The Federal Reserve Board (FRB) on September 23, 2016, invited public comment on a proposed rule that would strengthen existing requirements and limitations on the physical commodity activities of Financial Holding Companies (FHCs). The proposal would help reduce the catastrophic, legal, reputational, and financial risks that physical commodity activities pose to FHCs. The proposal, which contends the “possibility of an environmental accident due to these activities presents significant risks to the firms,”1 comes after a Fed recommendation earlier in September that big banks should be barred from buying stakes in non-financial companies.2 This would be a removal of merchant-banking abilities that would have to be initiated by Congress. These recommendations are part of the Fed’s goal to control how Wall Street invests its money outside of traditional lending.3 This stems in part from a Senate investigation (2014) into the industry’s controversial dealings in physical commodities, such as warehousing aluminum, shipping oil and operating mines.

 

What this Means

Under current law, FHCs may invest in energy storage and transportation in ways that other banks cannot. The physical commodities businesses at two FHCs in particular were protected under a 1999 law, which grandfathered their ability to own extensive commodities infrastructure such as metals warehouses, power plants and oil terminals.4 The Fed is seeking to curtail this ability by putting a 1,250 percent risk weight on any assets held under grandfathering. This would mean that for every $1 in investment, $1 in capital would be needed.5 For banks other than those eligible for grandfathering, the Fed is proposing a 300 percent risk weighting for physical commodities, triple the capitalization necessary for corporate debt or construction loans.6 In doing this, the Fed is aiming for a “level of capitalization for such activities that is roughly comparable to that of nonbank commodities trading firms.”7

In addition to the capital requirements, and based on a broad review of FHCs physical commodity activities, together with the comments received on the Fed’s advance notice of proposed rulemaking, the proposal would:8

  • Tighten the quantitative limit on the amount of physical commodity trading activity firms may conduct
  • Rescind authorizations that allow firms to engage in physical commodity activities involving power plants
  • Establish new public reporting requirements on the nature and extent of firms physical commodity holdings and activities
  • Limit a firm’s holdings of copper, by no longer considering it a precious metal, thus joining an earlier proposal from the Office of the Comptroller of the Currency (OCC)

Fed officials estimate that the rule would mean about $4 billion in additional capital to fund the industry’s current level of investment.9

 

Key Observations and Take-aways

Meanwhile, since 2008, banks that were traditionally big players in physical commodities have shied away. Two of the FHCs still active in the physical commodities business have recently sold their oil businesses, metals warehouses, and coal mining operations. These firms do however continue to trade extensively in commodities, both physical and futures, and the business continues to be a significant contribution to earnings.10 The new rules, if adopted, would make physical commodities trading prohibitively expensive, and so effectively force banks out of the commodities business.

Comments on the proposed rule will be accepted by the Fed for ninety days, after the proposals publication in the Federal Register.11

 

References 

  1. “Fed Seeks Aggressive Limit on Wall Street Commodity Holdings,” Bloomberg Markets, September 23, 2016. Access at: http://www.bloomberg.com/news/articles/2016-09-23/fed-proposes-aggressive-rule-on-wall-street-commodity-holdings-itfye706.
  2. Ibid
  3. Ibid
  4. “Fed unveils rule on banks in physical commodities,” Financial Times, September 23, 2016. Access at: https://www.ft.com/content/e311e1b3-1a83-3be4-b01c-cfbb787ff64c.
  5. “Fed Seeks Aggressive Limit on Wall Street Commodity Holdings,” Bloomberg Markets, September 23, 2016. Access at:http://www.bloomberg.com/news/articles/2016-09-23/fed-proposes-aggressive-rule-on-wall-street-commodity-holdings-itfye706.
  6. Ibid
  7. Ibid
  8. Board of Governors of the Federal Reserve System, Press Release, September 23, 2016. Access at: http://www.federalreserve.gov/newsevents/press/bcreg/20160923a.htm.
  9. “Fed Seeks Aggressive Limit on Wall Street Commodity Holdings,” Bloomberg Markets, September 23, 2016. Access at: http://www.bloomberg.com/news/articles/2016-09-23/fed-proposes-aggressive-rule-on-wall-street-commodity-holdings-itfye706.
  10. “Fed Seeks Aggressive Limit on Wall Street Commodity Holdings,” Bloomberg Markets, September 23, 2016. Access at: http://www.bloomberg.com/news/articles/2016-09-23/fed-proposes-aggressive-rule-on-wall-street-commodity-holdings-itfye706. “Federal Reserve proposes new limits on Wall Street Energy Bets,” Reuters, September 23, 2016. Access at: http://www.reuters.com/article/us-usa-fed-commodities-idUSKCN11T1ZB.
  11. Board of Governors of the Federal Reserve System, Press Release, September 23, 2016. Access at: http://www.federalreserve.gov/newsevents/press/bcreg/20160923a.htm.

 

Newsletter Author: Samantha Regan, Mairi Bryan

Newsletter Contact Person: Nghi Pham

Visit www.accenture.com/RegulatoryCompliance for latest insights on regulatory remediation and compliance transformation.

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