The Federal Reserve on Friday proposed new rules on bank dealings in physical commodities, a policy that would especially affect megabanks Goldman Sachs and Morgan Stanley.
A key feature of the new rules would be higher capital requirements for banks that trade in physical commodities — that is, buying, selling, transporting, and storing physical metals or liquids, rather than just paper.
Current rules limit banks’ ability to trade in physical commodities. But Goldman Sachs and Morgan Stanley were grandfathered into the new rules and kept the ability to do so. A 2014 Senate investigation found that the banks incurred major risks from activities such as transporting uranium and raised concerns about manipulation of markets.
Since then, federal regulators have raised concerns about the possibility of an environmental disaster that took place on a bank’s watch threatening the financial system.
This month, the Federal Reserve recommended to Congress that it pass legislation to get banks out of the business of directly managing commodities or owning businesses that do.
By requiring higher capital levels for banks that do manage physical commodities, the Fed would effectively force them to rely less on borrowing and more on ownership shares to fund that activity. The idea is that doing so would make the banks less of a liability to fail and force owners to take a more active role in overseeing the banks’ risks.
In addition to higher capital levels for the banks, the rules proposed Friday would limit banks’ commodities businesses as a share of their overall business. The rules would apply not just to the two grandfathered-in banks, but also to all the banks authorized to trade in commodities as part of other services they offer to clients.
The Fed also would rescind the existing authorities for banks to be involved in managing power plants. The 2014 report found some instances of bank employees running power plants, although Friday’s notice indicated that banks have mostly cut back on doing so.
Lastly, the rules would prohibit banks from owning or storing copper. Copper is not used as a store of value anymore, the notice said, but only as an industrial metal.
In a statement, Tom Quaadman of the U.S. Chamber of Commerce’s financial regulation arm said that the rule would raise prices for businesses looking to hedge commodities costs. “By restricting physical commodities and commodity-linked derivatives in the marketplace, businesses face reduced liquidity and would be forced to search for alternatives – and it is not clear to what extent alternatives could be found – to satisfy their hedging needs,” he said.
The public will have 90 days to comment on the rule.
