Sometimes, standing on principle just isn’t worth the trouble.
That seems to be what JPMorgan Chase (NYSE: JPM) has concluded about its physical commodities business, built up through billions of dollars worth of acquisitions over the past five years.
The bank announced Friday that it is seeking a buyer for its physical trading business, an impressive group of businesses as described by Reuters: “a global oil trading division includes a contract supplying the biggest refinery on the East Coast; Henry Bath & Sons Ltd's 72 metal warehouses from Baltimore to Busan; a U.S. natural gas book three times larger than that of any other bank; and enough electricity contracts to light up Indiana.”
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The announcement by JPMorgan came only days after critics of banks’ ownership of power plants, metals warehouses and refineries dominated the lineup of witnesses at a Senate Banking Committee hearing in Washington. The bank said in a statement that it will still be “fully committed” to “traditional banking activities” in the commodity markets.
The commodity bull cycle that began around 2002 or so may have run its course, or is at least taking an extended breather thanks to China and the 2008 crash. As The Wall Street Journal notes, commodity revenue across the industry is down by about half over the past five years. So, the regulatory scrutiny may have been the straw that broke the camel's back.
What remains to be seen is whether the banks that are beginning to shed these commodity holdings will be as effective players as they were when they had large direct holdings that provided them with insight into the market dynamics. For instance, a bank that owns and operates a metals warehouse and talks to clients about their decisions to shift copper or aluminum into or out of that warehouse, is able to make better informed trading decisions.
It is true that the banks have often used that knowledge to trade for their own books as much as to serve their clients. But a bank’s willingness to work with clients depends on the confidence that it understands a market’s fundamentals, and the commodity market is more opaque than many others.
As an example, in the wake of the 1996 copper trading scandal, several large banks temporarily or permanently shut down some of their metals trading desks. Within months, one giant mining company was complaining privately that it was finding it difficult to hedge its exposure to price movements, since several of the banks that previously had taken the other side of those trades, or had structured them, were no longer doing so. The decision – based at that time on the banks’ own view of the risks of being involved in the business, not just regulatory pressure – had real world implications for banking clients, at least on a temporary basis.
The fallout from these asset sales, whenever and however they take place, can’t be estimated at this point, and almost certainly will include both positive and negative elements. It may well be that liquidity and transparency improve, and banking clients find no change in their ability to hedge or borrow. Let’s just hope that the regulators and policymakers, patting themselves on the back today, don’t forget to monitor those consequences before the next problem crops up.
As the lone voice speaking on behalf of the banks last week pointed out during his testimony, rogue traders and others aren’t confined to the banks, and banning banks from the commodities business isn’t going to make it suddenly pure. The one certainty is that JPMorgan Chase has removed one big hurdle in its attempts to resolve its dispute with the Federal Energy Regulatory Commission. Knowing that the bank soon won’t own the assets that precipitated the allegations of wrongdoing may make a rapid settlement possible.
