unintended consequences “We believe that the world’s major banks
do not need to be involved in commodities trading, and that their involvement in commodity markets increases risks of bank failure, and increases the chance that they might manipulate commodity prices. The fact that major banks are voluntarily exiting from some of their commodity trading activities is good news for the world banking system,” according to Tony Danaher at Guild Investment Management [see Box]. Nevertheless,
sweeping changes to
any established market run the risk of unintended consequences, “particularly when those changes result from multiple pieces of legislation and regulation, often written independently of each other and introduced more or less at the same time,” according to the influential blog
CommodityFACT.org Ongoing scrutiny of banks’ size and
power by Congress, regulators and the press continues five years after the
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