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S. HRG. 113–67

EXAMINING FINANCIAL HOLDING COMPANIES:

SHOULD BANKS CONTROL POWER PLANTS,

WAREHOUSES, AND OIL REFINERIES?

HEARING

BEFORE THE

SUBCOMMITTEE ON 

FINANCIAL INSTITUTIONS AND CONSUMER 

PROTECTION

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE

ONE HUNDRED THIRTEENTH CONGRESS

FIRST SESSION

ON

EXAMINING PERMISSIBLE BANKING ACTIVITIES UNDER THE BANK 

HOLDING COMPANY ACT (BHCA)

JULY 23, 2013

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

Available at: http://www.fdsys.gov/

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

JOE MANCHIN III, West Virginia 

ELIZABETH WARREN, Massachusetts 

HEIDI HEITKAMP, North Dakota 

MIKE CRAPO, Idaho 

RICHARD C. SHELBY, Alabama 

BOB CORKER, Tennessee 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

TOM COBURN, Oklahoma 

DEAN HELLER, Nevada

CHARLES YI, Staff Director 

GREGG RICHARD, Republican Staff Director

DAWN RATLIFF, Chief Clerk 

KELLY WISMER, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION

SHERROD BROWN, Ohio, Chairman 

PATRICK J. TOOMEY, Pennsylvania, Ranking Republican Member 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

JON TESTER, Montana 

JEFF MERKLEY, Oregon 

KAY HAGAN, North Carolina 

ELIZABETH WARREN, Massachusetts 

RICHARD C. SHELBY, Alabama 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

JERRY MORAN, Kansas 

DEAN HELLER, Nevada 

BOB CORKER, Tennessee

GRAHAM STEELE, Subcommittee Staff Director

TONNIE WYBENSINGER, Republican Subcommittee Staff Director

KATHRYN MILANI, Legislative Fellow

(II)

CONTENTS

TUESDAY, JULY 23, 2013

Page

Opening statement of Chairman Brown ................................................................ 1

WITNESSES 

Saule T. Omarova, Associate Professor of Law, University of North Carolina 

at Chapel Hill ....................................................................................................... 3

Prepared statement .......................................................................................... 35

Response to written questions of: 

Chairman Brown ....................................................................................... 81

Randall D. Guynn, Partner & Head of the Financial Institutions Group, 

Davis Polk & Wardwell LLP ............................................................................... 5

Prepared statement .......................................................................................... 60

Response to written questions of: 

Chairman Brown ....................................................................................... 82

Joshua Rosner, Managing Director, Graham Fisher & Co. ................................. 7

Prepared statement .......................................................................................... 69

Response to written questions of: 

Chairman Brown ....................................................................................... 88

Timothy Weiner, Global Risk Manager, Commodities and Metals, MillerCoors 

LLC ........................................................................................................................ 9

Prepared statement .......................................................................................... 76

Response to written questions of: 

Chairman Brown ....................................................................................... 90

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

ALCOA prepared statement ................................................................................... 103

(III)

(1)

EXAMINING FINANCIAL HOLDING COMPANIES: SHOULD BANKS CONTROL POWER 

PLANTS, WAREHOUSES, AND OIL REFINERIES? 

TUESDAY, JULY 23, 2013

U.S. SENATE, SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

AND CONSUMER PROTECTION, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Subcommittee convened at 10:05 a.m. in room SD–538, Dirksen Senate Office Building, Hon. Sherrod Brown, Chairman of the 

Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN SHERROD BROWN 

Senator BROWN. The Subcommittee will come to order. 

Thank you to the four witnesses. Thank you for those of you in 

attendance for being here and part of this interesting hearing. I 

will begin. Senator Toomey will join us in a few moments, and I 

understand a couple of other Members will likely be here. 

In 1913, former Supreme Court Associate Justice Louis Brandeis 

voiced concerns about the growth of trusts in the United States. He 

said:

Investment bankers became the directing power in railroads, public service, 

and industrial companies through which our great business operations are 

conducted. They became the directing power also in banks and trust companies. Distinct functions each essential to business and each exercised originally by a distinct set of men became united in the investment banker. It 

is to this union of business functions that the existence of the money trust 

is mainly due.

Today, large, complex, opaque, diverse corporations, we know, of 

course, are no longer called trusts. Instead, we have financial holding companies, large conglomerates combining banks and trading 

firms and energy suppliers and oil refiners and warehouses and 

shipping firms and mining companies. 

The question is, how did we get here? For years, our Nation had 

separated banking from traditional commerce. But in 1999, after 

years of eroding that protection, finally, Congress tore down that 

wall. Beyond just combining commercial banking with insurance 

and investment banking, banks were now allowed to trade in commodities and to engage in a variety of nonfinancial activities. 

Four years later, the Federal Reserve enabled the first financial 

holding company to trade in physical commodities. The justification 

2

for allowing this activity is a familiar one. Other companies were 

doing it. Banks were at a competitive disadvantage. 

Over the next 6 years, the rules became looser and looser. Goldman Sachs, in its own words, now engages in the production, storage, transportation, marketing, and trading of numerous commodities, including crude oil products, natural gas, electric power, agricultural products, metals, minerals, including uranium, emission 

credits, coal, freight, liquefied natural gas, and related products. 

This expansion of our financial system into traditional areas of 

commerce has been accompanied by a host of anti-competitive activities, speculation in oil and gas markets, inflated prices for aluminum and, we learned, potentially copper and other metals, and 

energy manipulation. 

It has also been accompanied by important and troubling questions. Do the benefits of combining these activities outweigh the 

harm to consumers and to manufacturers? Can regulators or the 

public fully understand these large and complex financial institutions and the risks to which these firms are exposing themselves 

and, importantly, the rest of society? Are the laws and regulations 

sufficiently stringent and transparent, and are regulators enforcing 

them aggressively enough? And what do we want our banks to do, 

to make small business loans or refine and transport oil? To issue 

mortgages or corner the metals market? 

There has been little public awareness of or debate about the 

massive expansion of our largest financial institutions into new 

areas of the economy. That is in part because regulators, our regulators, have been less than transparent about basic facts, about 

their regulatory philosophy, about their future plans in regards to 

these entities. 

Most of the information that we have has been acquired by combing through company statements in SEC filings, news reports, and 

direct conversations with industry. It is also because these institutions are so complex, so dense, so opaque that they are impossible 

to fully understand. The six largest U.S. bank holding companies 

have 14,420 subsidiaries, only 19 of which are traditional banks. 

Their physical commodities activities are not comprehensively or 

understandably reported. They are very deep within various subsidiaries, like their fixed-income currency and commodities units, 

Asset Management Divisions, and other business lines. Their specific activities are not transparent. They are not subject to transparency in any way. They are often buried in arcane regulatory filings. 

Taxpayers have a right to know what is happening and to have 

a say in our financial system because taxpayers, as we know, are 

the ones who will be asked to rescue these megabanks yet again, 

possibly as a result of activities that are unrelated to banking. 

I thank the witnesses for being here. I look forward to their testimony, and I will introduce the four of them now for your opening 

statements. 

Saule Omarova is an Associate Professor of Law at the University of North Carolina at Chapel Hill Law School. Prior to joining 

the Law School, Professor Omarova practiced law in the Financial 

Institutions Group of Davis Polk and Wardwell, where she specialized in a wide variety of corporate transactions and advisory work 

3

in the area of financial regulation. In 2006 and 2007, she served 

at the U.S. Department of Treasury as a Special Advisor for Regulatory Policy to the Under Secretary for Domestic Finance. 

Randall Guynn has served as partner and head of Davis Polk’s 

Financial Institution Group since 1993. Coincidentally, or perhaps 

not so, he was Professor Omarova’s supervisor while she worked at 

the firm. I noticed the glancing look there when I said Davis Polk. 

They will agree on everything today, I understand. 

[Laughter.] 

Senator BROWN. His practice focuses on providing bank regulatory advice and advising on M&A and capital markets transactions. He has advised all the United States’ six largest banks and 

many non-U.S. banks on Dodd-Frank and its regulatory implementation. 

Joshua Rosner is Managing Director at independent research 

consultancy Graham Fisher and Company. He advises regulators 

and institutional investors on housing and mortgage finance issues. 

Mr. Rosner was among the first analysts to identify operational 

and accounting problems at the Government-Sponsored Enterprises 

and was one of the first to identify the peak in the housing market 

and the weaknesses in the credit rating agencies’ rating of 

collateralized debt obligations. Mr. Rosner co-authored Reckless 

Endangerment with New York Times columnist Gretchen 

Morgenson, which traces the beginning of the housing crisis. 

Tim Weiner is the Global Risk Manager of Commodities and 

Metals for MillerCoors. With 29 years of risk management, commodity training, and fund management in many globally exchanged, traded, and over-the-counter futures and options, including interest rate, agricultural currency, metals, and energy commodities for the last 7 years, he has managed commodity price risk 

at MillerCoors for multiple commodities with a primary focus on 

global aluminum. 

So, we will start with Ms. Omarova. Please proceed. And thank 

you all four for joining us, and please proceed. 

STATEMENT OF SAULE T. OMAROVA, ASSOCIATE PROFESSOR 

OF LAW, UNIVERSITY OF NORTH CAROLINA AT CHAPEL HILL 

Ms. OMAROVA. Thank you for the opportunity to testify on this 

important issue today. You have my written statement that lays 

out the details of what I have to say, so let me focus on a few key 

points. 

I am an academic and my job is not to represent the interests 

of any particular industry. My job is to ask questions that need to 

be asked. One such question which I have been researching for 

some time concerns the legal and policy implications of what appears to be a significant expansion over the past decade or so of 

large U.S. banking institutions into physical commodity and energy 

markets. 

These bank holding companies, or BHCs, own federally insured 

banks, and as a result are subject to the Bank Holding Company 

Act of 1956 that significantly limits their ability to conduct nonfinancial commercial activities. Yet, these companies through their 

nonbank subsidiaries currently own and operate metals warehouses, oil pipelines and terminals, tankers, electric power plants, 

4

and coal mines. This phenomenon raises potentially significant regulatory and policy questions. 

The foundational principle underlying U.S. bank regulation is 

the principle of separation of banking from general commerce. 

Since at least 1863, federally chartered banks have been allowed 

to engage only in the business of banking and, therefore, prohibited 

from trading physical commodities other than gold and bullion. 

In 1956, Congress extended the same principle to banks’ parent 

companies, BHCs, and generally limited their activities to those 

closely related to banking. The Gramm-Leach-Bliley Act of 1999, 

which partially repealed the Glass-Steagall Act, also allowed certain qualified BHCs or financial holding companies to expand their 

commercial activities, subject to certain limits. 

Since the early 2000s, several large firms have availed themselves of these newly created statutory powers to grow physical 

commodity operations. Now, depending on the nature and magnitude of these operations, which we currently do not have the 

means of tracking, this trend potentially undermines the principle 

of separation of banking from commerce and implicates specific policy concerns behind that principle. 

Let me give you a few examples of such potential concerns, including safety and soundness of financial institutions, potential 

systemic risk, market integrity and consumer protection, firm 

governability, regulatory capacity, and concentration of financial 

and economic power. 

Safety and soundness. Financial institutions may argue that allowing them to trade crude oil will enhance their safety and soundness by diversifying their sources of income. However, it will also 

expand the sources of risk to these institutions. What if the Deepwater Horizon disaster happened on an oil-rig-owned and operated 

by JPMorgan? How would that affect Chase’s deposit base? 

Systemic risk. In the same example, how would the news about 

JPMorgan’s oil spill affect the financial markets in which 

JPMorgan is a major dealer and counterparty? Would that also rattle, for example, Citigroup and Bank of America, who have huge 

exposures to JPMorgan? 

Market integrity and consumer protection. If the same financial 

institution, for example, Goldman Sachs, is a major dealer and 

trader in both oil derivatives and underlying physical oil, the potential for market manipulation and artificial inflation of consumer 

prices is obvious. 

Leakage of public subsidy. The financial industry often asserts 

that banks’ entry into commercial sectors provides public benefits 

by increasing competition and by enabling them to provide better, 

more efficient services to their clients. What these claims leave out, 

however, is the potential competitive advantage that the Federal 

subsidy of banking institutions gives them when they act in commodity markets. An oil refinery may very well benefit from a low 

cost of its crude inventory supplied entirely by Morgan Stanley. 

But is Morgan Stanley able to offer the low price because its own 

cost of funding is partly subsidized by the taxpayer? 

Institutional governability. Allowing large financial conglomerates to grow commodity merchant operations may make their internal risk management much more challenging. These institutions 

5

already are enormous and complex, and making them even bigger 

and more complex may make the next ‘‘London Whale’’ episode 

much more likely to happen. 

Regulatory capacity. Even more troubling is the fact that bank 

regulators, including the Fed, may be incapable of effectively monitoring and overseeing complex financial industrial conglomerates. 

Bank regulation is simply not geared toward controlling the risks 

of banking institutions acting like Enron. Other regulators cannot 

fill that gap effectively, as each one may be looking only at the slice 

of the conglomerate’s activities where the essence of the problem is 

the whole. 

Finally, political economy. It has been a venerable American tradition to view large aggregations of economic and financial power 

in the hands of a few money trusts with great suspicion and fear 

of this power translating into political influence. If the same institutions that control the flow of credit throughout the economy also 

control the flow of raw materials, these fears are greatly exacerbated. 

In conclusion, let me emphasize that I am not arguing that any 

of these policy concerns actually presents an imminent danger and 

must be acted upon in a hurried manner. At this point, we simply 

lack the necessary data on what exactly is happening in this space 

and how risky it all may be. If sunlight is the best disinfectant, 

however, it will do us good to shine some intense light on BHCs’ 

commodity activities. 

Thank you. 

Senator BROWN. Thank you very much, Ms. Omarova. 

Mr. Guynn. 

STATEMENT OF RANDALL D. GUYNN, PARTNER AND HEAD OF 

THE FINANCIAL INSTITUTIONS GROUP, DAVIS POLK & 

WARDWELL LLP 

Mr. GUYNN. Thank you, Chairman Brown, Ranking Member 

Toomey, and Members of the Subcommittee. 

The regulation of our financial system is a serious matter. Having rules and regulations that ensure an appropriate level of financial stability while allowing the financial system enough flexibility 

to innovate, meet ever changing client needs, and otherwise adjust 

to ever changing market conditions is essential. 

A longstanding principle of our banking laws is that banking 

should generally be separate from commerce. Thus, our banking 

laws generally do not allow the Wal-Marts of the world to own a 

bank or vice-versa. But our banking laws have allowed banks to 

buy and sell gold, silver, and other precious metal commodities 

since at least 1863. They have also allowed them to buy and sell 

a wide variety of derivative contracts, including contracts for physical commodities, for many decades, as long as these contracts have 

been traded on recognized exchanges or have otherwise been sufficiently liquid to be appropriate banking assets. 

The connection between banking and commodities is not a new 

development. It has very ancient roots. Physical commodities, such 

as grain and salt, were among the first forms of money in ancient 

Mesopotamia, Egypt, China, Japan, and even the colonies that became the United States. These physical commodities have the esVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6601 S:\DOCS\82568.TXT SHERYL
6

sential characteristics that we have come to associate with money: 

Fungibility, divisibility, and relative liquidity. 

Indeed, the modern history of banking began with grain merchants in Lombardy. Many of the merchants of the 19th century 

in the United States similarly started as dry goods and commodity 

traders, including Lazard Brothers and Brown Brothers. The private banking partnership of J.P. Morgan engaged in a wide variety 

of activities, including investing in physical commodities and related facilities. In short, U.S. banks and other financial institutions 

have long been actively involved in the physical commodities markets. 

Congress understood this history when it enacted the GrammLeach-Bliley Act in 1999 and expressly authorized financial holding 

companies to engage in merchant banking and permanently grandfathered the commodities activities of investment banks that were 

not yet bank holding companies. Congress clearly understood and 

expected the Federal Reserve to permit the new Citigroup to retain 

its physical commodities affiliate, Phibro. Indeed, the only issue in 

controversy was whether Congress would allow the new Citigroup 

to rely on the commodities grandfathering provision. Ultimately, 

Congress revised the grandfathering provision to exclude the new 

Citigroup, but did so fully understanding and expecting that Citi 

would be able to obtain these powers through the new complementary powers provision. 

Thus, when Professor Omarova and Mr. Rosner describe the 

physical commodities powers in modern banks and bank holding 

companies as a radical departure from the traditional separation of 

banking and commerce, or that the Federal Reserve somehow went 

rogue to the surprise of Congress when it allowed Citigroup to retain Phibro, they are engaging in revisionist history. This was not 

radical. It was not a breach of the traditional principles separating 

banking from commerce. And it was not unexpected by Congress. 

The problem with treating the general principle of separating 

banking from commerce as a strict legal wall is that reasonable 

people disagree over where the line between banking and commerce should be drawn. Professor Omarova believes that it should 

exclude physical commodities activities. But former Congressman 

Jim Leach of Gramm-Leach-Bliley fame, one of the most ardent 

and consistent champions of the separation of banking from commerce, would disagree. As recently as 2008, former Congressman 

Leach said that the merchant banking, complementary powers, and 

commodities grandfathering provisions of the Gramm-Leach-Bliley 

Act did not breach this principle. 

In their written testimony, Professor Omarova and Mr. Rosner 

identify a long list of potential—and I stress ‘‘potential’’—dangers 

of allowing financial holding companies to continue to engage in 

physical commodities activities, but they do not provide a shred of 

evidence to support the view that these potential dangers are likely 

to be realized. In contrast, both the Congress that enacted the 

Gramm-Leach-Bliley Act and the Federal Reserve Board that 

granted the complementary powers to Citigroup concluded that the 

public benefits of allowing financial holding companies to engage in 

physical commodities activities were likely to outweigh their potential adverse effects. I refer the Subcommittee to my written testiVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6601 S:\DOCS\82568.TXT SHERYL
7

mony outlining the numerous public benefits and the safeguards 

that are designed to prevent any potential adverse effects. 

In conclusion, it is certainly appropriate for this Committee to review whether our banking laws, including the extensive amendments made by the Dodd-Frank Act, reflect an appropriate balance 

between financial stability and operating freedom. But in light of 

the history of the longstanding connection between banking and 

commodities activities, the extensive public benefits of allowing financial holding companies to engage in these activities, and the 

relevant safeguards, my view is that this Subcommittee should not 

seek to repeal or curb these powers unless and until substantial 

evidence is provided that these commodities powers cannot, in fact, 

be exercised without creating a substantial risk to the safety or 

soundness of depository institutions or the financial system generally. 

Thank you. 

Senator BROWN. Thank you, Mr. Guynn. 

Mr. Rosner, please proceed. Thank you for joining us. 

STATEMENT OF JOSHUA ROSNER, MANAGING DIRECTOR, 

GRAHAM FISHER & CO. 

Mr. ROSNER. Thank you. Chairman Brown, Ranking Member 

Toomey, Members of the Subcommittee, thank you for having me 

here to testify this morning. I would hope that you would read my 

written testimony. 

My name is Josh Rosner, and a an independent bank analyst, I 

saw the mortgage crisis firsthand. I warned it was coming, but too 

few listened. It resulted in the loss of $7 trillion in real estate 

wealth. The recession that followed still shackles a generation of 

our fellow Americans, many of whom lost jobs, lost homes, lost 

hope. 

Mixing banking and commerce will not bring these trillions back. 

It will not help the working class, the middle class, the upper-middle class, or the investor class. In fact, it has already cost them billions. It will not help anyone but those bankers. 

What I see now in the mixing of commerce and banking is the 

dawn of a new Gilded Age, where the fruits of all are enjoyed by 

a few, where competition in the real economy is stifled by the advantages bestowed by a generous Federal Reserve, and where we 

will forever be one small tragedy away from another financial crisis 

that will dwarf 2008. 

Since 2003, our Government and central bank have allowed the 

unprecedented use of insured deposits for speculation and the expansion of far-flung business interests. This is partially the result 

of unilateral decisionmaking by Congressionally empowered and 

unelected officials at the Federal Reserve. Only Congress can prevent this unfortunate consolidation of American business and act 

to prevent the Federal Reserve from continuing its coddling of 

these biggest banks. Only Congress can put the brakes on a handful of firms that nearly ruined the American economy in 2008 because it could not police itself and may well wreck the economy 

again. Congress did not hold the line. Congress did not protect the 

American people. 

8

Regulators remain unprepared. Appreciate how difficult it is to oversee a bank holding company with $2 trillion in assets and businesses in 160 countries. Now add oil tankers, coal mines, electrical 

generating plants, and zinc warehouses. As we have seen, even top 

bank managers cannot keep track of everything a big bank does. 

Before you know it, $6.2 billion is gone and the reputational damage is irreparable. 

We have been lucky so far, but a regime based on luck is not sustainable. Now the banks, having received approval or exemption for 

whatever they wish to do, seek to control nonfinancial infrastructures all over the world. They have already taken control of ports, 

airports, electric utilities, water utilities, sewer utilities, wind 

power farms, parking meters, solar power generation, parking garages, rail leasing, charter schools, and more. These activities create significant conflicts of interest, may be anti-competitive, and 

certainly engender operational and reputational risks that can lead 

to systemic failure. This is not hypothetical nor is it hyperbole. We 

have seen it happen. 

Mortgages were once the boring way banks made money. But the 

conflicts of interest resulting from the combination of commercial 

and investment banking laid bare what compliant regulators had 

never dreamed would happen. The banks went too far. As a result, 

bank counterparties began to question toxic mortgage exposures of 

firms and their ability to cover losses on those exposures. As questions of solvency arose, demands for more collateral ensued and liquidity was withdrawn from those firms, leading to failures contagion and the need for Federal backstops. 

Think of a scenario, not farfetched, of a disaster befalling a bankcontrolled pipeline or oil tanker. The outcomes would be similar to 

the mortgage meltdown, when banks funded by the Fed protected 

their reputations by bailing out affiliated hedge funds and legally 

isolated investment vehicles. The possibility that such events could 

threaten the flow of money and bring the financial system to a 

standstill again should not be tolerated. These risks should stay 

outside the banking system, with its call on the Fed’s window and 

the FDIC’s insurance guarantee. 

Executives of dominant firms can convince captured regulators 

that whatever they do is in the national interest. This is not true. 

These executives are correctly motivated by real obligations that do 

not allow them to sacrifice returns in consideration of the common 

good, even if they would be so personally inclined. 

Congress has the power to rein in the Federal Reserve. Congress 

has the power to mandate the biggest, most complex banks’ businesses get narrower and easier to resolve should they collapse. 

Congress has the power to protect industry in the biggest and potentially best economy in the world and to stand up for ordinary 

Americans who pay more for aluminum and gasoline simply because banks and investment banks take a cut. 

Historically, Congress has acted when a few large firms exploited 

their advantage and sought to control too much. Congress must 

honor that history and curtail big banks’ activities in commercial 

business or else we are destined to view 2008 as the first financial 

crisis and not the worst. 

Thank you. 

9

Senator BROWN. Thank you, Mr. Rosner. 

Mr. Weiner. 

STATEMENT OF TIMOTHY WEINER, GLOBAL RISK MANAGER, 

COMMODITIES AND METALS, MILLERCOORS LLC 

Mr. WEINER. Good morning, Mr. Chairman and Members of the 

Committee. My name is Tim Weiner and I am the Global Risk 

Manager of Commodities and Metals for MillerCoors. Thank you 

for letting me testify today. My written statement and my comments are supported by a group of companies, including the CocaCola Company, Novelis, Ball Corporation, Rexam, Dr. Pepper 

Snapple, Yuengling, North American Breweries, Rogue Brewery, 

and Reynolds Consumer Products, just to name a few. 

Mr. Chairman, my statement is neither an indictment of the free 

market principles nor the existing exchange traded futures system 

here in the United States, which we use regularly to hedge our 

commodity price risks and volatility. In fact, it is our hope that the 

LME system could one day function in a manner equally as transparent and efficient as the exchanges here in the United States. 

MillerCoors will produce this year in excess of 60 million barrels 

of beer in the United States. Over 60 percent of our beers are sold 

in aluminum cans, bottles, and kegs. Aluminum is critical to our 

supply chain and our single largest commodity risk. 

In my written statement, I provided the Committee an in-depth 

look at how the LME functions and how their system negatively 

impacts our ability to manage and secure aluminum we have purchased with associated costs we must pay under this system. It has 

cost MillerCoors tens of millions of dollars in excess premiums over 

the past several years, and billions to the entire industry, with no 

end in sight. 

Mr. Chairman and Members of the Committee, I am a beer guy 

that simply buys critical materials for our business. I manage a 

comprehensive portfolio of commodities for brewing, packaging, and 

shipping of our fine beers, like corn, barley, natural gas, and diesel 

fuel. 

Mr. Chairman, let me give you a snapshot of how we buy barley. 

Senator Tester, who serves on your Subcommittee, knows we are 

one of the largest grain purchasers in the State of Montana. We 

contract with our barley growers and we pay for our harvested 

crop. We receive delivery of that crop. It is immediate. It enters our 

grain elevators in Huntley and Power, Montana. The same can be 

said for the delivery of corn from the CME and natural gas from 

the NYMEX. But not so for aluminum under the LME warehouse 

rules. 

Mr. Chairman, in a nutshell, here is how the LME warehouse 

system works. Banks and trading companies pay an incentive to 

aluminum producers to attract and store the majority of global aluminum production directly to their own warehouses. In the United 

States, it is mainly drawn into warehouses located in Michigan, but 

also other locations throughout the United States. Just imagine a 

warehouse with a huge door marked ‘‘in’’ and a tiny door marked 

‘‘out.’’

The banks pay an incentive because they receive rent each day 

the aluminum stays in the warehouse. This makes it harder and 

10

more expensive for MillerCoors and other aluminum consumers to 

get the aluminum we need to make the fine products we sell to 

keep our employees working. 

So let us take the LME system and apply it to, let us say, buying 

a case of beer in a store in Trenton, Ohio. I am one of your constituents and I go into a store to buy a case of Miller Lite—of Coors 

Lite. I pay in full. As I reach for my beer, the cashier grabs the 

case and tells me I need to go around back and pick it up from the 

warehouse. ‘‘Not to worry,’’ says the cashier. ‘‘Just present your receipt and you will get your beer in a timely manner.’’ So I go 

around back, present the receipt, and the warehouse manager informs me that due to the warehouse constraints, I will have to 

come back in 16 months to pick up my beer. He then tells me that 

my beer will be kept safe in storage, but that I will have to pay 

for rent each and every day that my beer sits in his warehouse. 

Can you imagine the revolt that would create with your constituents, not to mention what that Congressional hearing would be 

like? 

My point is how absurd it is to buy a commodity, in our case aluminum, and then have to wait an average a year to 18 months to 

obtain our physical possession of the purchased metal from the 

LME warehouses. The current LME warehouse system is not functioning as other futures exchanges do. 

Mr. Chairman, we have tried to resolve this problem directly 

with the LME, and you will probably hear that some minor 

changes have been made to their operations over the past few 

years and that they are investigating additional minor changes 

that, at the earliest, would not go into effect until April of 2014. 

In our view, these changes do not go far enough, fast enough, nor 

do they correct the underlying problem. 

In my testimony, I recommend very specific changes to the LME 

rules and we simply ask for the same regulatory and legislative 

oversight of the LME that other U.S. futures exchanges receive in 

order to level the playing field and ensure a transparent, balanced, 

and functional market for both buyers and sellers. This oversight 

will restore the free market functioning of the LME, which will regain our confidence in the institution and permit us to successfully 

brew, ship, and sell our fine beers. 

I thank the Committee for allowing me to appear to testify here 

today and I am happy to answer any questions that you may have. 

Thank you. 

Senator BROWN. Thank you, Mr. Weiner. I really appreciate it. 

I am going to turn it to Senator Toomey, who has to leave early, 

but I want to ask one real quick question first. Mr. Guynn, what 

was ‘‘you are not fair or not correct’’ about the story that Mr. 

Weiner just told about the consumer in Trenton, Ohio, walking in 

to buy a case of beer? What was either misleading, incorrect, or not 

fair about his story as an example of what has happened in aluminum? 

Mr. GUYNN. Just as a prelude, just so you know, I do not represent either JPM or Goldman on the LME situation, so I have no 

facts to add other than what is in the public record. But what I 

understand is that the LME metals warehouses only hold about 5 

percent of the aluminum that is actually bought and sold globally 

11

annually, that, in fact, 95 percent of the aluminum is bought directly from the producers. So I cannot quite understand where the 

market share issue is here. 

Also, I think the LME warehouse owner is only a custodian, so 

it is not as if they are the owner of the metals in the warehouse. 

Lastly, I think the CFTC has announced they are going to do an 

investigation. So, to the extent there are issues with the warehouse 

owners’ violating any laws, contracts, or rules, presumably, that 

will be dealt with in that investigation. 

Senator BROWN. OK. Thank you. I would only illuminate on that 

by saying that while it is a small part of the whole aluminum market, what the LME pricing structure is, as peculiar as it is and circuitous as it is, that affects price for all aluminum sold in the market, but we will get to more of those questions in a moment. 

We are setting the clock for 7 minutes for each Member and we 

will do second or third round as long as Senator Merkley and Senator Toomey, if he can come back and stay. So thank you. 

Senator TOOMEY. Thank you very much, Mr. Chairman, and 

thank you for your kind accommodation of my challenging schedule 

this morning. I appreciate that very much. 

I appreciate the testimony. Let me just say briefly, Mr. Weiner, 

I read your testimony last night and it certainly does seem rather 

odd that a large buyer of any commodity cannot access that commodity in a timely fashion. That is—I just do not know of any other 

precedent for that. It strikes me, as your testimony suggests, that 

there are some problems with the rules by which the warehouse 

operates. It strikes me that it may be more specific to the rules 

than it is to whoever happens to own the warehouse, but the rules 

by which they operate are strange, it seems. I would like to learn 

more about this, but I think it is a little bit tangential to some of 

the things I would like to explore. So I would like to follow up with 

you on another occasion on some of the particulars there. 

I would like to address my first question to Mr. Guynn, and I 

read your testimony, as well. Some of this gets a little bit confusion. There has been discussion about whether the Fed would revisit some rules in September. Could you just briefly summarize 

the actual legal authority by which bank holding companies engage 

in dealing in physical commodities as opposed to a regulatory discretion. But what is the legal authority? 

Mr. GUYNN. It is actually important to distinguish between different types of banking entities. Insured banks can buy and sell 

precious metals commodities under the National Bank Act. They 

can also trade in commodities contracts where the underlying commodity is a variety of things, including the energy and physical 

commodities we talked about here, as part of their core banking 

powers. That is, again, an interpretation of the National Bank Act. 

Bank holding companies and the nonbank affiliates of banks, are 

also able to do similar trading, again, limited to contracts. 

Then Gramm-Leach-Bliley added a provision that said that financial holding companies—special bank holding companies that 

meet certain capital and management requirements—would be able 

to engage in expanded powers, including these complementary powers. And it is pursuant to that provision that the Federal Reserve 

authorized Citigroup and other financial holding companies, startVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00015 Fmt 6633 Sfmt 6601 S:\DOCS\82568.TXT SHERYL
12

ing in 2003, to trade in physical commodities as a complement to 

their financial activities of trading in the contracts. 

And then there is a separate provision, there is a grandfathering 

provision in Section 4 of the Bank Holding Company Act that was 

actually designed to provide a two-way street for investment banks 

and commercial banks so that if Goldman Sachs and Morgan Stanley, for instance—who were not bank holding companies in 1999—

became bank holding companies later on, their commodities activities would be grandfathered. 

Senator TOOMEY. OK. Thank you. 

Let me just ask you—this may be a judgment call, an opinion 

call on your part, Mr. Guynn. Do you think part of the motivation 

for banks to engage in this is that it is profitable for banks? 

Mr. GUYNN. That certainly is part of the motivation, certainly, 

because when things are profitable——

Senator TOOMEY. Right. 

Mr. GUYNN.——it helps their balance sheet. 

Senator TOOMEY. So, this has been going on a long time, that 

banks have engaged in various levels of physical commodity dealing. Can you point to any time in which large financial company 

trading in physical commodities created a systemic risk for our financial system? 

Mr. GUYNN. I cannot think of a single example. 

Senator TOOMEY. Let me ask you this. Well, that might be because it is a profitable line of business, and, as such, might actually 

diminish risk rather than enhance risk. 

But let me ask you this. Could you give us an example of how 

a large, sophisticated commodity trading operation—it could be a 

bank holding company—provides a service that might actually be 

valuable to consumers? 

Mr. GUYNN. Sure. So, a good friend of mine founded JetBlue. 

JetBlue is a discount airline that obviously consumes a lot of jet 

fuel. They need to be able to manage the price risk of that jet fuel. 

As we know, jet fuel has been fairly volatile in recent years. And 

so they can enter into long-term fixed price contracts with Goldman 

Sachs, Morgan Stanley, JPMorgan, Citi, others who have the power 

to enter into those sort of contracts, in order to fix that price or 

manage their price risk. And then the financial institutions can go 

long in the physical commodity to hedge their risk in the contract, 

or go short, depending on how they are otherwise positioned. 

That reduces the cost for JetBlue and other airline companies 

and, presumably, those reduced costs are passed on to consumers 

in the form of lower traveling costs, or at least avoid higher travel 

costs. 

Senator TOOMEY. Or maybe greater job security on the part of 

their employees? 

And does it work in the opposite direction? In other words, you 

just gave an example where a buyer of a commodity benefits from 

the assurance of a known fixed price into the future. But what if 

you are in—say you are a silver miner. You mine silver and you 

sell it. You have got a lot of sunk costs, heavy capital investment. 

It seems to me your biggest variable cost is probably labor. If the 

price of silver collapses, you are probably going to lay off a lot of 

workers. If you could sell it at a known price in advance, would 

13

that give you some more stability, some more security for your 

workforce, for your business? 

Mr. GUYNN. Obviously, and that is why it is important to have 

strong, deep, liquid markets if we can have them in those sort of 

commodities, so that the silver miner or other miners will be able 

to buy or sell their goods in large quantities, very quickly, without 

causing price movements. 

Senator TOOMEY. And this example that you gave with JetBlue 

and that we discussed with, say, a silver miner, does that actually 

happen? Are there consumers who do, in fact, engage in these 

medium- and longer-term contracts for commodities? 

Mr. GUYNN. I think that is actually most of the business, that, 

in fact, these financial institutions engage in. 

Senator TOOMEY. OK. Thank you very much, and again, Mr. 

Chairman, I really appreciate your cooperation. 

Senator BROWN. Sure. Thanks for joining us. 

Mr. Weiner, I will start with a series of questions for you, if I 

could. I want to be clear exactly how this works. Is it correct, the 

warehouses pay premiums to aluminum producers to store the 

metal in their warehouses and then that they also charge purchases like yourselves and the companies you are representing 

today, that you said, rents to store the aluminum there after you 

have purchased it? Is that my understanding? 

Mr. WEINER. Yes, that would be correct. They actually pay an incentive to the producers to attract the metal to their warehouses 

and then store that metal in that warehouse and they do charge 

rent for the period of time that that metal stays in that warehouse. 

Senator BROWN. And Goldman Sachs is entitled—you mentioned, 

I am not sure you called it by name, but the Michigan warehouses, 

many of them owned by Metro—Goldman Sachs bought Metro. 

They are entitled to hold it for 10 years as a merchant banking investment. Mr. Guynn explained sort of the legal parts of this, and 

that term, merchant banking investment, is what Goldman Sachs 

supposedly operates under, although as Ms. Omarova pointed out, 

we do not have enough data to know nearly all of what we need 

to know. 

At current capacity, our estimates are that Goldman Sachs could 

earn $26 billion in rental income over that period. My question is, 

is it correct that four of the six largest LME, London Metal Exchange, warehouses are owned by Goldman Sachs and JPMorgan 

and the commodity trading firms Trafigura and Glencore so that 

there is limited competition in the warehouse business? 

Mr. WEINER. Yes. There are limited owners of the warehouses. 

I am not sure on the exact numbers. I can get that back to you. 

But they are—the two that you mentioned are some of the largest 

warehouse owners and it is limited to a small number, group of 

people. 

Senator BROWN. Both the banks that own the warehouses and 

the London Metal Exchange acknowledge that the aluminum held 

for companies like yours, companies that actually make things from 

aluminum, the manufacturers themselves, are given secondary status. This means that aluminum bought by people who buy aluminum as investments are given priority in the queue. One, is that 

true? Second, what effects do those delays have upon consumers 

14

and businesses like MillerCoors? What does it do to the price of 

your, ultimately, of your product? 

Mr. WEINER. I cannot speak to that particular point on the 

banks, but I can say that as far as the effect to us as a consumer 

of aluminum, it has a great effect, and also the companies that I 

mentioned. The increased cost that we incur takes away from innovation and new products that we can come up with, other qualities 

that we may be able to offer to our consumers, not only for us but 

for the companies that I mentioned here on this list. 

Senator BROWN. Well, you said you cannot speak to the question 

of whether they are given priority in the queue, the people who buy 

aluminum as investments. But the fact is, you cannot get the quantity of aluminum you want, apparently, correct? 

Mr. WEINER. If a buyer buys aluminum through the LME system, buys aluminum, cancels, gets a warrant, and goes to the warehouse to get his metal, if he gets his metal, for example, use Detroit for an example if you are in the United States, it can take up 

to 18 months to receive your——

Senator BROWN. Which would lead me to think, and you do not 

need to necessarily acknowledge this, but it would lead me to think 

that you are not a very high priority compared to those—because 

of, I mean, the New York Times said delays have increased from 

6 weeks not that long ago to 7 months in 2011 to 16 months today. 

Mr. WEINER. Mm-hmm. 

Senator BROWN. That would imply you are not a very high priority. 

Mr. WEINER. You could take that implication. 

Senator BROWN. Now, Goldman Sachs and JPMorgan are reportedly exploring selling the warehouses. The LME has proposed new 

warehouse rules. Reuters is saying the CFTC could investigate this 

issue. The Fed is reportedly reconsidering its policies. Are those actions sufficient to address this problem? 

Mr. WEINER. No. They are all wonderful ideas. They are all proposals——

Senator BROWN. It is necessary for intervention. You want these 

things to happen, but you think they are not sufficient? 

Mr. WEINER. Yes, we do. In fact, this is—we are going down the 

right path. This is a great beginning, but these are not sufficient 

to resolve the problem. We have heard about the warehouses selling—or the banks selling the warehouses. We have heard about all 

these other promises of new changes in the rules. And they are all 

wonderful ideas. They are all in the right direction. But they do not 

resolve the situation. 

Senator BROWN. What——

Mr. WEINER. It will take, as I mentioned in my testimony, the 

new rules that they have proposed, even if they go into effect, could 

not take effect any earlier than April of 2014, if that. 

Senator BROWN. If they could take effect immediately, would that 

solve your problem? 

Mr. WEINER. It could. It depends upon which rule changes they 

make. We gave a list of rule changes in my testimony. If they were 

to take some of those rule changes, it might have a much quicker 

effect as far as changing the current situation and status and the 

functioning of the LME warehouses. 

15

Senator BROWN. As your company and others have talked to 

Graham Steele and Katie Malone in my office and talked to us, you 

have made clear that you have done a number of other things. 

Could you describe your efforts to engage U.S. and LME? I mean, 

I know there has been a problem. LME says it does not have jurisdiction in Detroit and the United States says U.S. regulators—I 

guess CFTC, right—says it does not have jurisdiction with LME because the ‘‘L’’ stands for London. Talk to me about your interaction, 

working with both U.S. and U.K. regulators. 

Mr. WEINER. We met with the LME and we made some very serious proposals, the same proposal we listed in our written statement, and they were shrugged off. We went to the FSA at the time, 

which is now the FCA, that is the——

Senator BROWN. That is the British regulators. 

Mr. WEINER. It is the regulator over the LME. And we were informed that the LME is a self-regulated entity and the FCA now 

has oversight over that. 

Senator BROWN. Well, who owns the LME? 

Mr. WEINER. The Hong Kong Exchange now owns the LME. 

Senator BROWN. But they bought them from——

Mr. WEINER. They bought them from a large group of owners in 

December of 2012, so about 6, 7 months ago. 

Senator BROWN. So they are a self-regulating exchange with no 

real government with teeth oversight? 

Mr. WEINER. That would be correct, yes. 

Senator BROWN. OK. So before—I am sorry to interrupt. Before 

Hong Kong, this company in Hong Kong bought them, they were 

almost a co-op of sorts? They were the aluminum producers, sellers, 

brokers——

Mr. WEINER. Yes. I mean, the exchange was owned by banks, by 

producers, by warehouse owners, by traders——

Senator BROWN. And they were partly funded by the rents 

charged in Detroit? 

Mr. WEINER. Yes. Well, by rents charged all over the world. 

Senator BROWN. In Detroit and elsewhere. But——

Mr. WEINER. Yes. Right. 

Senator BROWN.——the money that Goldman was making in Detroit, the bountiness—no, I will not judge this—the money made in 

Detroit, the more that was, the more the LME got paid. 

Mr. WEINER. No. Actually, the more that was, the more it went 

to the warehousing company, Metro, that owns those warehouses. 

Senator BROWN. But then LME got a percentage——

Mr. WEINER. The LME gets a small one or one-and-a-half percent 

of all the metal——

Senator BROWN. Continue on your efforts with U.S. and U.K. regulators, if you would. 

Mr. WEINER. Yes. So we then came back to the United States. 

We went to the CFTC, who felt for us and understood our cause 

but said that they really had no regulatory power over the LME 

warehouses here in the United States or the LME, which is a foreign exchange. We have gone to several other regulatory agencies 

to see what they would do and now we are here today and this is 

just the next step in hopefully resolving this problem. 

16

Senator BROWN. One more question and then I will turn to Senator Merkley. I want to read you the response of Goldman Sachs 

to the complaints about the role of their warehouse in aluminum 

prices. Roughly 95—and this echoes a little bit of what Mr. Guynn 

said. Roughly 95 percent of metal sold every year does not pass 

through the warehouse system and it all goes straight from producers to consumers. Metro, Goldman’s company, does not own or 

control the metal in its warehouses. That is up to its consumers 

and subject to LME rules. So the extent that metal flows inside the 

warehouse system on and off warrant there is a function of consumer demand. As you might expect, the vast majority of the buildup in inventories at warehouses is a result of the financial crisis 

and the subsequent lack of demand. 

Goldman continues, the warehouses absorbed excess production, 

but the macro picture is one of soft demand and excess supply, 

which is why aluminum prices have come down substantially over 

past years, roughly 40 percent lower since pre-crisis level, Goldman 

says, another factor the New York Times failed to mention. As with 

other global commodity markets, prices are only driven by supply 

and demand. There has been significant over-capacity in the global 

aluminum market for years now, thus the need for storage, thus 

the role the warehouses have increasingly played. 

Your response? 

Mr. WEINER. I can respond to a couple things in there. Number 

one, I can respond to the fact that the real crux of the problem here 

in the LME is the fact that up through December of this past year, 

the owners of the LME warehouse sat on all the committees to 

make the rules for the warehouses that they own, are really the 

backing or the real problem here, because you have people setting 

up rules for themselves under a self-regulated exchange. And this 

is what I talked about in my testimony. I would like to get transparent and a functioning LME market, just like we have here in 

the United States, and that is really the problem that we have here 

today. It is not that demand has dropped or supply has increased, 

because when demand drops, prices usually—should go down and 

should disincentivize producers from producing, and that has not 

happened because there have been incentives to have the producers 

continue producing in a significantly over-supplied market. 

Senator BROWN. The incentives come from Metro, for instance, 

paying a premium to bring the aluminum there. 

Mr. WEINER. Yes. Otherwise, why would you produce aluminum 

in an over-supplied market and deliver it into a warehouse? 

Senator BROWN. Any other comments on Goldman’s statement? 

Mr. WEINER. Well, the 9 and 95 percent. All of our contracts, and 

all the contracts of the companies that I mentioned here in my 

statement, all of our contracts are linked to the price of the LME 

plus a premium that we pay, and the way that we buy the metal 

through the LME, which we pay the LME plus the premium or the 

time that it sits in a warehouse, or we go to a warehouse outside 

of the LME, we still pay the same price. It is kind of like if I went 

to you to sell you an apple for $100 and someone came and they 

offered you something for $50, you would go and buy it for $50, but 

you are not going to offer it cheaper to somebody else. It is just not 

going to happen. 

17

Senator BROWN. So you are saying that only—if you agree that 

5 percent of this aluminum is in the warehouse only, 5 percent——

Mr. WEINER. Using that as an example. I cannot——

Senator BROWN. OK, but, I mean, that is what Goldman said, 5 

percent. If that is, in fact, true——

Mr. WEINER. Yes. 

Senator BROWN.——the price charged in the warehouse for that 

aluminum affects the other 95 percent of the market because of 

LME, perhaps arcane, obscure, hard to understand, but because of 

LME rules, correct? 

Mr. WEINER. Absolutely correct. 

Senator BROWN. OK. All right. 

Senator Merkley. 

Senator MERKLEY. Thank you, Mr. Chair, and thank you all for 

testifying. 

I wanted to follow up, Mr. Weiner, on the point that if demand 

is dropping, it would seem like it would take less time to get your 

aluminum out of the warehouse because you have fewer customers 

knocking on the door, if you will. Would that not be the logical conclusion if demand was diminishing? 

Mr. WEINER. Absolutely. 

Senator MERKLEY. OK. This whole discussion is fascinating. I 

think that the general picture is one in which you can make a lot 

of money by manipulating a market. Now, if you can put a thumb 

on the scale, you can do a number of things. You can make bets 

on the future price. That is one way of making a lot of money, if 

you can influence the supply and demand and make bets on the 

supply and demand. In addition, you can charge customers more 

for getting their product by charging rent, as you have pointed out, 

on the warehouse. 

So which is the bigger issue here? Is the bigger issue that by controlling the warehouses, you can influence the prices and thereby 

make a lot of money by adjusting the outcome for bets you are 

making, or is the bigger issue the rent, the additional rent being 

charged that seems so unjustified? 

Mr. WEINER. It is a combination of both——

Senator MERKLEY. OK. 

Mr. WEINER.——because—I am sorry. Go ahead. 

Senator MERKLEY. I wanted to turn to Ms. Omarova. 

Ms. OMAROVA. Yes. 

Senator MERKLEY. Thank you for your testimony. I think what 

is being presented here is a pattern. We have JPMorgan being involved in the supply of electricity, and I believe you have done 

work on Morgan Stanley’s involvement in oil, petroleum markets. 

Ms. OMAROVA. Only research work, not the real involvement. 

Senator MERKLEY. Research work. And then we have this case 

of aluminum, and then we have a conversation about coming ownership through electronic traded funds in copper. And so is really 

what we see—is this a vast strategy employed by large financial institutions that are theoretically banks that take deposits and make 

loans, but really, they are giant firms dedicating themselves to be 

able to make bets on prices and then control behind the scenes, 

help control those prices? 

18

Ms. OMAROVA. You are asking a very important question, actually. Is there a vast pattern of these large financial institutions 

turning into effectively trade and financial super-intermediaries? I 

believe there is a reason to suspect that there is, in fact, such a 

pattern emerging. 

My point is that we really do need to get more specific data, specific information, to assess the vastness of this pattern, because 

this trend has enormous implications for the rest of the economy 

and the rest of our country. 

Now, in this connection, let me just make a clarifying point further to Randy’s testimony. It has been said here today that what 

is happening in the physical commodities markets with JPMorgan 

and Morgan Stanley and Goldman Sachs accumulating these physical assets is, in effect, nothing new. It is just sort of incremental 

continuation of what banks have been doing since ancient Egypt. 

That is true and yet not exactly true. At least, it is not helpful. 

First of all, the relevant history here is not what happened in ancient Egypt. The relevant history here is what has been happening 

since 1956, when Congress made an explicit decision that bank 

holding companies should not be engaged in commodities or other 

commercial activities unless specifically permitted. And although in 

1999 Congress did, in fact, create the merchant banking authority, 

the complementary authority, and the grandfathering exception, 

there is no evidence that Congress meant for these exceptions to 

swallow the rule. Whether or not in reality the law has been effective in preventing such swallowing of the rule by the exceptions is 

precisely the issue at stake today. We need to figure that out. I do 

not have substantial evidence of whether or not it happened, but 

it is not my position to present such evidence. 

Now, history has also—you know, history can prove too much 

and too little, right. Just because some bank somewhere in the past 

did something and that was OK does not mean necessarily that it 

is OK today. For example, I am sure that some time, some bank 

has financed slave trade, right? That does not mean that JPMorgan 

today should be financing human trafficking based on some historical tradition. So that is basically my point on history. 

With respect to the law, and especially the Gramm-Leach-Bliley 

Act provisions, it is one thing to say that the law, as written, technically allows for these types of investments to be conducted as 

long as they comply with certain requirements. My concern is how 

that law is implemented. Has it worked in reality? 

Let me give you a quick example. For example, merchant banking authority, right, it was meant to allow banking institutions to 

make purely financial private equity, very passive, investments for 

financial appreciation, right. We invest in the company, then we resell it and make money on it. And there is an important requirement for such a merchant banking investment, for example, that 

Goldman Sachs as the financial holding company cannot participate in the routine management of an oil company or Metro International, the warehousing company it owns. And it all sounds really important, right. No routine management. That means they directly cannot participate in that business. 

But in reality, what it means is that, for example, Goldman 

Sachs’ managing director cannot be the CEO of Metro, or that 

19

Goldman Sachs cannot formally obligate Metro International to 

check with Goldman Sachs every time they want to hire a janitor, 

for example. But, Goldman Sachs has the full right under the law, 

as written, to appoint all directors on the board of directors of that 

company. They can engage in extensive consultations with the 

managers of Metro International with respect to the business. 

And it is very hard to tell how much of informal influence Goldman Sachs, for example, exerts over Metro International’s management decisions. They may not exert any influence. It may, in fact, 

be a purely financial investment. But I wonder if the Federal Reserve, for example, is actually doing its job, asking those kinds of 

questions and looking in what is happening on the ground instead 

of just referring us to the letter of the law. 

Senator MERKLEY. Thank you. 

Mr. Rosner, to my broader question here, if I want to be in the 

business of making a lot of profits on placing bets on the price of 

commodities, owning a fair amount of the commodity itself and 

owning the pipelines or the ships, in the case of oil, or owning the 

warehouses, in the case of aluminum and copper, do not those 

things give me significant ability to manipulate the market? 

Mr. ROSNER. Well, of course they do. And, in fact, we should be 

expanding this just beyond the warehouses. The example was given 

about the delivery of metals by the miner. Well, there is nothing 

that prevents through the Asset Management Division one of these 

banks from becoming the general partner, the control over a mine, 

OK, which creates other problems. 

Look at what we saw, as an example, in California, where the 

government demanded that AES bring two power plants back online to make up for lost capacity and we saw JPMorgan attempt 

to block that. FERC ended up intervening and overruling them, but 

there were attempts. One has to ask if they were driven by profit 

motives on the desk, keeping prices up in the market for their benefit, and, frankly, one has to ask and go further, what would happen if, in fact, through the Asset Management Division they had 

control of a generating facility on that grid. Again, that would end 

up helping their pricing. So, I think these are very real. 

Now, add one more level, which I really think needs to be 

stressed. If, in fact, we saw a catastrophic event at any of these 

owned facilities, nonfinancial facilities, the impact, reputationally 

and operationally, not only to the institution but to the Federal Reserve, would be catastrophic. 

Senator MERKLEY. Thank you very much. Thanks. 

Senator BROWN. Thank you, Senator Merkley. 

Senator Warren, and we are setting the clock at 7 minutes. 

Please proceed. 

Senator WARREN. Thank you, Mr. Chairman, and I apologize. We 

are having simultaneous hearings and I was off at an NLRB hearing. But I appreciate your having this hearing, Mr. Chairman. 

An interesting conversation about the history. The way I sort of 

see this is that, you know, the turn of the 20th century, the biggest 

banks, and JPMorgan was one of the prime examples, played an 

active role in the management of many of the Nation’s key industrial companies. JPMorgan partners, for example, sat routinely on 

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porations. Now, it began to change leading up to the Great Depression as reformers like Louis Brandeis warned again and again and 

again about the dangers of both conflicts of interest and the concentration of power and as they generated greater and greater public support for the notion that these should be separated. 

After the 1929 crash, the Glass-Steagall Act clamped down on 

the banks’ interconnectedness with industry by separating boring 

banking, like checking and savings accounts, from the high-risk 

gambling found on Wall Street. 

So I am glad we are having this hearing today because our banks 

and industrial have changed, but the dangers of concentration and 

the principles at stake have not, and that is why I share the concern of many of my colleagues about asset managers at huge Wall 

Street banks exercising control over key parts of America’s infrastructure. 

So I thought I would start my questions with you, Mr. Rosner. 

If we ever experience again a crisis like the crisis in 2008, how do 

you think Wall Street control over electric plants or seaports or airports could factor into the systemic risk confronted by the Department of Treasury and the Fed and, ultimately, the taxpayer? 

Mr. ROSNER. Right. As I said in my testimony, I think that those 

are very real risks that need to be considered. The situation is not 

terribly different than in 2008, where we watched the industry go 

from originally making mortgage loans to taking over through investment banking the entire mortgage complex, from front, hiring 

third-party mortgage originators, pooling and packaging securities, 

making money on the sale and trading of those securities, proprietary trading on those securities, owning the servicing and, in some 

cases, we watched the servicing companies that they purchased run 

not by separate divisions but actually be owned and operated by 

the trading desk, creating significant opportunities for informational advantage of the firm over its customers, and incentives 

that, frankly, led to many of the outcomes that we have seen and 

losses, OK. 

The problem ends up being that with the backstop of the Federal 

Reserve, with the backstop of insured deposit regimes through the 

FDIC, there will always be an ultimate call on the system. Now, 

one institution theoretically could be resolved under Dodd-Frank. I 

do not believe that Title I, Title II works. But even assuming that 

it could, the reality is, if we had a catastrophic risk in one of these 

infrastructure businesses, the counterparty exposure would lead to 

exactly the same outcome, the calls for more collateral, the risk of 

contagion, counterparties backing away, liquidity leaving the system, and ultimately the Government being called in to stabilize 

against the risk of contagion. 

Senator WARREN. Or to say this another way, the interconnectedness——

Mr. ROSNER. Absolutely. 

Senator WARREN.——increases the likelihood——

Mr. ROSNER. Absolutely. 

Senator WARREN.——that these institutions——

Mr. ROSNER. That is right. 

Senator WARREN.——remain too big to fail. 

21

Mr. ROSNER. That is right. And as I said before, you know, one 

does have to question what would have happened if, in fact, the 

Exxon Valdez was owned by one of these bank holding companies. 

Senator WARREN. Yes. Good. Thank you. 

I have another question for you. I do not think there is any question that institutional investors, like pension funds, hope that asset 

managers at a big bank will return solid profits over time. But I 

also do not think that most retirees realize that their pension or 

retirement savings are used to pave the way for big banks to be 

able to control an electric plant or an oil refinery. So, Mr. Rosner, 

what dangers do you think result from big banks spending, as 

Brandeis put it, other people’s money to amass this kind of power 

and control? 

Mr. ROSNER. Well, I mean, I think we saw this with JPMorgan’s 

ownership and control of U.S. Steel, one-sixth of the Nation’s railroad, rail lines, General Electric and Edison, and we saw some of 

the outcomes, the consolidation of the power, the impact on pricing. 

I think it is also, though, important to really think about, and 

if you have any questions about the strategy here, look at some of 

the footnotes in my written testimony. The statements, the language used by these asset managers, these bank-run asset managers in pitching to those firms include the advantages of controlling monopolistic and quasi-monopolistic assets as an inflation 

hedge because of the ability to negotiate long-term leases with riders that allow pricing to rise even when demand falls. 

Senator WARREN. So say this one again, Mr. Rosner. I mean, I 

just want to make sure you put the right summary on this. These 

people are out amassing this power. They are using the money that 

people invest, for example, in their pension plans. They are using 

it to amass this power and then they are selling, in effect, themselves on the notion that if you will invest with their company, 

they are going to have the benefits of having created this powerful 

and interconnected sort of corporate and banking conglomerate 

that will be able not only to produce big returns because you have 

figured out the right things to invest in, but produce big returns 

because they will have, as you describe it, monopoly control——

Mr. ROSNER. As they describe it. 

Senator WARREN. As you described their describing it——

Mr. ROSNER. Correct. 

Senator WARREN.——because they will have monopoly control. 

Mr. ROSNER. That is correct. 

Senator WARREN. Thank you, Mr. Rosner. I think that is clear. 

Mr. Chairman, thank you. 

Senator BROWN. Thank you, Senator Warren. 

I want to pursue, and I will start with you, Mr. Guynn, more on 

the oil, gas, and energy markets that both my colleagues touched 

on. Before Morgan Stanley converted in 2008, largely to get access 

to the window, apparently, it was one of the leading investment 

banks directly involved in the physical commodities and energy sectors. That would lead you to think they would be grandfathered. 

They currently own TransMontaigne, a petroleum and chemical 

transportation and storage company, and Heidmar, Inc., which reportedly manages some 100 oil tankers, 80 of which might be at 

sea on a given day. Bloomberg reported on Friday that a spokesVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00025 Fmt 6633 Sfmt 6601 S:\DOCS\82568.TXT SHERYL
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man for Morgan Stanley said the bank did not expect, quote, ‘‘to 

have to divest any of its activities after the grace period ends in 

September.’’ That was the grandfather issue, I believe. 

In a 2012 Reuters story, one expert said that owning physical assets in trading financial markets, quote:

gives you the visibility of the market to make far more successful proprietary trading decisions in both physical and financial markets. It is trading 

with material nonpublic information. The difference compared with equity 

markets is that it is perfectly legal.

So, as they know the markets so much better because of their 

control of some of these assets—it could be Metro, it could be something else—they have an advantage, purportedly, in the marketplace in terms of proprietary trading. There are not conflicts of interest in the insider trading issues with equity markets. The laws 

do not apparently apply the same way. 

So my question, Mr. Guynn, are there concerns when a financial 

company that is wagering on oil prices also controls a fleet of over 

100 tankers that it can hold back from delivering to a port to influence prices? So you own 100 tankers for a period of time. You scale 

back the number of those tankers delivering oil. And you are also 

in a position to wager on oil prices. Is that a concern to you? 

Mr. GUYNN. So, I think all of these things—trading in material 

nonpublic information, having and abusing market power—are serious concerns. Obviously, if they had a large enough market share 

to give them market power, and they abused that power, they 

would presumably be violating the antitrust laws. I am not sure 

that it is actually quite accurate to describe the sharing of information between these two markets—the cash and derivatives markets—as sharing material nonpublic information. I think the better 

analogy is a bank buys the bonds or trades in the bonds of a company. It also enters into swaps with the company and uses the information from each market in the other market. I think that is 

the better analogy. 

In fact, actually having knowledge of both markets helps price 

discovery and helps the prices in the derivatives markets and the 

prices in the physical markets to converge, which is actually a good 

thing. It helps the markets. It helps the liquidity of the markets. 

It helps the miner in Senator Toomey’s example to be able to sell 

his product very quickly with a known and expected price. 

Senator BROWN. But this situation, you do not think is a particularly serious potential problem? 

Mr. GUYNN. The situation——

Senator BROWN. With owning oil tankers and also wagering on 

the price of oil. 

Mr. GUYNN. Well, I mean, if they own oil tankers and they participate in the markets—the spot market and the futures market 

for oil—and they had market power and they abuse it, I suppose 

that could be a problem. Presumably, the antitrust authorities 

would look at that, however. Unlike the 19th century, we have the 

Sherman Act and the Clayton Act now and we have the U.S. Department of Justice and the Federal Trade Commission that survey 

that. We have bank regulators that look at that. We also have securities and commodities regulators that look at insider trading or 

misuse of information. If there are any gaps in the regulations, I 

23

would have thought that it would be a legitimate thing to fill any 

gaps and to make sure that any sort of bad behavior of the sort 

you are suggesting as potential did not occur. 

Senator BROWN. I would like to think that we have regulators in 

the Justice Department that would be as aggressive as you suggest 

they might. 

Ms. Omarova, comment on Mr. Guynn’s comments, please. 

Ms. OMAROVA. Well, I think oil market and the way price is, 

quote-unquote, discovered in oil markets is in itself a very interesting and complicated question. The term ‘‘price discovery’’ sounds 

very neutral, and it generally refers to this very liquid, very public 

market, lots of buyers and sellers come independently and somehow in that wonderful process the fair price for particular goods is 

established. 

But in these markets, for example, over-the-counter oil derivatives markets, Goldman Sachs is not just doing price discovery in 

that traditional sense. I suspect they are actually able to form the 

price, to set the price, because they are a major dealer in these 

markets. 

Now, is that an issue, that not only can they set the price or affect the price in these financial markets, but they can also influence the price of the physical oil if they own the fleet of tankers 

or contractually have access to the physical barrels of oil? I think 

it is a far more important issue than the traditional antitrust DOJ 

concerns with just the market share calculated based on some definition of a market, for example. 

I am all for the DOJ to actually conduct a serious antitrust investigation of these issues. But recently, there have been attempts 

internationally to figure out, to investigate how the global oil prices 

are actually discovered or established and that investigation did 

not go anywhere because the oil industry basically refused to cooperate, it is my understanding. So if this is the market in which 

Morgan Stanley and Goldman Sachs are playing, it makes me uncomfortable as a banking law person. 

Senator BROWN. The response of the panel to my colleagues’ 

questions about a potential Exxon Valdez or BP oil spill, if the 

banks had ownership in those companies, begs the question, can 

bank examiners, already overworked, already underfunded, sometimes too captured by the people whom they regulate—perhaps 

leave that part of it out—but can these bank examiners fully appreciate and understand the kind of environmental potential impact on some of these commodities? 

Ms. OMAROVA. Well, if there are actually bank examiners that realistically can do that, then probably they should be running the 

world, because it is extremely difficult to imagine a human being—

and I do not know what kind of professional qualifications bank examiners must have to get the job, right. I assume that even if they 

had a Ph.D. in economics or finance or anything like that, they 

might still have a difficulty figuring out exactly the dynamics of a 

market as globalized and as complicated and as nontransparent as 

oil, for example. 

Now, on top of that, if you move to electricity, that is a whole 

different market with its own factors shaping the prices and shaping the behavior of market actors, and so on and so forth. There 

24

is no such thing as a single unified commodity sector that one can 

study and understand and then say, well, everything is under control. 

The fact that there are many regulators looking at various aspects of this sprawling enterprise that JPMorgan or Goldman 

Sachs are becoming does not necessarily mean that, as a whole, as 

a team, they are looking at the right things. That is the most important issue. We need to be able to say that our regulators are actually capable of overseeing and monitoring these risks and I have 

serious doubts they can do it. 

Senator BROWN. Thank you. 

I am sorry. Let me do one more question and then turn it again 

to Senator Warren. 

Morgan Stanley also markets energy and owns energy generation 

facilities in the United States and Europe. JPMorgan has similar 

authority. JPMorgan said that power has monopolistic pricing 

power and demand that is relative insensitive to price, which essentially is saying that you can charge what you want for electricity and people will pay for it. 

I want to quote from Mr. Rosner’s testimony. You said, FERC 

took action against JPMorgan for its attempts at preventing the 

implementation of State sequestered changes to Huntington Beach, 

California, power plants owned by AES Corporation. The State 

deemed the work necessary to replace lost power capacity that resulted from the shutdown of a nuclear plant. JPMorgan sought to 

prevent the changes and claimed its marketing contract with AES 

gave them the right to veto the work. 

While the bank’s motives were not stated, it is reasonable to consider that the firm sought to profit from the higher peak energy 

prices that would have resulted from its actions to prevent new capacity from coming online. Media reports are that there is a $400 

million settlement around that, a payment from JPMorgan. It suggests heightened risks of conflicts of interest, anti-competitive practices, market manipulation that can arise when a company controls 

the supply of a commodity and trades in financial markets for that 

commodity as a market maker and as a principal. 

Mr. Rosner, I mean, I quoted you, but expand on that, if you 

would, or how concerned you are with this, and do regulators have 

the ability or the authority to regulate these sorts of arrangements? 

Mr. ROSNER. No. I mean, look, even the information advantage 

that comes from their knowledge of what their intent is has real 

impact in the marketplace and has real benefits that it can provide 

in the marketplace. 

To suggest that regulators have the ability to manage these is to 

ignore all of the areas directly related to banking and investment 

banking businesses that the regulators failed to oversee or manage 

leading to the crisis. In fact, as I warned in 2006, regulators did 

not even have access to underlying CDO data, OK, collateralized 

debt obligation data, and, therefore, could not really look at the underlying collateral or the risks posed to the institutions by those 

exposures. 

To expect the regulators to have working knowledge and to expect the regulators to be able to understand the web of relationVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6601 S:\DOCS\82568.TXT SHERYL
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ships that exist here is not rational. And, in fact, if we think about 

it more fully, just even looking at the various businesses that come 

off of this—let us take that mortgage period as an example. So the 

banks made loans to third-party mortgage originators and they got 

paid for warehouse lines from those. One distinct business opportunity. They took the mortgages they received. They pooled them, 

they packaged them, and they securitized them. They sold them to 

investors. Second distinct line of business. Then they were able to 

trade them in a secondary market on behalf of those customers. 

Third income stream. They also were able to trade them on a prop 

basis. Fourth income stream. They had servicing businesses that 

they owned and were able to glean informational advantage both 

in advance of their customers, it turns out, and also for the income 

streams provided by that servicing. 

The conflicts of putting together all of these business lines, even 

within financial services, need to be managed. They were not managed so well by the regulators. And to expect that we can see the 

expansion into far more lines of business, far more far-flung infrastructure assets, I think, is unrealistic and, as I said, poses a very 

different level of catastrophic risk. No one should suggest that private industry should be prohibited from owning businesses. But 

when you have the backstop, implied or explicit, of the Federal 

Government, it changes the equation, and I would contend that 

these institutions have become today’s equivalent of the Government-Sponsored entities that we saw fail in the mortgage crisis. 

Senator BROWN. Mr. Guynn, why is he wrong? You seemed—the 

look on your face suggests you think he is. 

Mr. GUYNN. So, first of all, I think the riskiest thing that financial holding companies do is actually lend money on a long-term 

basis. That is actually the asset that tends to fall in prices, it tends 

to result in runs. It actually is probably the riskiest thing they do. 

The bank regulators are not omniscient. They are human beings. 

They make mistakes. They made lots of mistakes in the financial 

crisis. So did lots of other people. And they are not going—and my 

guess is it would be the unusual bank examiner who understands 

the commodities markets or the oil markets or oil tankers and so 

forth. But they do have tools that they have used, can use and have 

used, to try to control this risk and have safeguards. 

So, for instance, in the complementary powers orders, they only 

allow activities by bank holding companies. It is important to know 

that the banks themselves cannot do it. We often sort of mix those 

up. So the separately capitalized, insulated nonbank affiliates can 

buy and sell physical commodities, but it is limited to physical commodities where there is a contract that is authorized for trading on 

an exchange by the CFTC, which means that they are sufficiently 

liquid, or if there is not a contract that is authorized, that the Federal Reserve has specifically determined is sufficiently fungible and 

liquid to be an appropriate banking asset. Then they have volume 

limits. 

They also have capital and liquidity requirements. There is no 

question that the bank regulators are not going to be able to calibrate the risk of these activities any more than they have been able 

to calibrate the risks of lending. And so the way they manage—the 

way they sort of put safeguards in place to manage all of the risks 

26

of the financial services industry is to have limits, capital requirements, liquidity requirements, surveillance, examinations, and so 

forth. 

Senator BROWN. Thank you. 

Ms. Omarova, do you want to just respond? 

Ms. OMAROVA. Just a quick note on this, that I do agree that 

lending in and of itself is an extremely risky activity and I do not 

think anybody seriously is aiming at eliminating risk entirely from 

the banking business. That is just impossible. 

However, it is important to understand that the entire system of 

banking law and regulation is built on an assumption that these 

are the kinds of risks banks generate for themselves, it is built on 

an assumption of what that business is about. And so, poorly or effectively, but that regulatory scheme actually targets those risks. 

Now, when that regulatory scheme has to deal with risks that 

are completely outside of that type of business and, therefore, were 

not even meant to be addressed, then this is an issue of legal efficiency and regulatory efficiency. 

Senator BROWN. Thank you. 

Mr. Rosner, last comment, then Senator Warren. Sorry. 

Mr. ROSNER. I just want to go back and point out that on September 27, 2012, the CFTC issued an order against JPMorgan for 

violations of 4(a)(b)(2) of the Commodities Exchange Act, finding 

deficiencies in newly created automated position limit monitoring 

system for the commodities business used by commodities traders 

to track their current positions, in particular, futures contracts. 

After learning of this deficiency, JPMCB utilized a manual position 

limit monitoring procedure pending correction of the automated 

monitoring system. Despite adoption of this manual position limit 

monitoring procedure, JPMCB violated its short side speculative 

position limits on several occasions. 

So, first of all, we find in that statement internal control failures. 

The company themselves could not manage those controls. 

More importantly to this point, those were uncovered by the 

CFTC. We are not talking about the bank examiners. We are not 

talking about the Federal Reserve. We are talking about the CFTC, 

OK. The primary regulator clearly does not have the capacity to 

manage all of the risks. Otherwise, we would not have seen one of 

these institutions spend 12 percent of net income between 2009 

and 2012 on settlements for various operational failures across 

their business lines. 

Senator BROWN. Thank you. 

Senator Warren. 

Senator WARREN. Thank you, Mr. Chairman. 

Professor Omarova, you have written about how regulators began 

chipping away at Glass-Steagall starting in the early 1980s and 

began breaking down the wall between commercial banking and investment banking. So, I want to ask you the other part of the question. What do you think is the impact of a financial institution 

being able to take consumer deposits while also being able to control, say, an electric plant or an oil refinery through its Management Division? Professor Omarova. 

Ms. OMAROVA. That is a very important issue that needs actually 

further significant research, and I am hoping that this hearing will 

27

start the process of asking the questions of the people who can provide us with information for us to be able to arrive at the full conclusion on that. 

But, as a preliminary matter, right, as a person sort of applying 

common sense and some knowledge of what has been happening in 

the past, I would say that there are some serious concerns with 

that situation. We have talked today a lot about potential, for example, for manipulating prices in either market. Now, it may or 

may not hurt the individual consumers, but that raises an issue of 

market integrity in the financial markets, also in the underlying 

commodities markets, right. It also interferes with the traditional 

supply and demand dynamics that typically form prices in a variety 

of markets. 

So, do we want that to happen? Of course not. Is it happening? 

It is hard to tell. But might it happen? Of course, it can happen, 

and that is the issue to be asked. 

Then there is this whole another problem with the systemic risk 

and what not. We have already talked about it. 

But then, ultimately, if you think about it from the point of view 

of a regular person, you know, if these trends were to continue 

without any kind of principled limitation on what should be allowed to banks, simply because they can afford to do it maybe 

cheaper than others, then probably at some point in the future, we 

will find ourselves in a situation where we—not only do we buy our 

house with the money borrowed from a big bank, not only that 

house was built maybe by a subsidiary of that big bank, it is heated and electrified and provided with water that is also distributed 

and perhaps produced by that same bank, and who knows what 

else. In fact, you know—this is hyperbolic hypothetical, of course, 

being a law professor, I cannot resist that——

[Laughter.] 

Ms. OMAROVA.——but one could envision JPMorgan’s new slogan 

as, ‘‘Get Everything You Need From Your Friendly Local Global Financial Conglomerate.’’

And perhaps that is OK. Perhaps that is the kind of a future for 

this country that we should be prepared to live with, because 

JetBlue or an oil refinery in Pennsylvania actually gets cheaper financing of its inventories, right. But if that is the case, what I am 

asking for is a chance for a public deliberation. We have to be able 

to make that decision. 

Senator WARREN. Mr. Rosner, did you want to weigh in on that? 

Mr. ROSNER. Yes, only in the discussion of cheaper financing, because I think it needs to be, again, stressed. There is nothing 

wrong with vertical integration of industries. There is nothing 

wrong with investors owning those assets, investing in those assets, controlling those assets within the confines of regulation. 

When you have institutions that have access to the Fed window, 

and that may well be the basis of their cheaper financing, it is anticompetitive. It prevents Wall Street, and I am talking about investors, I am talking about where price discovery happens, where people buy and sell securities, trying to bring price and value in line. 

You are distorting the ability of markets to function, and I think 

that really needs to be front in people’s minds here. 

28

This is not about liking or disliking Wall Street’s investments in 

infrastructure assets. That is a clear driver of our economy. The 

question is tying those to competitive advantage of the Federal 

funds. 

Senator WARREN. Well, it is both. It is competitive advantage 

and it is risk——

Mr. ROSNER. Right. 

Senator WARREN.——that we are talking about. 

Mr. ROSNER. No, that is right. 

Senator WARREN. So let me ask the question, then, from the 

other direction, and that is that Senator McCain, Senator Cantwell, 

Senator King, and I recently introduced a 21st century GlassSteagall Act. So, what impact do you think a new Glass-Steagall 

Act would have on the developments you have seen in the marketplace? Mr. Rosner. 

Mr. ROSNER. Well, so, first of all, I have not read the text, so I 

cannot comment on the specifics. 

Senator WARREN. Fair enough, but I will tell you, it is short. 

Mr. ROSNER. I do worry that, given the complexity of these institutions, it may be difficult to achieve, and even if we did have the 

Congressional intent to do so. We have got institutions whose derivative books themselves are enormous. And, frankly, there are 

real questions as to what they know of their thresholds within 

those businesses. And so I think to expect the quick dismantling 

of those would be difficult——

Senator WARREN. Fair enough, although I will tell you, in the 

bill, there is a 5-year period, because it acknowledges exactly that 

point, that we have created a tangle and it takes time to undo that. 

But at least in terms of the direction we are trying to head, and 

that is to say that commercial banking, boring banking, should be 

separated from these other functions. 

Mr. ROSNER. Well, we certainly have seen negative outcomes 

from the broader economy and, frankly, for financial markets as a 

result of the combination of those businesses. Now, we often hear, 

well, our largest institutions will be less competitive globally, to 

which I would usually respond, one, we have—first of all, I would 

be very happy if this gentleman was able to secure cheap funding 

because a German bank had a cheaper cost of funds because it had 

a backstop of the German government. I would actually find that 

to be OK, if we outsourced that risk, prevent our largest institutions from underpricing risk to be competitive, because in Europe, 

through actions——

Senator WARREN. Let me just make sure I am following. You 

would be glad to shift that risk——

Mr. ROSNER. Absolutely. 

Senator WARREN.——over to the German taxpayers——

Mr. ROSNER. That is right. 

Senator WARREN.——so long as the American taxpayers do not 

take it on. 

Mr. ROSNER. Well, that is the point, right? So we have in our 

country Dodd-Frank. The intent was to make sure that our largest 

financial institutions are not sovereign obligations. In Europe, they 

have accepted them as sovereign obligations. And so that competitive issue really suggests that we are willing to say, let business 

29

get funding from capital markets, where, by the way, most of it 

comes from, or where foreign banks are willing to underprice risk, 

because lending is very risky, as we discussed, let them do so without creating the race to zero, bringing our institutions down that 

road. 

Senator WARREN. OK. Or, to say it another way, but not the 

American taxpayer. 

Mr. ROSNER. That is right. 

Senator WARREN. And, Professor Omarova, would you like to 

weigh in on that? 

Ms. OMAROVA. Well, personally, I think that the proposed bill on 

the 21st century Glass-Steagall Act is a move potentially in the 

right direction. What I want to emphasize, though, is that just by 

separating boring banks from the rest of the financial system, we 

may not completely, of course, resolve the issue we are talking 

about today, because, ultimately, this is about financial institutions 

that are also dealers and traders in financial markets, capital markets, and credit markets, being engaged on such a large scale in 

the physical trading of commodities. That is the combination that 

worries us here today, and that does not necessarily depend on the 

actual charter. 

So I would urge you, Senator Warren, and your colleagues to perhaps, you know, think more in terms of perhaps expanding the——

Senator WARREN. I think it is fair to say that many of us are 

very well aware of the need for multiple tools in the toolbox and 

looking for more ways to move us in the right direction, that GlassSteagall is not designed to solve every problem, but it helps move 

us in the right direction, helps reduce risk, helps, at least to some 

extent, disentangle what has become a mess that is both hard to 

regulate and is creating additional risk on its own. So thank you 

very much. 

Thank you, Mr. Chairman. 

Senator BROWN. Thank you, Senator Warren. 

This is a picture of the ownership structure of an exchange traded fund, a so-called ETF, established by JPMorgan to invest in copper. In documents filed with the SEC, JPMorgan acknowledges, as 

you can see from this chart, and I will quote:

The trust, the sponsor, the administrative agent, the warehouse keeper, the 

JPMorgan Securities LLC, the initial authorized participant are all affiliates of JPMorgan Chase. Although the sponsor attempts to monitor these 

conflicts, it is extremely difficult, if not impossible, for the sponsor to ensure 

that conflicts of interest do not, in fact, result in adverse consequences to 

the trust.

They note the sponsor has the authority to fire the warehouse, 

their own Henry Bath subsidiary, but they have an incentive not 

to exercise this authority even when it may be in the best interest 

of shareholders to do so because of the affiliation among the entities. I would also point out, Reuters reported that JPMorgan added 

commodity chief Blythe Masters and some other JPMorgan executives to Henry Bath’s board. 

Reading on, ‘‘JPMorgan Chase Bank currently engages in and in 

the future expects to engage in trading activities related to copper.’’ 

Much talk about aluminum and energy in this discussion today, 

less so about copper, but my guess is, a year from now, we might 

30

be talking a lot more about copper. And I spoke to a labor official 

today who represents industrial workers and he talked about how 

important copper is in so many of the products that his workers 

and the companies they work for make. 

Futures contracts in copper and other copper-related investments 

for its accounts or for the accounts of its clients. Essentially, other 

parts of the bank may bet against investors in the copper ETF. 

This structure is eerily reminiscent of Mr. Rosner’s comments 

about the subprime collateralized debt obligation arrangements 

that we saw before the financial crisis, and I have a series of questions for Mr. Rosner. 

We know, first of all, we know the three largest ETFs could control up to 80 percent of the copper available in the market. Mr. 

Weiner pointed out the problems they faced in aluminum. This 

could be, perhaps, worse. So, questions, Mr. Rosner. Are you troubled by the effects that this could have for end users of copper? 

Should regulators share your concern? Should consumers? Should 

investors? Are you troubled by the ETF structure and the conflicts 

of interest involved? 

Mr. ROSNER. Well, of course. Look, in the industry, the financial 

service industry, whether it is commercial banking or investment 

banking, there will always be conflicts and those conflicts must always be managed. And so if we had confidence that the regulators 

could appropriately manage those conflicts or that the companies 

themselves could appropriately manage those conflicts, there would 

be no reason for us to be here today. 

I do not suggest that any of the activities that we are talking 

about today are being run by people who are malicious, malevolent, 

or have particular schemes to intentionally harm the public. Functionally, though, we have businesses where those conflicts of interest are driven by management who have obligations to their investors. That is their primary obligation. And so to make sure that the 

public is not harmed, we need to make sure that those are fully 

private industries without Government support, to Senator Warren’s point. 

We had Wall Street function, frankly, for generations, effectively, 

both in doing lending functionally through syndicates—financing, I 

should say, through syndicates—and investment banking businesses. All of those activities are fine. They just should not be tied 

to the Government support. 

And so where they are, yes, all of these activities should raise 

concern, should raise questions, and the conflicts of interest become 

all the more meaningful specifically because the U.S. taxpayer is 

functionally on the hook. 

Senator BROWN. Does anyone else wish to comment on that? 

OK. Let me go to another line of questions on transparency. Ms. 

Omarova, you, in your opening statement, you talked about lacking 

the necessary data generally to address so many of these issues. 

We have talked about the lack of transparency on both the regulators and the institutions. We do not even know what the regulators seem to be doing. There is no easy way for Senator Merkley 

or Senator Warren or me or Senator Toomey, any of us, to learn 

about practices that these banks are undertaking or if the process, 

even the process, most egregiously in my mind, by which the FedVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00034 Fmt 6633 Sfmt 6601 S:\DOCS\82568.TXT SHERYL
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eral Reserve reviews and approves these activities, we do not even 

know if, in fact, they have a deadline, when that deadline might 

be, although we think we can calculate it, but the Fed will not acknowledge it, that September deadline. It might apply to Goldman 

and Morgan Stanley, but we do not know. 

The Fed says that there is no deadline. Morgan Stanley’s public 

filings say it has 5 years from September of 2008. It is not hard 

to add 5 years and come up with 2 months from now that they 

have to comply with the Bank Holding Company Act. Other companies say they expect the Federal Reserve to clarify the scope of permissible grandfathered activities sometime this fall. 

Ms. Omarova, should Members of the Banking Committee, 

should the public generally be forced to feel around in the dark in 

order to figure this stuff out? 

Ms. OMAROVA. Well, of course, we should not. Being in the dark 

about this issue may in some ways make our lives easier, right, because we do not—you know, what we do not know does not hurt 

us, supposedly. But it still might hurt us and it is better to be prepared for what is going on and weigh into that conversation before 

it is too late. 

Now, with respect to that September deadline, the banking statutes, and the Bank Holding Company Act is no exception, are frequently written in such an unclear manner that it is very difficult 

to figure out what exactly is required and what exactly is discretionary. 

So while the text of the Gramm-Leach-Bliley Act that created 

that grandfathering exemption for newly registered bank holding 

companies after 1999 technically does not require the Fed to approve the use of this particular exemption—on its face, the statute 

does not do that. However, the same statute also says that within 

5 years at the maximum, right, these institutions have to be, in effect, approved by the Fed as being fully in compliance with the 

Bank Holding Company Act prohibitions on their activities. 

So as a practical matter, as a procedural matter, it is up to the 

Fed at some point to weigh in on the question that after you have 

become a bank holding company now and now are subject to these 

limitations, what did you do with those assets that you held prior 

to such conversion and at the time did not have to comply with the 

limitations of the Bank Holding Company Act? And that is the decision that is made by the Fed in negotiation with these companies. 

Now, what I would like to do, or what I would like you to do, 

I suppose, is to ask the Fed these questions. Has the Fed been 

looking into this issue, what kind of criteria the Fed is using when 

it talks to these institutions, and how specifically does the Fed arrive at its conclusions, for example, that a particular type of an investment or activity is, in fact, consistent with the public interest. 

And, again, this is a very important inquiry. 

Senator BROWN. Well, and we have asked those questions. We 

have not asked them in a public forum. They have been less than 

forthcoming. We will do a hearing probably in September, and I 

hope it is before the deadline, but we do not know when the deadline is because they will not tell us when the deadline is, if that 

sounds a bit circuitous. But we will continue this, and it was not 

just Morgan Stanley and the Fed. It has also been JPMorgan. 

32

For instance, Reuters, in a different situation but still leaving 

Fed involvement, is attempting to convert its ownership of the 

Henry Bath warehouse into a merchant banking investment, as 

you know, allowing them to hold it for 5 more years beyond the 

2015 cutoff. Goldman Sachs apparently—apparently—also holds its 

Metro warehouse system under this provision. They elect to do so 

using a Federal Reserve form that is not necessarily available to 

the public. 

So the Fed, again, has not been forthcoming in showing us this 

form, discussing the deadline, allowing us a schedule on how the 

form is filled out and when it is due. Surely, and I will not even 

pose this question because the answer is so obvious, that this information should be available to Members of Congress, to the public, 

to all of us. 

Senator Warren. 

Senator WARREN. Thank you. 

So, Mr. Weiner, I read your testimony about what happened in 

the market for aluminum as a result of the activities of the large 

financial institutions. I thought it was pretty alarming, and I just 

wanted to ask you, can you describe specifically how you think the 

market developments here have affected consumers. 

Mr. WEINER. We are the ultimate consumers here of aluminum. 

It affects all of us. What it does is it takes away our opportunity 

to give the consumers what they want. Our consumers, in our particular case, 60 percent of our products are packaged in aluminum. 

We would like to give them what they ask for and they want aluminum. We give them the punch-top can. We give them the aluminum pint. We give them all these innovations, which creates jobs 

so we can buy new can lines to promote and push our business forward. These are the things that are held back from us that we cannot offer to the general public. 

Senator WARREN. Thank you. That is very useful. 

And, Professor Omarova, you wrote last year that big banks 

began actively seeking expanded authority to conduct physical commodities and energy trading activities in the early 2000s, shortly 

after the fall of Enron, the pioneer in financializing commodity and 

energy markets. 

Now, you said in this paper that it is difficult to draw causal connections here because of the timing, but you also seem to have a 

hunch that this was not a coincidence. Would you be willing to expand on that a little? 

Ms. OMAROVA. Well, again, let me reiterate, I do not—I have not 

done research to substantiate the link between the fall of Enron 

and the rise of Morgan Stanley and Goldman Sachs as this kind 

of integrated super-intermediary derivatives/physical commodities 

traders. But, you know, there is at least a plausible, a very plausible argument that Enron was the pioneer in discovering a business model that brought together the ability to move physical commodities, like oil, gas, and other things, right, through a network, 

vast network of commodity infrastructure throughout the entire 

Nation and a major derivatives platform that is tied to the price 

of those commodities that Enron was moving. 

Now, it is important to understand that in that model, it is not 

really even the key to own any particular producing company in 

33

that chain or any particular distributor. Through contractual networks, Enron was able, or at least it was seeking the ability, to establish this kind of vast network of kind of trade intermediation 

plus financial intermediation. 

What happened to Enron, we all know. Now, once that model, 

though, was discovered, that model was up for the taking, and I 

think that the early 2000s is a particularly important threshold because that was the beginning of the major, unprecedented global 

commodities boom. And, again, it is hard to draw any kind of causal connections. Was the boom at least in part facilitated by the influx of the financial institutions into the commodities market and 

financialization of commodities markets? Perhaps, at least partly, 

the answer is yes. 

Or was it the other way around? Was it that when Citigroup, for 

example, and JPMorgan saw that physical commodities have become the next hot asset class after the dot-com boom ended, they 

have decided that they should use this sort of ability in the statute 

to actually start getting into that physical commodities game? I am 

sure, partly, at least, the answer is yes. 

Senator WARREN. So, I do have to say here, whichever way the 

causation era runs, the notion that two of our largest financial institutions in this country are adopting a business model that was 

pioneered by Enron suggests that this movie does not end well and 

that we are now pulling more and more risk into the system, and 

that what happened with Enron at least should stand as a cautionary tale as we look forward to the integration of these larger 

financial institutions and the commodities market. So, thank you 

very much. 

Mr. Rosner, did you want to comment on that? 

Mr. ROSNER. No. 

Senator WARREN. Good. Thank you very much. I appreciate it. 

Mr. Chairman, thank you. 

Senator BROWN. Thanks, and I want to just close with a couple 

of comments. 

One, to be fair, I mentioned Morgan Stanley and JPMorgan 

Chase in terms of the failure or the inadequacy of the Fed response. I would add that Goldman’s investment in Metro and energy company Kinder Morgan are both merchant banking and 

tended to be passive investments. Two managing directors of Goldman Sachs serve on Kinder’s board of directors, owning a 19 percent stake in the company. So that, I think—that is another place 

where the Fed should look a little more carefully, we think. 

We primarily learned three things, I think, from this hearing. We 

learned that this kind of ownership of a whole part of the real 

economy can potentially be a risk for the banking system. 

We learned that the banks, when they own, they can get less expensive financing because of their access to the window, can get 

less expensive financing to capitalize their commodity holdings. 

And we learned that there is an advantage because of their 

knowledge of the buying and selling and storing and transporting 

of commodities. These banks get an advantage for proprietary trading. 

None of those seem to fit, in my mind, with the history of financial regulation in this country, but they are two sides of debate. 

34

Mr. Guynn argued that we should not be that troubled that banks 

are recreating the old model of the original JPMorgan. Mr. Rosner 

cited Mr. Morgan as a reason to be wary. We should ask ourselves 

what it does to the rest of our society, to our businesses, to our consumers, to our manufacturers, to taxpayers, when wealth and resources are diverted into finance that way. 

The issue needs more explanation. The Federal Reserve and the 

banks themselves are in the best position to provide it. Stay tuned. 

I so appreciate the four of you being here. I appreciate Senator 

Warren’s and Senator Toomey’s and Senator Merkley’s questions. 

If the Members of the Subcommittee may have questions of you, 

they will have a week to get them to you. Please respond as quickly 

as you can. 

Thank you all very much. The hearing is adjourned. 

[Whereupon, at 11:53 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:]

35

1 12 U.S.C. § 24 (Seventh). 

2 12 U.S.C. §§ 1841–43. 

3 12 U.S.C. § 1843(k)(1)(A). 

PREPARED STATEMENT OF SAULE T. OMAROVA

ASSOCIATE PROFESSOR OF LAW

UNIVERSITY OF NORTH CAROLINA AT CHAPEL HILL

JULY 23, 2013

I am an Associate Professor of Law at the University of North Carolina at Chapel 

Hill, where I teach subjects related to U.S. and international banking law and financial sector regulation. Since entering the legal academy in 2007, I have written articles examining various aspects of U.S. financial sector regulation, with a special 

focus on systemic risk containment and structural aspects of U.S. bank regulation. 

For 6 years prior to becoming a law professor, I practiced law in the Financial Institutions Group of Davis Polk & Wardwell and served as a Special Advisor on Regulatory Policy to the U.S. Treasury’s Under Secretary for Domestic Finance. 

For the past 14 months, I’ve been working on a research project examining the 

involvement of large U.S. banking organizations in physical commodities and energy 

markets. The working draft of my article, entitled ‘‘The Merchants of Wall Street: 

Banking, Commerce, and Commodities’’ is available on the Social Science Research 

Network, at http://papers.ssrn.com/sol3/papers.cfm?abstractlid=2180647. This 

written testimony represents an abbreviated version of that article. For further details and full citations, please see the text of the article. 

I. The Legal Background: Separation of Banking from Commerce 

One of the core principles underlying and shaping the elaborate regime of U.S. 

bank regulation is the principle of separation of banking and commerce. Pursuant 

to that principle, U.S. commercial banks generally are not permitted to conduct any 

activities that do not fall within the relatively narrow band of the statutory concept 

of ‘‘the business of banking.’’1 In addition, under the Bank Holding Company Act 

of 1956 (‘‘BHCA’’), all bank holding companies (‘‘BHCs’’)—i.e., companies that own 

or control U.S. banks—are generally restricted in their ability to engage in any business activities other than banking or managing banks, although they may conduct 

certain financial activities ‘‘closely related’’ to banking through their nondepository 

subsidiaries.2 The Gramm-Leach-Bliley Act of 1999 (‘‘GLBA’’) amended the BHCA 

to allow certain BHCs qualifying for the status of ‘‘financial holding company’’ 

(‘‘FHC’’) to conduct broader activities that are ‘‘financial in nature,’’ including securities dealing and insurance underwriting.3 All BHCs (including their subset, FHCs) 

are subject to extensive regulation and supervision by the Board of Governors of the 

Federal Reserve System (the ‘‘Board’’), an agency in charge of administering and implementing the BHCA. 

In effect, the entire system of U.S. bank and BHC regulation is designed to keep 

institutions that are engaged in deposit-taking and commercial lending activities 

from conducting, directly or through some business combination, any significant 

nonfinancial activities, or from holding significant interests in any general commercial enterprise. The main arguments in favor of maintaining this legal wall between 

the ‘‘business of banking’’ and purely commercial business activities have traditionally included the needs (1) to preserve the safety and soundness of insured depository institutions, (2) to ensure a fair and efficient flow of credit to productive economic enterprise (by, among other things, preventing unfair competition and conflicts of interest), and (3) to prevent excessive concentration of financial and economic power in the financial sector. The BHCA, which was originally envisioned as 

explicitly anti-monopoly legislation, embodies and seeks to implement these policy 

objectives. 

Of course, in practice, the relationship between banking and commerce in the 

United States has never been simple, as the legal wall separating them has never 

been completely impenetrable. Numerous exemptions from the general statutory restrictions on affiliations, such as the exemption for unitary thrift holding companies 

or companies controlling certain State-chartered industrial banks, historically have 

allowed a wide variety of commercial firms to own and operate deposit-taking institutions. Banks and BHCs, in turn, have always been allowed at least some degree 

of involvement in nonfinancial activities, subject to various statutory and regulatory 

conditions and limitations. For example, BHCs are generally permitted to invest in 

up to 5 percent of any class of voting securities of any nonfinancial company—an 

36

4 12 U.S.C. § 1843(c)(6),(7). 

5 12 U.S.C. § 1843(k)(4)(H). 

6 12 C.F.R. Part 225, Subpart J. 

7The Merchant Banking Rule provides the following definition: 

Section 4(k)(4)(H) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H)) and this subpart authorize a financial holding company, directly or indirectly and as principal or on behalf 

of one or more persons, to acquire or control any amount of shares, assets or ownership interests 

of a company or other entity that is engaged in any activity not otherwise authorized for the 

financial holding company under section 4 of the Bank Holding Company Act. For purposes of 

this subpart, shares, assets or ownership interests acquired or controlled under section 

4(k)(4)(H) and this subpart are referred to as ‘‘merchant banking investments.’’ 12 C.F.R. § 

225.170.

exception designed to allow banking organizations to take small, noncontrolling 

stakes in commercial businesses as passive investors.4

In the last decade, however, there has been a qualitative change in the practice 

of mixing banking and commerce, at least within the structure of large, systemically 

important FHCs. Thus, large U.S. FHCs—including Goldman Sachs, Morgan Stanley, and JPMorgan Chase & Co. (‘‘JPMC’’)—have emerged as major merchants of 

physical commodities and energy, notwithstanding the legal wall designed to keep 

them out of any nonfinancial business. As explained in greater detail below, these 

three FHCs currently own and operate what appear to be significant businesses 

trading in crude oil, gas, refined petroleum products, electric power, metals, and 

other physical commodities. In conducting these activities, they function as traditional commodity merchants rather than purely financial intermediaries. That’s why 

it is important to understand how the law has failed to prevent, and apparently has 

enabled, this extensive entry of banking organizations into the sphere of general 

commerce. In an important sense, the story begins with passage of the GLBA in 1999. The 

GLBA is best known for partially repealing the Glass-Steagall Act and thereby 

opening the door to a mixing of commercial with investment banking. More significantly for present purposes, however, the GLBA also opened the door to a greater 

mixing of banking with commerce. Under the BHCA, as amended by the GLBA, 

there are currently three main sources of legal authority for FHCs (but not all 

BHCs) to conduct purely commercial activities, despite the general separation of 

banking from commerce: (1) merchant banking authority; (2) ‘‘complementary’’ powers; and (3) ‘‘grandfathered’’ commodities activities. In order to engage, directly or 

through any subsidiary, in any nonfinancial, commercial activity—including producing, refining, storing, transporting, or distributing any physical commodity—an 

FHC has to ‘‘fit’’ that activity within the legal confines of at least one of these three 

statutory exceptions created by the GLBA. 

A. Merchant Banking Powers 

The merchant banking authority permits an FHC to acquire or control, directly 

or indirectly, up to 100 percent of any kind of ownership interest—including equity 

or debt securities, partnership interests, trust certificates, warrants, options, or any 

other instruments evidencing ownership—in any entity that engages in purely commercial, as opposed to financial, activities.5 By creating this new investment authority, the GLBA sought to enable FHCs to conduct a broad range of securities underwriting, investment banking, and merchant banking activities, subject to statutory 

conditions and limitations. At the height of the high-tech stock boom, the GLBA’s 

grant of merchant banking powers allowed FHCs to compete with securities firms 

and venture-capital funds by investing in technology startups. 

The statute, however, does not define the term ‘‘merchant banking.’’ In 2001, the 

Board and the Department of Treasury jointly issued a final rule implementing Section 4(k)(4(H) of the BHCA (the ‘‘Merchant Banking Rule’’).6 The Merchant Banking 

Rule defines ‘‘merchant banking’’ activities and investments as those activities and 

investments that are not otherwise authorized under Section 4 of the BHCA.7 In 

effect, the merchant banking power serves as a catch-all authority for FHCs to invest in commercial enterprises, as long as any such investment meets the following 

key requirements: 

(1) the investment is not made or held, directly or indirectly, by a U.S. depository 

institution (such as a bank subsidiary of the FHC);

(2) the investment is made ‘‘as part of a bona fide underwriting or merchant or 

investment banking activity,’’ which includes investments made for the purpose of appreciation and ultimate resale;

(3) the FHC either (i) is or has a securities broker-dealer affiliate, or (ii) has both 

(A) an insurance company affiliate that is predominantly engaged in underVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00040 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
37

8 66 Fed. Reg. 8466, 8469 (Jan. 31, 2001). 

9 12 C.F.R. § 225.171(b)(1). An FHC is deemed to be engaged in the routine management or 

operation of a portfolio company if (1) any director, officer, or employee of the FHC or certain 

of its subsidiaries (including depository institutions, securities broker-dealers, and merchant 

banking subsidiaries) serves as, or has the responsibilities of, an executive officer of a portfolio 

company; or (2) any executive officer of the FHC or any of the same subsidiaries as mentioned 

above serves as, or has the responsibilities of, an officer or employee of the portfolio company. 

Id. An FHC is presumed to be routinely managing or operating a portfolio company if (1) any 

director, officer, or employee of the FHC serves as, or has the responsibilities of, a non-executive 

officer or employee of a portfolio company; or (2) any officer or an employee of the portfolio company is supervised by any director, officer, or employee of the FHC (other than in that person’s 

capacity as a director of the portfolio company). 12 C.F.R. § 225.171(b)(2). An FHC may rebut 

these presumptions by providing the Board with sufficient information showing the absence of 

routine management or operation. 12 C.F.R. § 225.171(c). 10 12 C.F.R. § 225.171(b)(1). 11 12 C.F.R. § 225.171(d)(2). 12 12 C.F.R. § 225.171(d)(3)(i),(ii). 13 12 C.F.R. § 225.171(d)(3)(iii). 14 12 C.F.R. § 225.171(d)(1). The portfolio company must employ officers and employees responsible for routinely managing and operating its affairs. An FHC may engage, on a temporary 

basis, in the routine management or operation of a portfolio company only if such actions are 

Continued

writing life, accident and health, or property and casualty insurance (other 

than credit-related insurance), or providing an issuing annuities and (B) a registered investment adviser affiliate that provides investment advice to an insurance company;

(4) the investment is held ‘‘only for a period of time to enable the sale or disposition thereof on a reasonable basis consistent with the financial viability of the 

[FHC’s] merchant banking investment activities;’’ and

(5) the FHC does not ‘‘routinely manage or operate’’ any portfolio company in 

which it made the investment, except as may be necessary in order to obtain 

a reasonable return on investment upon resale or disposition.

At least in theory, the requirement that a permissible merchant banking investment be made as part of a bona fide underwriting or investment banking activity

imposes an important functional limitation on merchant banking activities. Even 

though an FHC is permitted to acquire full ownership of a purely commercial firm, 

the principal purpose of its investment must remain purely financial: making a profit upon subsequent resale or disposition of its ownership stake. The Board made 

clear that merchant banking authority was not designed to allow FHCs to enter the 

nonfinancial business conducted by any portfolio company. This explicitly stated 

statutory requirement ‘‘preserves the financial nature of merchant banking investment activities and helps further the [ ] purpose of maintaining the separation of 

banking and commerce.’’8

Another important requirement that shapes the practical usefulness of the merchant banking authority to FHCs investing in commercial companies is the holding 

period for merchant banking investments, which is generally limited to a maximum 

of 10 years. If the investment is made through a qualifying private equity fund, the 

maximum holding period is fifteen years. In certain exigent circumstances, the FHC 

may petition the Board to allow it to hold the investment for some limited time in 

excess of the applicable holding period. Explicit limits on the duration of merchant 

banking investments underscore the principally financial nature of this activity. 

Finally, the prohibition on FHCs’ involvement in the routine management and operation of portfolio companies they own or control under the merchant banking authority is designed to serve as an additional safeguard against mixing banking and 

commerce. The Merchant Banking Rule lists the indicia of impermissible routine 

management or operation of a portfolio company, which include certain kinds of 

management interlocking 9 and contractual restrictions on the portfolio company’s 

ability to make routine business decisions, such as hiring non-executive officers or 

employees or entering into transactions in the ordinary course of business.10 Arrangements that do not constitute routine management or operation of a portfolio 

company include contractual agreements restricting the portfolio company’s ability 

to take actions not in the ordinary course of business;11 providing financial, investment, and management consulting advice to, and underwriting securities of, the 

portfolio company;12 and meeting with the company’s employees to monitor or advise them in connection with the portfolio company’s performance or activities.13 Importantly, the Merchant Banking Rule specifically allows an FHC to elect any or all 

of the directors of any portfolio company, as long as the board of directors does not 

participate in the routine management or operation of the portfolio company.14

38

necessary to save the economic value of the FHC’s investment and to obtain a reasonable return 

on such investment upon its resale or disposition. 12 U.S.C. § 1843(k)(4)(H)(iii); 12 C.F.R. § 

225.171(e). 15 12 U.S.C. § 1843(k)(1). 16 12 C.F.R. § 225.89(a). 17 12 C.F.R. § 225.89(b)(3). 18 12 U.S.C. § 1843(j)(2)(A). 19 Id. This list essentially reiterates the policy concerns underlying the principle of separation 

of banking from commerce. 20The Financial Services Act of 1998—H.R. 10: Hearing before the S. Comm. on Banking, 

Housing, and Urban Affairs, 105th Cong. 172 (1998) (prepared statement of John G. Heimann, 

Chairman, Global Financial Institutions, Merrill Lynch & Co., Inc., on behalf of the Fin. Servs. 

Council).

B. Activities ‘‘Complementary’’ to a Financial Activity 

As discussed above, the main justification for allowing FHCs to own or control 

commercial companies under the merchant banking authority is the notion of merchant banking as a fundamentally financial activity. However, the GLBA also contains a separate grant of authority for FHCs to conduct activities that are clearly 

not financial in nature but are determined by the Board to be ‘‘complementary’’ to 

a financial activity. The statute requires that the Board also determine that any 

such complementary activity ‘‘not pose a substantial risk to the safety or soundness 

of depository institutions or the financial system generally.’’15

Procedurally, the Board makes these determinations on a case-by-case basis. Any 

FHC seeking to acquire more than 5 percent of the voting securities of any class 

of a company engaged in any commercial activity that the FHC believes to be complementary to a financial activity must apply for the Board’s prior approval by filing 

a written notice. In the notice, the FHC must specifically describe the proposed commercial activity; identify the financial activity for which it would be complementary 

and provide detailed information sufficient to support a finding of 

‘‘complementarity;’’ describe the scope and relative size of the proposed activity (as 

measured by the expected percentages of revenues and assets associated with the 

proposed activity); and discuss the risks the proposed commercial activity ‘‘may reasonably be expected’’ to pose to the safety and soundness of the FHC’s deposit-taking subsidiaries.16

The notice must also describe the public benefits that engaging in the proposed 

activity ‘‘can be reasonably expected’’ to produce. In making its determination, the 

Board is required to make a specific finding that the proposed activity would 

produce public benefits that outweigh its potential adverse effects.17 The statutory 

list of such public benefits includes ‘‘greater convenience, increased competition, or 

gains in efficiency.’’18 The Board must balance these benefits against such dangers 

as ‘‘undue concentration of resources, decreased or unfair competition, conflicts of 

interests, unsound banking practices, or risk to the stability of the United States 

banking or financial system.’’19

The legislative history of this provision shows that the industry deliberately 

sought the inclusion of the ‘‘complementary’’ clause as an open-ended source of legal 

authority for banking organizations to engage in any commercial activities that may 

become feasible or potentially profitable in the future. In congressional hearings, financial services industry representatives stressed ‘‘the importance of having the 

flexibility to engage in nominally commercial activities, particularly those related to 

technology and telecommunications, that support and complement [their] core business.’’20 This is how the then Vice-Chairman of J.P. Morgan & Co. described the 

industry’s vision of ‘‘complementary’’ business activities: 

The world of finance has changed. Information services and technological 

delivery systems have become an integral part of the financial services 

business. Financial firms use overcapacity in their back office operations by 

offering services to others such as telephone help lines or data processing 

for commercial firms. These activities may not be strictly ‘financial,’ yet 

they utilize a financial firm’s resources and complement its financial capabilities in a manner that is beneficial to the firm without adverse policy implications.

Financial firms also engage in activities that arguably might be considered 

nonfinancial, but which enhance their ability to sell financial products. One 

example is American Express, which publishes magazines of interest to 

cardholders—Food & Wine and Travel & Leisure. Travel & Leisure magazine is complementary to the travel business (an activity permitted within 

the definition of financial in H.R. 10) in that it gives customers travel ideas 

which the company hopes will lead to ticket purchases and other travel arVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00042 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
39

21 H.R. 10—The Financial Services Modernization Act of 1999: Hearings Before the Comm. On 

Banking and Fin. Servs., 106th Cong. 294–95 (1999) (prepared testimony of Michael E. Patterson, Vice Chairman, J.P. Morgan & Co., Inc., on behalf of the Financial Servs. Council). 22 As the CEO of Bank One Corp. put it, ‘‘The area on the commerce side that is most interesting to me is what is happening on the Internet.’’ H.R. 10—The Financial Services Modernization Act of 1999: Hearings Before the Comm. On Banking and Fin. Servs., 106th Cong. 18 (1999) 

(testimony of John B. McCoy, President and CEO, Bank One Corporation). 23 H.R. 10, 106th Cong. § 102 (as reported by H. Comm. on Banking & Fin. Servs., June 15, 

1999) (internal citations omitted). ). An earlier House Committee Report included a similar provision. See H.R. Rep. No. 106–74, pt. 1, at 5 (Mar. 23, 1999). 24 68 Fed. Reg. 68,493 (Dec. 9, 2003) (emphasis added). 25 As of mid-2012, the Board approved only one other type of activity—certain disease management and mail-order pharmacy services—as complementary to a financial activity of underwriting and selling health insurance. Wellpoint, Inc., 93 Fed. Res. Bull. C133 (2007). Wellpoint, 

which was not a BHC, submitted an application to the FDIC to obtain deposit insurance for 

its new Utah-chartered industrial bank. Although owning an industrial bank would not make 

Wellpoint a BHC subject to the BHCA’s activity restrictions, Wellpoint had to request the 

Board’s determination because, at the time, the FDIC-imposed temporary moratorium on providing deposit insurance to new industrial banks prohibited approval of any such applications 

unless the applicant (Wellpoint, in this instance) engaged exclusively in FHC-permissible activities. See Moratorium on Certain Industrial Bank Applications and Notices, 72 Fed. Reg.5290 

(Feb. 5, 2007). 26 12 U.S.C. § 1843(o).

rangements through American Express Travel Services. Similarly, Food & 

Wine promotes dining out, as well as purchases of food and wine, all of 

which might lead to greater use of the American Express Card. These activities are complementary to financial business and thus should be permissible for financial holding companies.21

The industry’s frequent references to Travel and Leisure and Food and Wine magazines effectively framed the congressional debate on ‘‘complementary’’ activities as 

a debate about relatively low-risk, low-profile activities, such as publishing and financial data dissemination. In reality, however, the possibility of having a flexible, 

undefined statutory category of permissible commercial activities was especially attractive to financial institutions seeking to take advantage of the dot-com boom and 

potentially expand into far riskier Internet ventures.22 From the industry’s perspective, an intentionally open-ended ‘‘complementary’’ authority was the key to such an 

expansion. 

In April 1999, the Senate introduced its version of the reform bill that for the first 

time included the ‘‘complementary powers’’ provision. In June 1999, the House bill 

was amended to incorporate a similar authorization of ‘‘complementary’’ activities 

but only ‘‘to the extent that the amount of such complementary activities remains 

small in relation to the authorized activities to which they are complementary.’’23

This express limitation disappeared from the final version enacted into law as part 

of the GLBA, leaving the Board free to set its own conditions for FHCs’ complementary activities. 

The Board has described the intended scope and purpose of its own authority to 

approve certain activities as complementary to an FHC’s financial activity in relatively cautious terms, as allowing individual FHCs ‘‘to engage, to a limited extent,

in activities that appear to be commercial if a meaningful connection exists between 

the proposed commercial activity and the FHC’s financial activities and the proposed commercial activity would not pose undue risks to the safety and soundness 

of the FHC’s affiliated depository institutions or the financial system.’’24

Curiously, between 2000 and 2012, the Board used its authority almost exclusively to approve physical commodity and energy trading activities as complementary to FHCs’ financial activity of trading in commodity derivatives.25 It seems that, 

after the GLBA was enacted, FHCs discovered that trading crude oil and wholesale 

electricity ‘‘complemented’’ their traditional financial activities much better than 

publishing travel and culinary magazines. This phenomenon raises critical questions 

about the scope and practical operation of the undefined and intentionally broad 

statutory concept of ‘‘complementarity.’’

C. Grandfathered Commodities Activities 

In addition to granting FHCs potentially broad and vaguely defined merchant 

banking and ‘‘complementary’’ powers, the GLBA contains a special grandfathering 

provision for commodities activities. Section 4(o) of the BHCA explicitly authorizes 

any company that becomes an FHC after November 12, 1999, to continue conducting 

‘‘activities related to the trading, sale, or investment in commodities and underlying 

physical properties,’’26 subject to the following conditions: 

40

27The statutory 5 percent limit on the FHC’s total consolidated assets attributable to the 

grandfathered commodities activities is designed to prevent a dramatic shift in the business profile of such an FHC from financial to purely commercial commodities activities. In absolute 

terms, however, even such a small fraction of total consolidated assets of a large FHC may allow 

for a considerable expansion of its commercial business of owning, producing, transporting, processing, and trading physical commodities. Such an expansion may very well implicate the fundamental policy concerns underlying the principle of separation of banking and commerce. 28Financial Services Competitiveness Act of 1995, 104 H.R. 1062 (Version 1), Sec. 109. 29 Id. In the 1995 versions of the House bill, these WFI holding companies were referred to 

as ‘‘Investment Bank Holding Companies.’’ Compare 104 H.R. 1062 (Version 1), Sec. 109 with

105 H.R. 10 (version 3), Sec. 131. 30This is how an American Bankers Association report described the 1997 proposal:

To allow for two-way affiliations between banks and securities firms, a new type of holding 

company would be permitted. This would be the investment bank holding company. These companies would have still wider powers than the new bank holding company format would bring, 

but the separation between banking and commerce would still be retained. These special holding 

companies could own wholesale financial institutions (WFIs, also known as ‘‘woofies’’) which 

would be uninsured but also not subject to standard bank holding company firewalls.

Steve Cocheo, Outlook Brightens for New Banking Laws, ABA BANKING JOURNAL, Feb. 27, 

1997, at 10. 31Goldman lobbied for specific inclusion of the commodity grandfathering clause in the 

‘‘woofie’’ provisions of the House bill because of its existing investment in J. Aron, a commodity 

trading company. In fact, at the time, the commodity grandfathering provision was ‘‘widely 

viewed as the ‘‘Goldman’’ exception.’’ Martin E. Lybecker, Financial Holding Companies and 

New Financial Activities Provisions of the Gramm-Leach-Bliley Act, in BACK TO THE FUNDAMENTALS: INSURANCE REGULATION, BROKER-DEALER REGULATION, AND IN-

(1) the company ‘‘lawfully was engaged, directly or indirectly, in any of such activities as of September 30, 1997, in the United States;’’

(2) the aggregate consolidated assets of the company attributable to commodities 

or commodity-related activities, not otherwise permitted to be held by an 

FHC, do not exceed 5 percent of the company’s total consolidated assets (or 

such higher percentage threshold as the Board may authorize); and

(3) the company does not permit cross-marketing of products and services between any of its subsidiaries engaged in the grandfathered commodities activities and any affiliated U.S. depository institution.

The vague phrasing of this section seems to allow a qualifying new FHC to conduct not only virtually any kind of commodity trading but also any related commercial activities (for example, owning and operating oil terminals and metals warehouses), if it engaged in any commodities business—even if on a very limited basis 

and/or involving different kinds of commodities—prior to the 1997 cutoff date. Potentially, so broadly stated an exemption may open the door for large financial institutions to conduct sizable commercial activities of a kind typically not allowed for 

banking organizations.27

To date, the outer limits of the commodities grandfathering clause have not been 

tested. It is difficult to assess, therefore, whether and to what extent this seemingly 

inconspicuous provision may be used to deal the final deathblow to the principle of 

separation of banking and commerce. The legislative history of this special 

grandfathering clause, however, provides valuable context in which to place analysis. It is also highly instructive from the point of view of the political economy of 

U.S. financial services regulation. 

The grandfathering of pre-existing commodities trading activities was originally 

proposed in 1995 by Congressman Jim Leach as part of a broader set of provisions 

establishing a new charter for ‘‘wholesale financial institutions’’ (‘‘WFIs’’), which 

could conduct a wide range of banking activities but, importantly, could not take federally insured retail deposits.28 Under the proposal, companies that owned or controlled one or more WFIs (but not FDIC-insured banks)—Wholesale Financial Holding Companies (‘‘WFHCs’’)—would be regulated and supervised by the Board but 

less stringently than regular FHCs.29 These provisions of the House bill were designed specifically to create a so-called ‘‘two-way street’’ for investment banks, to enable them to acquire commercial banks and offer their institutional clients wholesale banking services, without becoming subject to the full range of activity restrictions under the BHCA.30 Because WFIs and their parent-companies—dubbed 

‘‘woofies’’—would not have access to Federal deposit insurance and, therefore, were 

not likely to pose any significant potential threat to the deposit insurance fund, the 

proposal authorized them to engage in a broader set of nonfinancial activities than 

regular FHCs backed by FDIC insurance. One of these explicit tradeoffs involved 

the grandfathering of woofies’ pre-existing commodities trading and related activities.31

41

VESTMENT ADVISER REGULATION (ABA CENTER FOR CLE NAT’L INSTITUTE, NOV. 8–

10, 2001), fn. 11. 32S. 900, 106th Cong. (as placed on the Senate calendar, Apr. 28, 1999). 33S. Rep. 106–44 (Apr. 28, 1999), at 3. 34Saule T. Omarova, The Quiet Metamorphosis: How Derivatives Changed the ‘‘Business of 

Banking,’’ 63 U. MIAMI L. REV. 1041 (2009). 35 Citigroup, Order Approving Notice to Engage in Activities Complementary to a Financial 

Activity, 89 Fed. Res. Bull. 508 (2003) [Citigroup Order]. 

Curiously, both Goldman and J.P. Morgan were among the big banks and securities firms that strongly pushed for the passage of the ‘‘woofie’’ charter. The proposal, 

however, became a subject of intense political contention in Congress. In contrast 

to the House bill, the Senate version of the reform legislation did not contain 

‘‘woofie’’ provisions.32 In April 1999, however, Senator Phil Gramm introduced an 

amendment that effectively replicated the commodity grandfathering provision for 

‘‘woofies’’ in the House bill—but without any reference to ‘‘woofies.’’33 In the Conference, the entire subtitle of the House bill dealing with ‘‘woofies’’ was dropped. The 

Senate’s broader version of the commodity grandfathering clause, however, remained in the text of the GLBA and became the current Section 4(o) of the BHCA. 

Thus, an initially limited concession to financial institutions that were explicitly denied access to Federal deposit insurance became an open-ended exemption available 

to all newly registered FHCs fully backed by the Federal Government guarantees. 

To sum up, the GLBA created significant opportunities for U.S. banking organizations to play a much more direct and active role in purely commercial sectors of the 

economy. In the years following the passage of the GLBA, large U.S. FHCs have 

used these statutory provisions to enter and grow operations in physical commodity 

and energy markets. 

II. From the GLBA to the Global Financial Crisis: Physical Commodity 

Trading as ‘‘Complementary’’ to FHCs’ Financial Activities 

Even before the enactment of the GLBA, U.S. commercial banks and their affiliates had become actively involved in trading and dealing in financial derivatives—

publicly traded futures and various over-the-counter contracts—linked to the prices 

of commodities. Since the mid-1980s, the OCC has been aggressively interpreting 

the bank powers clause of the National Bank Act to include derivatives trading and 

dealing as part of the ‘‘business of banking.’’34 Similarly, under the BHCA, trading 

in commodity derivatives is generally treated as a financial activity that raises no 

controversial legal issues. Handling physical commodities, however, was a much different matter. Even physical settlement of permissible commodity derivatives—

which necessitated taking ownership, transporting, and storing actual crude oil or 

iron ore—presented a problem in light of the general principle of separating banking 

from commerce. FHCs seeking to engage in physical trades had to find a specific 

legal authority to do so. 

In the early 2000s, global commodities markets began experiencing an unprecedented price boom, which coincided with the increased push by large U.S. financial 

institutions to establish large-scale physical commodity trading operations. Between 

2003 and 2008, several large U.S. FHCs and foreign banks successfully obtained 

Board orders allowing them to trade physical commodities as an activity ‘‘complementary’’ to the financial activity of trading and dealing in commodity derivatives. 

In 2003, Citigroup became the first to receive Board approval of its physical commodities trading as a ‘‘complementary’’ activity.35 Under the Board’s order, 

Citigroup was allowed to purchase and sell oil, natural gas, agricultural products, 

and other nonfinancial commodities in the spot market and to take and make physical delivery of commodities to settle permissible commodity derivative transactions. 

The Board based its determination on four main considerations. First, the Board 

found that the proposed activities ‘‘flowed’’ from FHCs’ legitimate financial activities, essentially providing them with an alternative method of fulfilling their obligations under otherwise permissible derivatives transactions. Second, permitting these 

activities would make FHCs more competitive vis-a-vis other financial firms not 

subject to regulatory restrictions on physically settled derivatives transactions. 

Third, the proposed activities would enable FHCs to offer a full range of commodityrelated services to their clients in a more efficient manner. Finally, conducting physical commodity activities would enhance FHCs’ understanding of the commodity derivatives market. 

To minimize the safety and soundness risks that this type of commercial activity 

may pose, the Board imposed a number of conditions on Citigroup’s commodity-trading business. First, the market value of any commodities owned by Citigroup may 

42

36 In 2003, Citigroup reported its total consolidated Tier 1 capital of nearly $66.9 billion. See

Citigroup Inc., Form 10–K, Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, for the fiscal year ending on December 31, 2003, at 56. This puts the numerical limit for the market value of the physical commodities held by Citigroup for 2003 at slightly 

above $3.1 billion. 37 JPMorgan Chase & Co., 92 Fed. Res. Bull. C57 (2006). Bank of America and Wachovia received Board approvals to conduct physical commodities trading in 2006–07. 38The Royal Bank of Scotland Group plc, 94 Fed. Res. Bull. C60 (2008) [RBS Order]. 

not exceed 5 percent of its consolidated Tier 1 capital.36 This market value limitation is generally meant to ensure that physical commodity trading does not grow 

too big, at least in relative terms. Second, Citigroup may take or make delivery only 

of those commodities for which derivatives contracts have been approved for trading 

on U.S. futures exchanges by the Commodity Futures Trading Commission 

(‘‘CFTC’’), unless the Board specifically allows otherwise. This requirement was designed to prevent Citigroup from dealing in finished goods and other items, such as 

real estate, which lack the fungibility and liquidity of exchange-traded commodities. 

Third, the Board made clear that Citigroup must conduct its physical commodity 

trading business in compliance with the applicable securities, commodities, and energy laws. 

Finally, the Citigroup Order stated that the FHC was not authorized to (i) own, 

operate, or invest in facilities for the extraction, transportation, storage, or distribution of commodities; or (ii) process, refine, or otherwise alter commodities. The expectation was that Citigroup would use storage and transportation facilities owned 

and operated by unrelated third parties. The purpose of this important limitation 

is to minimize nonfinancial risks inherent in physical commodity trading: storage 

risk, transportation risk, and potentially serious environmental and legal risks associated with these activities. The Board relied on specific representations from 

Citigroup to the effect that it would exercise heightened care in avoiding these nonfinancial risks. Thus, Citigroup represented that it would require the owner of any 

vessel carrying oil on behalf of Citigroup to carry the maximum insurance for oil 

pollution available from a protection and indemnity club and to obtain a substantial 

amount of additional pollution insurance. Similarly, it promised to require all thirdparty storage facilities to carry a significant amount of oil pollution insurance from 

a creditworthy insurance company. Citigroup would also place age limitations on 

vessels and develop a comprehensive backup plan in the event any owner of a vessel 

or storage facility fails to respond adequately to an oil spill. 

In subsequent years, the Board granted similar orders authorizing physical commodity trading activities on the part of FHCs and foreign banks treated as FHCs 

for purposes of the BHCA. These grants of complementary powers allowed large 

non-U.S. banks—such as UBS, Barclays, Deutsche Bank, and Societe Generale—to 

expand their worldwide physical commodities businesses by adding U.S. operations, 

albeit on a limited scale. In 2005, JPMC also obtained an order permitting the FHC 

to engage in physical commodity trading activities as complementary to its booming 

financial derivatives business.37 In all of these cases, the Board imposed the same 

standard set of conditions and limitations originally articulated in the Citigroup 

Order. 

In 2008, The Royal Bank of Scotland (‘‘RBS’’), then the U.K.’s largest banking 

group, received the Board’s order authorizing a wide range of physical commodities 

and energy trading activities as complementary to RBS’s financial derivatives activities.38 RBS sought these expanded powers in connection with its acquisition of a 51 

percent equity stake in a joint venture with Sempra Energy, a U.S. utility group. 

The joint venture, RBS Sempra Commodities (‘‘RBS Sempra’’), was set up to conduct 

a worldwide business of trading in various physical commodities—including oil, natural gas, coal, and nonprecious metals—and be an active player in power markets 

in Europe and North America. 

In the RBS Order, the Board significantly relaxed the standard limitations and 

expanded the scope of permissible trading in physical commodities. Thus, the Board 

allowed RBS to take and make physical deliveries of nickel, even though nickel futures were not approved for trading on U.S. futures exchanges by the CFTC. The 

Board reasoned that contracts for nickel were actively traded on the London Metals 

Exchange (‘‘LME’’), a major non-U.S. exchange subject to regulation comparable to 

the regulation of the U.S. futures exchanges. The Board also authorized physical 

trading in a long list of physical commodities—including natural gasoline, asphalt, 

kerosene, and other oil products and petrochemicals—despite the fact that contracts 

for these commodities have not been approved for trading on any major exchange. 

In authorizing physical trading in these commodities, the Board relied on the fact 

that these commodities were fungible and that contracts for them were traded in 

43

39Fortis S.A./N.V., 94 Fed. Res. Bull. C20 (2008) [Fortis Order]; the RBS Order; Board Letter 

Regarding Fortis S.A/N.V. (May 21, 2008) [2008 Fortis Order]. 40The administrative tasks include, among other things, arranging for third parties to provide 

fuel transportation or power transmission services, coordinating fuel purchases and power sales, 

negotiating and monitoring contracts with the plant owner’s counterparties. 

sufficiently liquid over-the-counter markets (through individual brokers and on alternative trading platforms). 

The Board authorized RBS to hire third parties to refine, blend, or otherwise alter 

the commodities. In effect, this removed the ambiguity in previous orders by explicitly allowing RBS, for example, to sell crude oil to an oil refinery and then buy back 

the refined oil product. The Board determined that this activity essentially posed 

the same risks as hiring a third party to operate a storage or transportation facility, 

as permitted under previous orders. In addition, RBS made a specific commitment 

that it would not have exclusive rights to use the alteration facility. 

The Board also permitted RBS to enter into long-term electricity supply contracts 

with large industrial and commercial customers. The Board noted that, while most 

commodities traded by FHCs were limited to wholesale markets, electric power 

could much more easily reach small retail customers. To ensure that RBS remained 

a wholesale electric power intermediary dealing only with sophisticated customers, 

the RBS Order specified the minimum consumption levels for customers to whom 

RBS was allowed to sell electricity on a long-term basis. 

Finally, in the RBS Order and in two separate orders issued to a Belgian-Dutch 

bank, Fortis, the Board specifically approved so-called energy management and energy tolling services these institutions sought to perform in the United States.39

RBS and Fortis were authorized to provide certain energy management services—

consisting of transactional and advisory services—to owners of power generation facilities under Energy Management Agreements (‘‘EMA’’). FHC-permissible energy 

management services generally entail acting as an intermediary for a power plant 

owner to facilitate purchases of fuel and sales of power by the plant, as well as advising the owner on risk-management strategies. Thus, the energy manager—Fortis 

or RBS—would buy fuel for the plant from third parties and sell it to the plant in 

a mirror transaction. It would then purchase the power generated by the plant and 

resell it in the market. In effect, the energy manager would provide credit and liquidity support for the plant owner, including the posting of any required collateral 

for transactions. In addition, the manager also would assume responsibility for administrative tasks in connection with, and the hedging of exposure under, fuel and 

power transactions.40

These FHC-permissible energy management services, however, were subject to 

several conditions designed to limit the safety and soundness risks of such activities. 

Thus, the Board required that the revenues attributable to the FHC’s energy management services not exceed 5 percent of its total consolidated operating revenues. 

The Board also required that all EMAs, pursuant to which the FHC engages in 

these activities, include certain mandatory provisions. For example, the EMA must 

mandate that the plant owner approve all contracts for purchases of fuel and sales 

of electricity, although the owner may be allowed to grant a standing authorization 

to the manager to enter into contracts that meet certain owner-specified criteria. 

The owner must retain responsibility for the day-to-day maintenance and management of the power generation facility, including hiring employees to operate it. The 

owner must also retain the right to (i) market and sell power directly to third parties, although the manager may have the right of first refusal; and (ii) determine 

the facility’s power output level at any given time. In addition, the FHC is prohibited, directly or through its subsidiaries, from guaranteeing the financial performance of the power plant and from bearing any risk of loss if the plant is not profitable. 

Energy tolling is generally similar to energy management. Under these arrangements, an FHC (the ‘‘toller’’) makes fixed periodic (usually, monthly) ‘‘capacity payments’’ to the power plant owner, to compensate the owner for its fixed costs, in exchange for the right to all or part of the plant’s power output. The plant owner retains control over the day-to-day operation of the power plant. The toller pays for 

the fuel needed to produce the power it directs the owner to produce. The owner 

receives a marginal payment for each megawatt hour produced by the plant, as compensation for its variable costs plus a profit margin. 

The Board approved energy tolling as a complementary activity because it found 

it to be an ‘‘outgrowth’’ of the relevant FHC’s permissible commodity derivatives activities. The Board reasoned, in a familiar fashion, that permitting energy tolling 

would provide the FHC with valuable information on the energy markets, which 

44

41Morgan Stanley May Sell Part of Commods Unit: CNBC, REUTERS, June 6, 2012, Among 

non-U.S. financial institutions, only UK’s Barclays and Germany’s Deutsche Bank currently 

compete with Morgan Stanley, Goldman and JPMC in global commodity markets. 42 12 U.S.C. § 1843(a)(2). 43The Goldman Sachs Group, Inc., 2011 Form 10–K, at 1–4. The firm’s Institutional Client 

Services activities are organized by asset class and include both ‘‘cash’’ and ‘‘derivative’’ instruments. Cash instruments refer to trading in the assets underlying derivative contracts, such as 

‘‘a stock, bond or a barrel of oil.’’ Id. at 3. The firm’s annual report does not provide details on 

their physical commodity operations and simply lists commodity products FICC trades: ‘‘Oil and 

natural gas, base, precious and other metals, electricity, coal, agricultural and other commodity 

products.’’ The report states that FICC generally facilitates client transactions and makes markets in commodities. Id. at 115. 

would help it to manage its own commodity risk, and allow the FHC to compete 

more effectively with other financial firms not subject to the BHCA. 

These competitors, of course, were Goldman and Morgan Stanley, at the time 

independent investment banks. The recent financial crisis, however, brought both 

of these firms under the direct jurisdiction of the Board as new FHCs—and raised 

the potential salience of U.S. banking institutions’ commodity trading activities to 

a whole new level. 

III. The ‘‘Game-Changing’’ Impact of the Crisis: Morgan Stanley, Goldman 

Sachs, and JPMC 

One of the most profound and least appreciated consequences of the recent financial crisis is the emergence of a powerful trio of large FHCs with extensive physical 

commodities business operations: Morgan Stanley, Goldman, and JPMC. Two extraordinary crisis-driven phenomena led to this result: the emergency conversion of 

Morgan Stanley and Goldman into BHCs and the once-in-a-lifetime acquisition by 

JPMC of the commodity assets of two failing institutions, Bear Stearns and RBS. 

On September 21, 2008, Morgan Stanley and Goldman received approval to register as BHCs subject to the Board’s regulation and supervision, in a desperate effort to bolster investor confidence and avoid potential creditor runs on their assets. 

In the midst of the unfolding crisis, the Board approved these firms’ applications 

to become BHCs almost literally overnight, without putting them through its normal, lengthy and detailed review process. It is highly unlikely that, at the time of 

the conversion, the Board focused on these firms’ extensive physical commodities assets and activities—or gave full consideration to the question of how to deal with 

such activities in the long run. 

JPMC followed a different route to the top of the Wall Street commodities game. 

In 2008, the firm acquired the physical commodity trading assets of failing Bear 

Stearns. In 2009–2010, JPMC bought the global commodities business of nationalized RBS. In a few short years, the firm’s aggressive growth strategy transformed 

it into one of the three biggest U.S. banking organizations dominating global commodity markets.41

Thus, in the wake of the financial crisis, the Board finds itself facing a qualitatively different commodities business conducted by three of the largest U.S. banking organizations. Under the BHCA, a newly registered BHC has up to 5 years from 

the registration date either to divest its impermissible nonbanking activities or to 

bring such activities into compliance with BHCA requirements.42 The statutory 5-

year grace period for the nonconforming commodity activities of Goldman and Morgan Stanley ends in the fall of 2013, at which point the Board must make a potentially fateful decision whether these firms will be able to continue—and further expand—their commodity and energy merchant businesses. This decision requires a 

thorough understanding of the nature and scope of these institutions’ actual involvement in physical commodities and energy markets. 

A. The Informational Gap 

Crucially, however, there is no meaningful public disclosure of banking organizations’ assets and activities related to physical commodities and energy. Hence, it is 

important to preface discussion of what is at stake in the Board’s coming decision 

with a note on the scarcity of information available to those who might wish to 

weigh in, including Congress. 

Three difficulties explain why the American public does not yet have a full picture 

of what is happening in this space. The first difficulty is that publicly traded financial institutions—including all of the largest FHCs—typically report their assets, 

revenues, profits, and other financial information for the entire business segment, 

of which commodities trading is only a part. For instance, Goldman includes commodities in its Fixed Income, Currencies and Commodities division, which is included in the firm’s Institutional Client Services business segment.43 The same is 

45

44Morgan Stanley, 2011 Form 10–K, at 2–3. According to the company’s description of its activities, The Company invests and makes markets in the spot, forward, physical derivatives and 

futures markets in several commodities, including metals (base and precious), agricultural products, crude oil, oil products, natural gas, electric power, emission credits, coal, freight, liquefied 

natural gas and related products and indices. The Company is a market-maker in exchangetraded options and futures and OTC options and swaps on commodities, and offers 

counterparties hedging programs relating to production, consumption, reserve/inventory management and structured transactions, including energy-contract securitizations and monetization. The Company is an electricity power marketer in the United States and owns electricitygenerating facilities in the United States and Europe. 45See ‘‘Consolidated Financial Statements for Bank Holding Companies—FR Y–9C,’’ Schedule 

HC–D (‘‘Trading Assets and Liabilities’’), Item M.9.a.(2) (the ‘‘Gross Fair Value of Physical Commodities held in Inventory’’). Form FR Y–9C is a quarterly report filed with the Board by BHCs 

with total consolidated assets of $500 million or more. 12 U.S.C. § 1844; 12 C.F.R. § 225.5(b). 46 JPMC, FR Y–9C, March 31, 2009, Schedule HC–D, Item M.9.a.(2). 47 JPMC, FR Y–9C, September 30, 2009, Schedule HC–D, Item M.9.a.(2). 48 JPMC, FR Y–9C, December 31, 2009, Schedule HC–D, Item M.9.a.(2). 49 JPMC, FR Y–9C, December 31, 2010, Schedule HC–D, Item M.9.a.(2). 50 JPMC, FR Y–9C, December 31, 2011, Schedule HC–D, Item M.9.a.(2). 51 JPMC, FR Y–9C, March 31, 2012, Schedule HC–D, Item M.9.a.(2). 52 JPMC, FR Y–9C, December 31, 2012, Schedule HC–D, Item M.9.a.(2). 53Morgan Stanley, FR Y–9C, March 31, 2009, Schedule HC–D, Item M.9.a.(2). 54Morgan Stanley, FR Y–9C, September 30, 2011, Schedule HC–D, Item M.9.a.(2). 55Morgan Stanley, FR Y–9C, March 31, 2012, Schedule HC–D, Item M.9.a.(2). 56Morgan Stanley, FR Y–9C, December 31, 2012, Schedule HC–D, Item M.9.a.(2). 57Goldman Sachs Group, FR Y–9C, March 31, 2009, Schedule HC–D, Item M.9.a.(2). 58Goldman Sachs Group, FR Y–9C, June 30, 2009, Schedule HC–D, Item M.9.a.(2). 

true of Morgan Stanley, which includes commodities operations in its Fixed Income 

and Commodities division within the Institutional Securities business segment.44

Neither firm provides full financial information attributable specifically to its commodities divisions. 

The second difficulty is that, to the extent FHCs include in their regulatory filings 

financial information specific to their commodities operations, such information usually pertains to both commodity-linked derivatives operations and trading in physical commodities. As a result, most financial information reported under the ‘‘commodities’’ rubric relates to the derivatives business, leaving one to guess what is 

going on in the firms’ physical commodities businesses. Because of this reporting 

pattern, industry analysts’ estimates of the revenues or profits generated by large 

FHCs’ commodities trading desks often include the estimated revenues and profits 

from purely financial transactions in commodity derivatives. More broadly, this disclosure format tends to de-emphasize—and thus make even less visible—the fact 

that financial institutions often act not only as dealers in purely financial risk but 

also as traditional commodity merchants. 

Currently, large FHCs are required to report to the Board, on a quarterly basis, 

only one financial metric directly related to their physical commodities operations: 

the gross market value of physical commodities in their trading inventory.45 These 

mandatorily reported data provide a hint of the potential scale of these activities. 

For instance, a look at this line item in JPMC’s filings reveals a significant growth 

in the market value of physical commodities the company holds for trading purposes. Thus, as of March 31, 2009, JPMC reported the gross fair value of physical 

commodities in its inventory as a relatively modest $3.7 billion.46 By September 30, 

2009, the amount had doubled to $7.9 billion.47 By the end of 2009, the number had 

further increased to slightly over $10 billion.48 At the end of 2010, the reported 

amount reached above $21 billion.49 As of December 31, 2011, JPMC reported the 

gross fair value of physical commodities in its inventory at approximately $26 billion.50 As of March 31, 2012, the gross fair value of physical commodities in JPMC’s 

inventory had slightly decreased to $17.2 billion.51 At the end of 2012, that number 

was $16.2 billion.52

Morgan Stanley’s regulatory filings show that, as of March 31, 2009, the gross fair 

value of physical commodities it held in inventory was slightly below $2.5 billion.53

The reported value of this line item in Morgan Stanley’s reports rapidly increased 

to $10.3 billion as of September 30, 2011,54 before going slightly down to approximately $9.6 billion as of March 31, 2012.55 At the end of 2012, the gross fair value 

of physical commodities in Morgan Stanley’s inventory was about $7.3 billion.56

Goldman’s filings show more fluctuations in the gross fair value of physical commodities in the firm’s inventory during the same 3-year period. Thus, as of March 

31, 2009, Goldman reported $1.2 billion in this line item.57 At the end of the next 

quarter, the number fell to $682 million.58 It peaked at the end of 2010 at over $13 

46

59Goldman Sachs Group, FR Y–9C, December 31, 2010, Schedule HC–D, Item M.9.a.(2). 60Goldman Sachs Group, FR Y–9C, March 31, 2012, Schedule HC–D, Item M.9.a.(2). 61Goldman Sachs Group, FR Y–9C, December 31, 2012, Schedule HC–D, Item M.9.a.(2). 62Similarly, the VaR data included in FHCs’ SEC filings provide a measure of their exposure 

to commodity price risk. 63There may be ways to collect some information on FHCs’ physical commodities activities 

from a wide variety of diverse sources, including statistical records maintained by the Department of Energy (‘‘DOE’’), FERC, or other nonfinancial regulators. However, theoretical availability of these disparate data does not cure the fundamental informational deficiency in this 

area. Even if it can be located, with significant effort, such amalgamation of data is not likely 

to create a complete and reliable picture of large FHCs’ commodity operations and assets. 64This is especially true of oil and gas markets. Currently, the markets for trading crude oil 

and oil products are dominated by three groups of players: major oil companies (Royal Dutch 

Shell, Total, and British Petroleum), independent commodity trading houses (Vitol, Gunvor, 

Glencore, Trafigura, and Mercuria), and financial institutions (Morgan Stanley, Goldman). See,

LITASCO SA, International Oil Markets Market and Oil Trading (Sept. 19, 2008), http://

www.litasco.com/llibrary/pdf/sociallacts/internationalloillmarketlandloilltrading.pdf.

Although these three types of oil traders have significantly different business structures and 

profiles, they have been converging in some important respects. Thus, the trading arms of oil 

majors and commodity trading houses have been developing active financial derivatives trading 

and dealing capabilities to supplement their traditional operations in physical markets. Recent 

media reports indicate that independent commodity trading companies have also been acquiring 

both upstream (oil production) assets and downstream (refining and processing) assets. Javier 

Blas, Trading houses: Veil slowly lifts on a secretive profession, FIN. TIMES, May 23, 2011; 

Javier Blas, Commodities traders face growing pains, FIN. TIMES, Apr. 26, 2012. It is nearly 

impossible, however, to ascertain how big or important financial institutions’ physical oil and 

gas trading operations are vis-a-vis the other two groups, in large part because that would require access to potentially sensitive nonpublic information on the oil companies’ and trading 

houses’ operations and activities. In an informal interview with the author, a professional oil 

industry consultant who wished to remain anonymous claimed that even a rough estimate would 

require a lot of sophisticated and prohibitively expensive investigative work not dissimilar to 

industrial espionage. 

billion.59 As of March 31, 2012, Goldman reported the gross fair value of its physical 

commodities inventory at $9.5 billion.60 At the end of 2012, Goldman’s number rose 

to $11.7 billion.61

As issuers of publicly traded securities, FHCs include the same data in their quarterly reports filed with the SEC. The gross market value of FHCs’ physical commodity trading inventory, however, measures solely their current exposure to commodity price risk.62 It does not provide a full picture of these organizations’ actual 

involvement in the business of producing, extracting, processing, transporting, or 

storing physical commodities. To a great extent, this nearly exclusive regulatory 

focus on commodity price risk reflects the underlying assumption that U.S. banking 

organizations do not conduct any commodity-related activities that could potentially 

pose any additional risks to their safety and soundness or create systemic 

vulnerabilities. If one assumes that banking organizations act only as arms’ length 

buyers and sellers of physical commodities, strictly for the purpose of providing financial risk management services to their clients, then it is logical to conclude that 

sudden price fluctuations in commodity markets are the main source of potential 

risk from such activities. In the absence of detailed information on U.S. banking organizations’ actual commodities assets and operations, however, this assumption becomes dangerously unreliable.63

Gaps in the current system of public disclosure and regulatory reporting explain 

the near-absence of reliable, detailed data on the precise nature and full scope of 

U.S. banking organizations’ physical commodity operations. The traditional lack of 

transparency in global commodity markets and the inherently secretive nature of 

the commodity trading industry create a third source of difficulties for understanding what exactly U.S. FHCs do, and how significant their role is, in these markets. A handful of large, mostly Switzerland-based commodities trading houses—including Glencore, Vitol, Trafigura, Mercuria, and Gunvor—dominate the global 

trade in oil and gas, petroleum products, coal, metals, and other products. Nearly 

all of these publicity-shy commodities trading firms are privately owned. They do 

not publicly report results of their financial operations and generally refrain from 

disclosing information about the structure or performance of their investments. Secrecy has always been an important attribute of the traditional commodities trading 

business, in which access to information is vital to commercial success and having 

informational advantage often translates into windfall profits. Given this lack of 

transparency and secretive nature of the commodities trading business, it is nearly 

impossible for an industry outsider—and even for most insiders—to gauge accurately the relative size and importance of U.S. FHCs as traders and dealers in the 

global markets for physical commodities.64

47

65Morgan Stanley May Sell Part of Commods Unit: CNBC, REUTERS, June 6, 2012. 66Matthew Robinson & Scott DiSavino, Deal or no deal,Morgan Stanley commodity trade 

shrinks, REUTERS, Jun. 7. 2012. 67 Id. 68http://www.heidmar.com/what-we-do/. 69http://www.transmontaigne.com/about-tmg/. 70http://www.transmontaigne.com/about-tmg/. TransMontaigne is the general partner of 

TransMontaigne Partners L.P., a publicly traded Delaware limited partnership. 71 CNN Money, Fortune 500 Rankings 2006, http://money.cnn.com/magazines/fortune/

fortune500/snapshots/1452.html. 72http://www.forbes.com/lists/2011/21/private-companies-11lTransMontaignel7I0O.html.

The estimate excludes the revenues generated by the company’s publicly traded subsidiaries. 

With these information-related caveats in mind, it is nevertheless possible to piece 

together enough data to get a sense of the potential significance of Goldman’s, Morgan Stanley’s, and JPMC’s physical commodities businesses. 

B. Morgan Stanley: Oil, Tankers, and Pipelines 

During the years preceding the latest financial crisis, Morgan Stanley built a significant business trading in oil, gas, electric power, metals, and other commodity 

products. According to industry estimates, Morgan Stanley’s commodities unit generated $17 billion in revenue over the past decade, trading both financial contracts 

and physical commodities.65 Unlike Goldman, Morgan Stanley ‘‘has remained resolutely a merchant-trader, focusing on the business of storing or transporting raw 

materials.’’66 According to a 2008 research report, traditional client ‘‘flow’’ business—market-making, selling indices to investors, and commodity risk hedging—

constituted only about 10–15 percent of the firm’s commodities activities.67 About 

half of Morgan Stanley’s commodities business is reportedly in crude oil and oil 

products, while about 40 percent is in power and gas. 

Morgan Stanley has been using physical assets in trading energy and commodities 

since the mid-1980s. In the early 1990s, Morgan Stanley’s oil trader, Olav Refvik, 

struck deals to buy and deliver oil and oil products to large commercial users 

around the globe and earned the nickname ‘‘King of New York Harbor’’ for accumulating a record number of leases on storage tanks at the key import hub, which gave 

the firm a great market advantage. During the same period, Morgan Stanley constructed power plants in Georgia, Alabama and Nevada, which allowed it to become 

a major electricity seller. 

In the mid-2000s, Morgan Stanley began aggressively expanding its energy infrastructure investments, especially in oil and gas transportation and logistics. In 

2006, Morgan Stanley acquired full ownership of Heidmar Inc., a Connecticut-based 

global operator of commercial oil tankers. Although Morgan Stanley sold 51 percent 

of equity in 2008, it still retained a 49 percent stake. Heidmar operates a fleet of 

more than 100 double-hull vessels and provides transportation and logistics services 

to major oil companies around the world.68

In September 2006, Morgan Stanley acquired, in a leveraged buyout, the full ownership of TransMontaigne Inc., a Denver-based oil-products transportation and distribution company. TransMontaigne markets ‘‘unbranded gasoline, diesel fuel, heating oil, marine fuels, jet fuels, crude oil, residual fuel oils, asphalt, chemicals and 

fertilizers.’’69 The company is affiliated with a fuel terminal facility operator, 

TransMontaigne Partners L.P., which operates oil terminals in several U.S. States 

and Canada.70 In 2005, the last year TransMontaigne was a publicly listed company, it reported revenues of about $8.6 billion and assets of slightly less than $1.2 

billion.71 Forbes estimated the company’s 2011 revenues at $12 billion.72

Both Heidmar and TransMontaigne are subsidiaries of Morgan Stanley Capital 

Group Inc. (‘‘MS Capital Group’’), Morgan Stanley’s commodities and energy trading 

arm through which it holds equity stakes in multiple commodity businesses. According to Morgan Stanley’s own description of its physical commodities business activities in its SEC filings:

In connection with the commodities activities in our Institutional Securities 

business segment, we engage in the production, storage, transportation, 

marketing and trading of several commodities, including metals (base and 

precious), agricultural products, crude oil, oil products, natural gas, electric 

power, emission credits, coal, freight, liquefied natural gas and related 

products and indices. In addition, we are an electricity power marketer in 

the United States and own electricity generating facilities in the United 

States and Europe; we own TransMontaigne Inc. and its subsidiaries, a 

group of companies operating in the refined petroleum products marketing 

and distribution business; and we own a minority interest in Heidmar 

48

73Morgan Stanley, Form 10–K, Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, for the fiscal year ending on December 31, 2011, at 27. 74TransMontaigne Partners L.P., Form 10–K, Annual Report pursuant to Section 13 or 15(d) 

of the Securities Exchange Act of 1934, for the fiscal year ending on December 31, 2011. 75http://sec.gov/Archives/edgar/data/1319229/000104746912005319/a2208753z10-

ka.htm#aa3, at 73. 76 Id. 77 According to Morgan Stanley’s own description of the risk factors specific to its physical 

commodities business in its annual report:

As a result of these activities, we are subject to extensive and evolving energy, commodities, 

environmental, health and safety and other governmental laws and regulations. In addition, liability may be incurred without regard to fault under certain environmental laws and regulations for the remediation of contaminated areas. Further, through these activities we are exposed to regulatory, physical and certain indirect risks associated with climate change. Our commodities business also exposes us to the risk of unforeseen and catastrophic events, including 

natural disasters, leaks, spills, explosions, release of toxic substances, fires, accidents on land 

and at sea, wars, and terrorist attacks that could result in personal injuries, loss of life, property 

damage, and suspension of operations.

Morgan Stanley, Form 10–K, December 31, 2011, at 27. 

Holdings LLC, which owns a group of companies that provide international 

marine transportation and U.S. marine logistics services.73

The SEC filings of TransMontaigne Partners, the only publicly traded subsidiary of 

MS Capital Group and TransMontaigne, provide a fascinatingly detailed picture of 

one significant facet of Morgan Stanley’s physical commodities business: ‘‘oil 

terminaling and transportation.’’74 TransMontaigne Partners owns and operates a 

vast infrastructure, including numerous crude oil and refined products pipelines and 

terminals along the Gulf Coast, in the Midwest, in Texas, along the Mississippi and 

Ohio Rivers, and in the Southeast. The company receives refined oil products and 

liquefied natural gas from customers via marine vessels, ground transportation, or 

pipelines; stores customers’ products in its tanks located at the terminals; monitors 

the volume of stored products in its tanks; provides product heating and mixing 

services; and transports the refined products out of its terminals for further distribution. 

In 2011, TransMontaigne Partners earned over $152 million in revenues, of which 

almost $107 million came from its affiliates.75 The company’s primary customers are 

its indirect parent-entities, MS Capital Group and TransMontaigne. This is how the 

company described the business activities of MS Capital Group: 

Morgan Stanley Capital Group is a leading global commodity trader involved in proprietary and counterparty-driven trading in numerous commodities markets including crude oil and refined products, natural gas and 

natural gas liquids, coal, electric power, base and precious metals and others. Morgan Stanley Capital Group has been actively trading crude oil and 

refined products for over 20 years and on a daily basis trades millions of 

barrels of physical crude oil and refined products and exchange-traded and 

over-the-counter crude oil and refined product derivative instruments. Morgan Stanley Capital Group also invests as principal in acquisitions that 

complement Morgan Stanley’s commodity trading activities. Morgan Stanley Capital Group has substantial strategic long-term storage capacity located on all three coasts of the United States, in Northwest Europe and 

Asia.76

TransMontaigne Partners’ SEC filings offer a rare glimpse into Morgan Stanley’s 

sprawling network of assets and activities in the energy sector. Ownership of critical 

infrastructure assets—including terminals, pipelines, and marine vessels—greatly 

facilitates Morgan Stanley’s trading of energy and commodities, in both physical and 

derivatives markets. At the same time, such a direct and active involvement in the 

business of oil and gas processing, storage, and transportation creates significant 

risks for Morgan Stanley. Global energy prices are notoriously volatile and depend 

on a complex interplay of various factors, including geopolitical ones. More importantly, however, these activities expose the firm to potential legal liability, financial 

loss, and reputational damage in the event of industrial accidents, oil spills, explosions, terrorist acts, or other catastrophic events that cause serious environmental 

harms.77 It is difficult to quantify the extent of this risk, especially in the case of 

potential large-scale environmental disaster, but it is not difficult to imagine that 

it may be potentially fatal even for a large company with a formidable balance 

sheet. For a financial institution whose main business depends greatly on its reputation and market perceptions of the quality of its credit, even a remote risk of 

such an event may be too much to live with. 

49

78 Jack Farchy, Goldman and Clive Capital to launch commods index, FIN. TIMES, June 12, 

2011. 79 Javier Blas, Commodities Trading Loses its Goldman Queen, FIN. TIMES, Jan. 12, 2012. 80J. Aron & Co. Reduces Staff, N.Y. TIMES, Aug. 19, 1983. 81 Ann Davis, Morgan Stanley Trades Energy Old-Fashioned Way: In Barrels, WALL ST. J., 

Mar. 2, 2005. 82 Ryan Dezember, Carlyle to Acquire Cogentrix from Goldman, WALL ST. J., Sept. 7, 2012. 

According to media, ‘‘Goldman sold off most of those plants—and built and sold others—during 

the last decade as Cogentrix transformed into more of a developer of power plants.’’ Id. In September 2012, Goldman reportedly agreed to sell Cogentrix to a private equity firm, Carlyle 

Group L.P., on undisclosed terms. 83Kinder Morgan, Inc., 2011 Form 10–K, at 5. In investing in KMI, Goldman teamed up with 

two private equity partners, The Carlyle Group (‘‘Carlyle’’) and Riverstone Holdings LLC 

(‘‘Riverstone’’). Id. 84 Id., at 121–22. 85 It is difficult to ascertain whether and to what extent this ownership structure and board 

membership give Goldman effective control over KMI’s management and operations. It appears 

that, for regulatory purposes, Goldman treats its investment in KMI as a merchant banking investment permissible to FHCs under the BHCA. In the context of Goldman’s overall commodities trading business, however, one may legitimately question whether Goldman’s stake in KMI 

is truly a passive, purely financial investment made solely for the purpose of reselling it at a 

profit. 86 According to the 2011 SEC filings, Goldman held a common equity stake in CIE through 

several controlled funds, and two of its managing directors in the merchant banking division 

served on CIE’s board. The firm originally invested in CIE in partnership with Carlyle and 

Riverstone. Cobalt International Energy Inc., 2011 Form 10–K, at 5; Cobalt International Energy Inc., Schedule 14A, Proxy Statement (filed on Mar. 22, 2012), at 10–17. 87 Joe Leahy, Goldman in Deal to Buy Vale’s Coal Assets, FIN. TIMES, May 28, 2012. 

C. Goldman Sachs: Metals, Warehouses, and Other Things 

Wall Street’s biggest commodities dealer by revenues, Goldman is ‘‘credited with 

attracting the investors to the asset class with the creation of the Goldman Commodity Index in 1991.’’78 According to industry estimates, the firm’s commodities 

business—including derivatives and physical trading—generated annual revenues of 

$3–4 billion between 2006 and 2008.79

Goldman’s commodities trading business goes back at least to 1981, when the firm 

bought its principal commodities trading subsidiary, J. Aron & Co., which at the 

time specialized mostly in trading futures and options on precious metals and coffee.80 In the 1980s–90s, Goldman focused primarily on client-driven financial transactions in commodities and built a dominant position in the energy futures and OTC 

derivatives markets. In the first decade of this century, however, Goldman has also 

been expanding into physical commodities, with ventures into coal and shipping 

trading. For example, in early 2005, the press reported that Goldman had bought 

30 electricity-generating plants.81 At least in part, this may have been a reference 

to Goldman’s 2003 acquisition of Cogentrix Energy LLC, a major power producer 

based in Charlotte, North Carolina. At the time, Cogentrix owned and operated 26 

coal- and natural gas-fired power plants.82

During the same period, Goldman reportedly made significant acquisitions in the 

oil and gas sector, including a significant stake in Kinder Morgan, Inc. (‘‘KMI’’), a 

major oil transportation and terminaling company that controls approximately 

37,000 miles of pipelines and 180 terminals handling crude oil, natural gas, and refined petroleum products.83 According to KMI’s SEC filings, at the end of 2011, 

Goldman owned (through several controlled funds) 19.1 percent of the company’s 

common stock.84 In addition, the report listed each of the two managing directors 

of Goldman who also served on KMI’s board of directors as holders of 19.1 percent 

of the company’s common stock.85 It appears that Goldman has similarly structured 

private equity investments in other energy companies, including Cobalt International Energy Inc. (‘‘CIE’’), a Houston-based deep-water oil exploration and production company.86

Even after becoming an FHC subject to the activities restrictions of the BHCA 

and the consolidated supervision by the Board, Goldman continued to acquire significant hard assets in the commodities sector. For instance, in May 2012, the Financial Times reported that Goldman made a $407 million deal with Brazil’s Vale, 

to acquire full ownership of Vale’s Colombian coal assets, including the El Hatillo 

coal mine, Cerro Largo coal deposit, and a coal port facility on Colombia’s Atlantic 

coast. The deal also included an 8.43 percent equity stake in the railway connecting 

the mines to the port.87

Goldman’s subsidiary, GS Power Holdings LLC, holds another prized asset in 

Goldman’s commodities empire: Metro International Trade Services LLC (‘‘Metro’’). 

Metro is a metals warehousing company that owns and operates nineteen warehouses in the Detroit metropolitan area, as well as warehousing facilities in Europe 

50

88Glencore, bought metals warehousing assets of Italy based Pacorini Group, while JPMC acquired the UK-based Henry Bath as part of its purchase of RBS Sempra’s assets. See Tatyana 

Shumski & Andrea Hotter, Wall Street Gets Eyed in Metal Squeeze, WALL ST. J., June 17, 

2011. 89 Id. 90 Jack Farchy, Banks force aluminium market shake-up, FIN. TIMES, Sept. 12, 2012 (‘‘The 

arrival of investment banks in the aluminum market has triggered a shake-up in the $100bn 

industry that is forcing producers from Alcoa to Rusal and consumers such as BMW and CocaCola to change the way they do business. The increasingly dominant role of banks including 

Goldman, JPMorgan and Deutsche Bank—as well as traders such as Glencore—has prompted 

a surge to record levels in the premium consumers pay for metal over the benchmark price set 

at the London Metal Exchange.’’). 91The LME rules set the minimum delivery rates for its warehouses. If the demand for delivery of aluminum out of a particular warehouse significantly exceeds the rate at which the 

warehousing company actually releases it, the resulting bottleneck prevents the industrial users 

of aluminum from getting their purchased metal. 92Financial institutions like Goldman Sachs can also use their warehouses to store vast quantities of physical metals in so-called ‘‘financing’’ deals. This strategy allows financial institutions 

to secure a guaranteed return. Removing a large portion of physical metal from the market, 

however, creates artificial shortages of aluminum for commercial purchase and inflates its market price. 93Pratima Desai, Clare Baldwin, Goldman’s New Money Machine: Warehouses,reuters.com,

Jul. 29, 2011 (stating that, in the first 6 months of 2011, ‘‘Metro warehouses in Detroit took 

in 364,175 tonnes of aluminum and delivered out 171,350 tonnes,’’ which ‘‘represented 42 percent of inventory arrivals globally and 26 percent of the metal delivered out.’’). 94Trefis Team, Metals Warehousing Pays Off for Goldman Sachs, FORBES, July 8, 2011 

(‘‘Goldman charges 42 cents to store a metric ton of aluminum in its facilities for a day, which 

translates into $150 in annual revenues for every metric ton it stores. With millions of tons in 

storage, the industry is expected to rake in $1 billion in storage revenues each year. Goldman 

Sachs which is estimated to hold 900,000 tons in its facilities can make $138 million in revenues 

from its storage business alone.’’). 95Laura Clarke & Matt Day, New Stab at Metals Gridlock, WALL ST. J., July 2, 2013, C1. 

and Asia. By acquiring Metro in February 2010, Goldman gained control of one of 

the largest metals warehouses in the global network of storage facilities approved 

by the LME. This acquisition strategically positioned the firm in the middle of the 

global metals trading chain. Storing large quantities of metal generates lucrative 

rental income for warehousing companies like Metro. The warehousing business is 

particularly profitable during economic downturns when slackening demand forces 

producers to hold more of their commodity inventories in storage. Not surprisingly, 

Goldman was not the only commodity trader that rushed to acquire large LME-approved warehouses in the wake of the global financial crisis.88 The recent entry of 

financial institutions effectively turned this traditionally low-profile industry run by 

dispersed independent operators into yet ‘‘another arm of Wall Street.’’89

This transformation has caused serious turbulence in the global market for aluminum, the second most widely used metal in the world after steel.90 Aluminum 

producers store their metal in LME-approved warehouses and then sell their metal 

to industrial users. The buyers claim their purchased quantities of aluminum from 

the warehouse, which must deliver it to the specific buyer.91 Ownership of the key 

LME warehouses by large commodity traders with integrated financial and physical 

metals operations allows them to control the supply of aluminum to commercial 

users and, as a result, to control prices.92 This led other market participants to 

worry about unfair advantage for such firms, as they now can use their knowledge 

of how much metal is stored, as well as their ability to control delivery of physical 

metal to consumers, to determine their own trading strategies. 

Goldman and its subsidiary Metro became the key figures in a recent ugly battle 

over global aluminum prices. In mid-2011, Metro reportedly stored nearly half of the 

global inventories of the industrial aluminum.93 Months-long delivery delays at the 

firm’s storage facilities in Detroit caused much discontent among big commercial 

users of aluminum, such as the soft-drink giant Coca-Cola and the aluminum sheetmaker Novelis. In mid-2011, Coca-Cola filed a complaint with the LME alleging that 

Goldman intentionally limited the releases of aluminum from its Metro-operated 

warehouses in order to inflate the price of aluminum. In addition to potentially enabling Goldman to sell its own aluminum at artificially inflated prices, holding aluminum in the warehouse generates additional fees for Metro, as the buyers have 

to pay for each day their purchased metal stays in the warehouse.94

In response to these complaints, the LME doubled the minimum delivery rates 

for large warehouses, including Metro. Nevertheless, warehousing bottlenecks and 

record-high aluminum premiums continued to wreak havoc in global aluminum 

markets. By mid-2013, the reported waiting time for aluminum in Detroit was 

longer than 460 days.95 In July 2013, the LME’s new leadership proposed another 

51

96 Jack Farchy, LME takes aim at warehousing queues, FIN. TIMES, July 1, 2013. 97Sambit Mohanty, JPMorgan to Start Physical Oil Trade; Eyes $200 Oil, REUTERS, May 

15, 2008. 98 JPMorgan Chase & Co., 2011 Form 10–K, at 184. 99Gregory Meyer, JPMorgan buys RBS Sempra Commodities’ trading book, FIN. TIMES, Oct. 

7, 2010 (‘‘In the second quarter [of 2010], RBS Sempra ranked the fifth-largest North American 

gas marketer by volume, after BP, Royal Dutch Shell, Conoco-Phillips and Macquarie, According 

to Platt’s. JPMorgan was 12th.’’). 100 J.P.Morgan, Energy Risk Names J.P.Morgan ‘‘Oil &Products House of the Year’’ (Jul. 1, 

2011), available at http://www.jpmorgan.com/cm/cs?pagename=JPMlredesign/

JPMlContentlC/GenericlDetaillPagelTemplate&cid=1309472621690&c=JPMlContent

lC.

101http://www.jpmorgan.com/pages/jpmorgan/investbk/solutions/commodities/energy.

change to its rules to require warehouses experiencing logjams to deliver out more 

metal than they take in.96 The new rule, however, is expected to become effective 

only starting in April 2014. 

D. JPMC: The New ‘‘Whale?’’

Unlike Morgan Stanley and Goldman, JPMC has always been a regulated BHC 

subject to activity restrictions. As discussed above, in 2005, JPMC received the 

Board’s approval to trade physical commodities as an activity ‘‘complementary’’ to 

its commodity derivatives business. Under the terms of the Board’s approval, however, JPMC did not have legal authority to own, operate, or invest in any physical 

assets and facilities for the extraction, transportation, processing, storage, or distribution of commodities. 

The financial crisis became the key turning point for JPMC, which emerged from 

it significantly larger and even more systemically important than before the crisis. 

In 2008, JPMC bought the key assets of Bear Stearns, an independent investment 

bank on the verge of failure. As part of the deal, JPMC acquired commodity trading 

assets and operations, including a significant network of electric power generating 

facilities owned by Arroyo Energy Investors L.P., a commodities subsidiary of Bear 

Stearns. 

After acquiring Bear’s energy assets, JPMC’s CEO Jamie Dimon and the head of 

commodities operations Blythe Masters began aggressively expanding the firm’s 

physical commodities business. In 2008, the firm started trading physical oil and 

looking at ‘‘more ways to boost its presence in energy markets.’’97 In addition to hiring more people in its commodities and energy trading and investment team, JPMC 

started drawing plans for strategically expanding its metals and energy operations 

in Asia. 

JPMC’s once-in-a-lifetime chance to become a major player in commodities came 

in late 2009, when the European Commission ordered nationalized RBS to divest 

its riskier assets, including its 51 percent stake in RBS Sempra, a large U.S. commodities and energy trading company. In July 2010, JPMC bought RBS Sempra’s 

global oil, global metals and European power and gas businesses. In addition to 

bringing in approximately $1.7 billion of net assets, the $1.6 billion acquisition nearly doubled the number of clients of JPMC’s commodities business and enabled the 

firm ‘‘to offer clients more products in more regions of the world.’’98

In November 2010, JPMC also bought RBS Sempra’s North American power and 

gas business, which added further strength to the operations the firm inherited from 

Bear Stearns. This purchase propelled JPMC into the top tier of natural gas and 

power marketers in North America.99 Several months after closing the deal, the 

firm boasted having control of ‘‘a diverse network of physical assets, including 70 

billion cubic feet per day of storage capacity—an increase of almost 100 percent 

since the purchase—and almost double the transport capacity it had had previously.’’100

By late 2010, JPMC had emerged as a formidable contender for the title of the 

dominant Wall Street energy and commodities trading house, previously shared by 

Morgan Stanley and Goldman. JPMC’s official Web site describes the firm as one 

of the leading energy market-makers in the world:

We are active in both the physical and financial markets worldwide for 

crude oil and oil-refined products, coal, power and gas, and have extensive 

capabilities in the voluntary and mandatory emissions markets. [ . . . ]. 

Our geographically diverse physical asset portfolio includes more than 40 

North American locations. In addition, we are one of the largest natural gas 

traders in the U.K. and European markets, with daily volumes of approximately 100 million therms.101

52

102Mike Jackson, Henry Bath & Son: A Company and family History (2010), available at 

http://www.henrybath.com/assets/lfiles/documents/junl11/HENRYBATHl1308588481l CompletelHenrylBathlHistory.pdf. 103 Jack Farchy, Copper ETF would ‘‘wreak havoc,’’ FIN. TIMES, May 23, 2012. The SEC approved JPMC’s plan to market its copper-backed ETF in December 2012. See http://

www.sec.gov/rules/sro/nysearca/2012/34-68440.pdf. 104Louise Armitstead & Rowena Mason, JPMorgan as mystery trader that bought £1-bn-worth 

of copper on LME, TELEGRAPH, Dec. 4, 2010. In April 2012, JPMC reportedly held 30–40 percent of total copper positions on the LME. CESCO week: Glencore, JPMorgan hold dominant 

copper position as back flares—sources, METALBULLETIN.COM, Apr. 18, 2012. 105 JPMC, 2011 10–K, Note 30, at 289. This probably reflects the general practice among 

FHCs engaged in physical commodity trading under the Board’s ‘‘complementary’’ orders. To 

avoid legally owning or operating any physical assets involved in the marketing chain, JPMC 

probably enters into some form of a sale-and-lease-back contract, whereby an unaffiliated third 

party is the legal owner of the physical facilities and operates those facilities under a lease 

agreement with JPMC. 

In addition to oil, gas, and electric power assets, JPMC’s crisis-driven acquisitions 

allowed the firm to become a significant force in global markets for metals. In late 

2011, JPMC bought a stake in LME from the bankrupt futures firm, MF Global, 

and became the exchange’s largest shareholder. As part of its Sempra deal, JPMC 

acquired control of Henry Bath, a UK-based metals warehousing company that owns 

and operates one of the largest LME-approved global metal storage networks. According to the company’s own description:

Today, Henry Bath, a subsidiary of JPMorgan, engages in the storage and 

shipping of exchange traded metals and soft commodities. It offers 

warehousing, shipping transportation and customs clearance services. The 

company stores and issues exchange traded warrants for commodities, including aluminum, copper zinc, lead, nickel, tin, steel billets, cocoa, coffee 

and plastics.102

Media reports indicate that JPMC has been building up its metals warehousing 

business in order to strengthen the competitive position of Henry Bath vis-a-vis

Glencore’s Pacorini and Goldman’s Metro. The reports of JPMC moving large 

amounts of metal from other warehouses into its own suggest that the firm may be 

rebuilding its stocks and consolidating its warehousing business in key European 

locations. This is likely to exacerbate the conflict within the aluminum industry over 

the unprecedented degree of power that the largest warehousing companies like 

Henry Bath and Metro exercise over global aluminum prices. 

JPMC may be in a particularly sensitive situation because of its controversial 

move to market the first exchange-traded fund (‘‘ETF’’) backed by physical copper.103 JPMC has been reportedly buying up copper since 2010, in anticipation of 

its ETF launch.104 The firm’s ability to remove from the market and store in its own 

warehouses vast quantities of this critically important metal potentially lends more 

credibility to the fears of market cornering expressed by the opponents of JPMC’s 

ETF plan. It makes it difficult for JPMC to argue that trading copper-backed ETF 

shares would not artificially inflate global copper prices. 

JPMC’s newly acquired physical commodity and energy assets and operations, 

however, raise a more fundamental legal question as to whether the firm has the 

statutory authority to own such assets and to conduct such operations in the first 

place. The Board’s original order authorizing JPMC’s physical commodity trading 

does not allow JPMC to own or operate any assets involved in generating, storing, 

transporting, or processing commodities. In fact, even energy tolling and energy 

management were outside of the scope of that original authorization. Presumably, 

as part of its Sempra acquisition, JPMC had to obtain the Board’s approval to continue the commodities activities permissible under the RBS Order. Unfortunately, 

it is difficult to locate any public records showing how and when the Board amended 

its original authorization, to allow JPMC to conduct ‘‘complementary’’ commodities 

activities of RBS, including energy tolling and energy management. 

It appears that JPMC generally conducts its physical commodity operations subject to Board-imposed limitations. According to the firm’s SEC filings, it entered into 

operating leases for ‘‘premises and equipment’’ used for ‘‘energy-related tolling service agreements.’’105 JPMC also enters into various forms of ‘‘supply and off-take’’ 

contracts with producers and processors of commodities, such as oil refineries. These 

contracts are functionally similar to energy management arrangements JPMC and 

other FHCs have with electric power plants under the ‘‘complementary’’ authority 

grants. Thus, in April 2012, business media reported that Delta Airlines was planning to purchase Conoco’s idle Trainer oil refinery, in order to lower its jet fuel 

costs, and that JPMC agreed to finance the entire production process through a supply and off-take agreement. Under the arrangement, JPMC would purchase and pay 

53

106 According to Blythe Masters, the head of JPMC’s commodities unit, it is this ‘‘risk and balance sheet capacity’’ that puts big banks in the unique position to do these supply and off-take 

deals. Nonbank commodity trading houses typically use about 75–80 percent of their credit 

lines, which leaves them little room for taking on new deals, while maintaining a comfortable 

cushion against sudden price rises. See Gregory Meyer, Wall Street banks step up oil trade role,

FIN. TIMES, July 15, 2012. 107 Because metal concentrate futures were not traded on major organized commodity exchanges, the Board excluded metal concentrates from the scope of its original order approving 

RBS’s ‘‘complementary’’ activities. 108On September 20, 2012, the FERC initiated official proceeding accusing J.P. Morgan Ventures Energy Corporation, JPMC’s commodity trading arm, in intentionally providing misleading 

information to the regulator. FERC, News Release (Sept. 20, 2012), available at http://

www.ferc.gov/media/news-releases/2012/2012-3/09-20-12-E-24.asp.

for delivery of the crude for the refinery’s operation, sell the jet fuel to Delta at a 

wholesale price, and then sell other refined products on the open market. In July 

2012, JPMC entered into a similar supply and off-take arrangement with the largest 

oil refinery on the East Coast, owned and operated by Sunoco and Carlyle. These 

transactions significantly reduce refineries’ working capital needs and offload the 

risk on JPMC, which has far greater balance-sheet capacity.106 In effect, JPMC contractually replicates owning oil refineries without violating the letter of the law. 

Nevertheless, some of JPMC’s recently acquired physical commodity operations 

appear to exceed the boundaries of the Board’s ‘‘complementary’’ power grants. In 

April 2012, JPMC sold its metals-concentrate trading unit to Connecticut-based 

Freepoint. The sale was reportedly part of the mandatory divestment by JPMC of 

RBS Sempra’s commercial assets and activities impermissible for FHCs under the 

BHCA.107 The firm’s ownership and operation of Henry Bath, however, continue to 

present a potential problem in this regard. 

JPMC’s speedy rise to the top of the Wall Street commodity-trading circle has created new legal and reputational risks for the firm. In the summer of 2012, the 

FERC launched an investigation into JPMC’s electric power trading practices. The 

agency began its probe in response to complaints from electric power grid operators 

in California and the Midwest in 2011, alleging that JPMC’s power traders had intentionally bid up wholesale electricity prices by more than $73 million. Artificial 

inflation of wholesale prices benefits power generators (which is functionally JPMC’s 

role) but translates into higher power prices for households and other endusers. As 

recent FERC enforcement actions demonstrate, the focus of today’s fraud prevention 

in power markets is on more subtle trading strategies that seek to manipulate the 

price of physical power in order to increase the value of the manipulator’s financial 

bets. JPMC’s role as the leading global energy derivatives dealer potentially exacerbates concern over the firm’s traders engaging in this type of Enron-reminiscent 

market manipulation.108

Even in the absence of conclusive evidence of any wrongdoing on the part of 

JPMC, however, the very fact of FERC’s investigation—and potentially severe regulatory sanctions—raises uncomfortable questions about the potential impact of the 

firm’s newly expanded energy operations on its overall institutional culture and reputation. These concerns become particularly acute in the context of the infamous 

‘‘London Whale’’ scandal that exposed deep problems with JPMC’s risk management 

practices. Both cases demonstrate the inherent difficulty of drawing regulatory distinctions among various transactions based on the firm’s intentions and proclaimed 

business purposes. Just like a legitimate hedge can become a lucrative bet under 

favorable market conditions, so can financing-and-risk-management arrangements 

with oil refineries and power generators become a profitable proprietary business 

of energy merchanting. 

How the law should deal with this complex reality is one of the key questions in 

today’s financial services regulation reform. 

IV. Potential Legal and Policy Implications of Allowing This Trend to Continue 

Even a cursory overview of publicly available information shows that the current 

commodity operations of Morgan Stanley, Goldman, and JPMC defy carefully drawn 

pre-crisis regulatory boundaries of FHC-permissible physical commodities activities—and, if permitted to continue, effectively nullify the principle of separating 

banking from commerce. Broadly, there are two potential ways to resolve this doctrinal tension: either FHCs’ commercial activities must be curtailed, or the law 

should be changed to reflect FHCs’ newly acceptable role as global commodity merchants. 

Unfortunately, the BHCA does not provide a clear and effective legal framework 

for making a fundamental policy decision on the socially efficient degree of mixing 

54

109While these arrangements may potentially reduce direct risks to individual FHCs’ safety 

and soundness, their proliferation implicates other policy concerns the Board must consider in 

granting ‘‘complementary’’ powers to FHCs: excessive concentration of market power, conflicts 

of interest, and increased systemic risk. 

banking and commercial commodities activities. There are, however, important policy reasons to suggest that such mixing, at least to the degree it is done today, may 

be socially undesirable and inefficient. Some of these policy concerns grow out of the 

traditional rationales for the separation of banking and commerce, while others reflect broader regulatory principles and normative commitments. 

A. The Indeterminacy of the Current Statutory Framework 

Under the BHCA, as amended by the GLBA, it is likely that all (or nearly all) 

of the existing physical commodity assets and activities of Goldman, Morgan Stanley, and JPMC can be permitted to continue as compliant with the formal requirements of the statute. However, while technically plausible, such an interpretation 

brings to the surface a deep tension within the existing legal regime between the 

letter and the spirit of the law. 

The commodity grandfathering provision of Section 4(o) of the BHCA potentially 

provides the greatest latitude for Morgan Stanley and Goldman, as two FHCs qualifying for this exemption, to continue owning and operating their extensive commodity assets ‘‘and underlying physical properties.’’ On its face, Section 4(o) does not 

impose any qualitative limits on grandfathered activities: the language of the provision is broad and open to expansive interpretation. Yet, as discussed above, the legislative history of this grandfathering provision, originally conceived as a special 

concession to ‘‘woofies’’—financial institutions without access to FDIC-insured retail 

deposit-taking—indicates that it was not conceived to operate as a completely openended commodity-business license for banking organizations. It is doubtful that, at 

the time the GLBA was passed, Congress actually envisioned the current extent and 

depth of these firms’ physical commodities operations. 

In the alternative, Morgan Stanley, Goldman, and JPMC can seek the Board’s approval of their existing commodities activities as complementary to FHC-permissible 

financial activities, such as commodity derivatives. As discussed above, the BHCA 

does not define what ‘‘complementary’’ means and leaves it largely to the Board’s 

discretion to determine whether any particular activity fits that description. An examination of published Board orders shows the regulator’s general reluctance to 

allow FHCs to incur nonfinancial risks associated with owning and operating oil 

rigs, coal mines, refineries, storage tanks, pipelines, and tankers. As is the case with 

any agency policy, however, the Board’s position may change in response to various 

internal and external factors. Moreover, even if the Board insists on its pre-crisis 

determination that ‘‘complementary’’ commodity trading activities exclude direct 

ownership and operation of physical assets, the practical impact of that seemingly 

bright-line border may be rather limited. FHCs can (and do) use various forms of 

‘‘sale and lease-back’’ or ‘‘supply and off-take’’ arrangements to replicate the effects 

of owning and operating individual key links in the commodity supply chain.109

Finally, FHCs can use merchant banking authority to keep, and even expand, 

their current physical commodity assets. Merchant banking is a potentially tempting choice, because it can be used without the Board’s pre-approval: the FHC can 

make the determination that it holds certain investments under that statutory authority. As discussed above, FHC-permissible merchant banking investments must 

meet certain statutory requirements intended to prevent FHCs from actively running the commercial businesses of their portfolio companies. The holding period limitations and the prohibition on FHCs’ involvement in ‘‘routinely managing’’ portfolio 

companies’ businesses seem tough in principle but are not necessarily ‘‘deal-killers.’’ 

It is not difficult to structure specific investments to meet the formal statutory criteria without giving up real control. It is difficult to ascertain, however, whether 

these investments are, in fact, truly passive private equity interests acquired purely 

for the purposes of profitable resale. In practice, FHCs can—and most likely do—

exercise informal influence on portfolio companies’ business decisions, which may be 

just as effective as a formal management role. 

It may be tempting to assume that the post-crisis regulatory reforms mandated 

by the Dodd-Frank Act—such as, e.g., the Volcker Rule—impose (at least, prospectively) effective limits on FHCs’ commercial activities. Yet, there is little basis for 

any such assumption at this point. Although the Dodd-Frank Act reiterated 

Congress’s general commitment to the principle of separation of banking and commerce, the new law does not directly address the issue of the proper scope of FHCpermissible nonfinancial activities. It is not clear whether and how the regulatory 

55

110 By assuming this role of a ‘‘super-intermediary,’’ financial institutions effectively—and far 

more successfully—adopted the business model pioneered by Enron. See William W. Bratton & 

Adam Levitin, A Transactional Genealogy of Scandal: From Michael Milken to Enron to Goldman Sachs (Aug. 13, 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstractl id=2126778.

implementation of the Act will ultimately affect large FHC’s physical commodities 

operations. 

B. Potential Policy Concerns and Implications 

Even though, as a technical matter of law, the U.S. FHCs’ current physical commodity-trading and related activities may be fully permissible under the BHCA, 

there are several compelling policy reasons to resolve the resulting doctrinal tension 

in favor of explicitly curtailing such activities. In the absence of comprehensive and 

detailed information on the precise nature and scale of individual FHCs’ physical 

commodity interests and activities, it is difficult to arrive at a definitive conclusion 

in this regard. Nevertheless, the potential gravity of these policy concerns demands 

their prompt and thorough investigation. 

1. Safety and Soundness; Systemic Risk 

From the perspective of safety and soundness of individual banking organizations, 

there is at least one straightforward, plausible argument for allowing FHCs to conduct physical commodities trading as a diversification strategy. Diversifying their 

business activities by investing in oil pipelines and metals warehouses should make 

FHCs less vulnerable to periodic crises in financial markets. Trading, transporting, 

storing, and processing physical commodities are volatile businesses, and that volatility is expected to continue for the foreseeable future. It is a reliably profitable 

business, as global commodity prices have been rising since the early 2000s and, despite sudden ups and downs, are generally expected to continue rising in response 

to increasing global demand. Intermediating physical commodities trading is the 

surest way to profit from these trends. 

As professional intermediaries, financial institutions appear to be perfectly positioned to assume that lucrative role. Large FHCs have huge balance sheets, access 

to cheaper financing, superior access to information and in-house research capacity, 

and sophisticated financial derivatives trading capabilities. To the extent that utilizing these unique advantages allows FHCs to be more efficient, low-cost suppliers 

of physical commodities and related logistics services, allowing them to perform that 

function should produce economic benefits for the FHCs and their customers.110

This traditional economic efficiency-based argument, however, misses or ignores 

a crucial fact—namely, that running a physical commodities business also diversifies the sources and spectrum of risk to which FHCs become exposed as a result. 

Let us imagine, for example, that an accident or explosion on board an oil tanker 

owned and operated by one of Morgan Stanley’s subsidiaries causes a large oil spill 

in an environmentally fragile area of the ocean. As the shocking news of the disaster spreads, it may lead Morgan Stanley’s counterparties in the financial markets 

to worry about the firm’s financial strength and creditworthiness. Because the full 

extent of Morgan Stanley’s clean-up costs and legal liabilities would be difficult to 

estimate upfront, it would be reasonable for the firm’s counterparties to seek to reduce their financial exposure to it. In effect, it could trigger a run on the firm’s assets and bring Morgan Stanley to the verge of liquidity crisis or collapse. 

But there is more. What would make this hypothetical oil spill particularly salient 

is a shocking revelation that the ultimate owner of the disaster-causing oil tanker 

was not Exxon-Mobil or Chevron but Morgan Stanley, a major U.S. banking organization not commonly associated with the oil business. That revelation, in and of 

itself, could create a far broader controversy that would inevitably invite additional 

public scrutiny of the commodity dealings of Goldman, JPMC, and other Wall Street 

firms. Thus, in effect, an industrial accident could potentially cause a major systemic disturbance in the financial markets. These hidden contagion channels make 

our current notion of interconnectedness in financial markets seem rather quaint by 

comparison. FHCs’ expansion into the oil, gas, and other physical commodity businesses introduces a whole new level of interconnections and vulnerabilities into the 

already fragile financial system. 

The basic economic efficiency-based argument may also be overstating the claim 

that forcing U.S. FHCs out of the physical commodity and energy business would 

leave consumers’ needs in those markets unmet. Traditional commodity trading 

companies will almost certainly step in to fill any such gap. These nonbank commodity traders may not be able to offer the same ‘‘fully integrated risk management’’ services to industrial clients by assuming nearly all financial risk (and 

56

111 In June 2012, when Moody’s downgraded JPMC’s credit rating by three levels, the rating 

agency was quoted as saying that:

JPMC benefited from the assumption that there’s a ‘‘very high likelihood’’ the U.S. Government would back the bank’s bondholders and creditors if it defaulted on debt. Without the implied Federal backing, JPMorgan’s long-term deposit rating would have been three levels lower 

and its senior debt would have dropped two more steps. 

Dawn Kopecki, JPMorgan Trading Loss Drove Three-Level Standalone Cut,

BLOOMBERG.COM, June 21, 2012. 112See Editorial, Dear Mr. Dimon, Is Your Bank Getting Corporate Welfare?

BLOOMBERG.COM, June 18, 2012. Section 23A of the Federal Reserve Act, which imposes 

quantitative and qualitative limitations on transactions between federally insured depository institutions and their affiliates, should theoretically prevent the leakage of this public subsidy 

from banks to their commodity-trading nonbank affiliates. 12 U.S.C. § 371c. As the recent crisis 

demonstrated, however, the practical effectiveness of this statutory firewall is subject to considerable doubt. See Saule T. Omarova, From Gramm-Leach-Bliley to Dodd-Frank: the Unfulfilled 

Promise of Section 23A of the Federal Reserve Act, 89N.C.L. Rev.1683 (2011). 

logistical headaches) inherent in such clients’ commodity-driven businesses. That 

possibility lends some support to the argument for letting banks act as super-intermediaries, or commodity traders plus.

At the same time, however, it begs the real question as to why banks are able 

to out-compete other commodity traders in this realm, or where that all-important 

plus comes from. Huge balance sheets, high credit ratings, and access to plentiful 

and relatively cheap financing—these factors enable large banking organizations to 

absorb their clients’ commodity-related risks at a lower cost than anyone else could. 

These unique advantages ultimately stem from the fact that, by taking deposits and 

serving as the main channel for the flow of payments and credit throughout the 

economy, banks perform a ‘‘special’’ public service and, therefore, enjoy a special 

public subsidy through access to Federal deposit insurance, special liquidity facilities, and other forms of implicit Government guarantees. In this context, the discussion should focus not on a factual question whether banks are in the best position 

to offer these services more efficiently but on a normative question: should banks 

be offering them at all? 

If banks’ superior ability to provide commodity-related services is rooted in the 

Federal subsidy, the answer to that question is not as simple as the efficiency argument assumes.111 If taxpayers are the party ultimately conferring this precious economic benefit on banks, taxpayers also have the right to stop banks from abusing 

that benefit by engaging in risky commercial activities unrelated to their ‘‘special’’ 

functions. The choice of moving into the physical commodities business does not belong solely to bank executives—the choice ultimately belongs to the taxpaying, 

bank-subsidizing public. If JPMC’s management wants to be free to make profits by 

drilling for and shipping crude oil, it should be able to do so without the estimated 

$14 billion in annual Federal subsidy it receives as a ‘‘special’’ banking institution.112

2. Conflicts of Interest, Market Manipulation, and Consumer Protection 

Banks’ extensive involvement in physical commodity activities also raises significant concerns with respect to potential conflicts of interest and market integrity. 

One of the key policy reasons for separating banking from commerce is the fear of 

banks unfairly restricting their commercial-market competitors’ access to credit, the 

lifeblood of the economy. Without reliable empirical data, it is difficult to assess the 

extent to which this obvious form of conflict of interest currently presents a problem 

in the commodities sector. Yet, there is a heightened danger that banks may use 

their financial market power to gain an unfair advantage in commodities markets, 

and vice versa. 

Goldman’s role in the ongoing aluminum warehousing crisis provides an instructive example. As discussed above, Coca-Cola complained that Goldman intentionally 

created a bottleneck at its Metro warehouses in order to drive up market prices for 

aluminum and sell their own metal stock at the inflated price. It is curious, however, that more industrial endusers did not publicly complain, a lot sooner and louder, about this potential conflict-of-interest situation. It is very likely that commercial 

companies deliberately avoided an open confrontation with Goldman because it was 

a Wall Street powerhouse with which they had—or hoped to establish—important 

credit and financial-advisory relationships. If they were facing Metro as an independent warehousing operator, they might have felt less pressure to keep quiet—

and to continue paying high aluminum premia. This form of subtle counterparty coercion may be difficult to detect and police but it raises a legitimate question for 

further inquiry. 

57

113 Craig Pirrong, Energy Market Manipulation: Definition, Diagnosis, and Deterrence, 31 ENERGY L.J. 1, 2 (2010). 114See, e.g., Robert Lenzner, Speculation in Crude Oil Adds $23.39 To The Price Per Barrel,

FORBES, Feb 27, 2012; Joseph P. Kennedy II, The High Cost of Gambling on Oil, N.Y. TIMES, 

Apr. 10, 2012. 

Moreover, metal warehousing operations are only one element in a large financial 

conglomerate’s complex business strategy involving trading in metals and related financial contracts. Goldman is one of the largest traders of derivatives in the metals 

markets. Unlike an independent warehouse operator, Goldman can potentially use 

its storage capabilities not only to generate rental income but also to move commodity prices in a way that would benefit its derivatives positions. This directly implicates serious issues of market integrity. As one of the world’s biggest dealers in 

commodity derivatives, Goldman can devise and execute highly sophisticated trading strategies across multiple markets. The ability to influence prices of physical assets underlying derivatives, in effect, completes the circle. It makes Goldman’s derivatives profits not so much a function of its traders’ superior skills or executives’ 

talents, but primarily a function of the firm’s structural market power.

It should be noted here that one of the fundamental drivers of the value of any 

derivative is the degree of volatility of the value of the underlying asset. If the value 

of the underlying asset is predictably stable, neither hedgers nor speculators would 

have any reason to enter into derivative contracts tied to that value. Conversely, 

the higher the volatility, the higher the demand for derivatives instruments allowing transfer of the underlying risk. This basic fact reveals the fundamental incentive 

for a derivatives dealer with sufficient market power in the underlying physical 

commodity markets to maintain price volatility in such markets, regardless of the 

fundamentals of supply and demand, as the necessary condition of continuing viability and profitability of its commodity derivatives business. 

Market manipulation in commodities markets has long been a hot button issue. 

In contrast to securities market, commodities markets are particularly vulnerable 

to so-called market power-based manipulation that may not involve fraud or deceptive conduct.113 A large trader can significantly move prices of futures and underlying physical commodities not only by ‘‘cornering’’ the market in a particular product but also by placing very large sell/buy orders in excess of available liquidity. 

This salience of market power in commodities market manipulation underscores the 

potential dangers of allowing large financial institutions to dominate both commodity derivatives markets and the related cash commodity markets. 

Finally, artificially high premia for industrial aluminum translate into higher consumer prices for a wide range of products, from soft drinks to automobiles. Similarly, if JPMC’s commodity traders did, in fact, inflate wholesale power prices in 

California, their manipulative conduct accounts for retail consumers’ higher electricity bills. Generally, commodity price inflation is a major component of consumer 

price inflation. To the extent that banks’ direct involvement in physical commodity 

markets distorts traditional supply and-demand dynamics and contributes to commodity price volatility, it becomes an important matter of consumer protection. 

An unsustainable rise in consumer prices, driven by the rising prices of basic commodities, has significant macroeconomic consequences. The recent spikes in nationwide gasoline and heating oil prices illustrate these systemic effects. Despite the 

general prevalence of traditional supply and-demand theories, there is also a legitimate argument that a significant factor explaining these prices is purely financial 

speculation in oil.114 Large financial intermediaries enable and amplify such speculation by creating, marketing, and dealing in commodity-linked financial products. 

Indirectly, these intermediaries’ physical commodities operations contribute to speculative bubbles in key commodities, which ultimately increase the cost of living for 

the ordinary Americans. Because rises in the costs of basic goods tend to 

disproportionally affect the poor, this artificially created price volatility can widen 

socioeconomic disparities that have tangible and potentially grave consequences for 

social cohesion and civil unity. From this perspective, large FHCs’ physical commodities businesses raise potential concerns not only as a matter of consumer protection 

but also as a matter of macroprudential regulation and even political stability. 

3. Concentration of Economic and Political Power 

Concerns with potential conflicts of interest, market manipulation, and consumer 

protection are closely connected to the broader policy concern with excessive concentration of economic power. That concern looms especially large in the context of 

FHCs’ physical commodity trading. 

It is difficult to overestimate the importance of this issue for the long-term health 

and vitality of the U.S. economy and of American democracy. Writing almost a cenVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00061 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
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115Louis D. Brandeis, OTHER PEOPLE’S MONEY: AND HOW THE BANKERS USE IT 

(1933), at 3. 116 Id. at 4. 117See, e.g., Simon Johnson & James Kwak, THIRTEEN BANKERS (2010); Matt Taibbi, Why 

Isn’t Wall Street In Jail? ROLLING STONE, Feb. 16, 2011. 118The Dodd-Frank Act requires SIFIs to submit to federal regulators enterprise-wide recovery and resolution plans, or ‘‘living wills,’’ to help their orderly resolutions in the event of failure. Dodd-Frank Act 165(d). Goldman, Morgan Stanley, JPMC, and other large FHCs have already submitted their living wills to the Board in July 2012. These documents should provide 

an exhaustive description of each institution’s corporate structure and core business activities. 

They could give regulators the necessary information on these firms’ physical commodity assets 

and operations. It is not clear, however, whether this is actually the case, as the bulk of the 

information in these resolution plans is confidential. None of the publicly available portions of 

the living wills filed to date contain any relevant information on this issue. See, http://

www.federalreserve.gov/bankinforeg/resolution-plans.htm.

tury ago, Justice Brandeis famously warned against the dangers of combination—

or ‘‘concentration intensive and comprehensive’’—that gave financial institutions direct control over industrial enterprises.115 Brandeis saw the ‘‘subtle and often longconcealed concentration of distinct functions, which are beneficial when separately 

administered, and dangerous only when combined in the same persons’’ as a great 

threat to economic and political liberties.116

The global financial crisis of 2008–2009 demonstrated the continuing salience of 

Brandeis’s concerns. The taxpayer-funded bailout of large financial conglomerates 

whose risky activities had contributed to—and, indeed, largely created—the crisis 

reignited the century-old debate on the role of ‘‘financial oligarchy’’ in American politics.117 Not surprisingly, one of the central themes in post-crisis regulatory reform 

is the prevention of future bailouts of ‘‘too big to fail’’ financial institutions. The ongoing transformation of large U.S. financial institutions into leading global merchants of physical commodities and energy, however, significantly complicates the 

reformers’ task. By giving banks that are already ‘‘too big to fail’’ an additional 

source of leverage over the economy—and, consequently, the polity—it elevates the 

dangers inherent in cross-sector concentration of economic power to a qualitatively 

new level. When large financial conglomerates that control access to money and 

credit also control access to such universal production inputs as raw materials and 

energy, their already outsized influence on the entire economic—and, by extension, 

political—system may reach alarming proportions. 

For these reasons, in rethinking the foundational principle of separating banking 

and commerce, especially in the context of energy and commodity activities, it is 

critically important to remember Brandeis’s warnings. Reassessing and reasserting 

the original antitrust spirit of U.S. bank holding company regulation may be the 

necessary first step in the right direction. 

4. Institutional Governability and Regulatory Capacity 

An examination of FHCs’ physical commodity activities also highlights potential 

problems such activities pose from the perspective of regulatory design, regulatory 

process, and firm governability. 

Understanding what exactly large U.S. FHCs own and do in global commodity 

markets is the critical first step toward developing an informed regulatory approach 

to this issue. Under the current regulatory disclosure system, there is no reliable 

way to gather and evaluate this information. Existing public disclosure is woefully 

inadequate to understand and evaluate the nature and scope of U.S. banking organizations’ physical commodities trading assets and activities. It may not be feasible 

or desirable to mandate detailed disclosure of every commercial activity of a large 

FHC, but when it comes to energy and other key commodities, what is hidden from 

the public view may be highly consequential.118 It is imperative, therefore, to mandate full public disclosure of financial institutions’ direct and indirect activities and 

investments in physical commodities and energy. 

Simply mandating more disclosure, however, will not be enough. The recent crisis 

has demonstrated the limits of disclosure as a regulatory tool, especially in the context of complex markets, institutions, and instruments. Complexity is one of the fundamental drivers of systemic risk, and managing complexity is one of the key challenges in today’s financial services sector. Large U.S. financial conglomerates are already complex, in terms of their corporate structure, risk management, and the 

breadth and depth of financial services and products they offer. Allowing these firms 

to run extensive commercial operations that require specialized technical and managerial expertise adds to their internal complexity. Firm-wide coordination and monitoring of operations, finances, risks, and legal and regulatory compliance become all 

the more difficult in that context. This is particularly true of capital-intensive, operationally complex, and potentially high-risk physical commodity activities. An effecVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00062 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
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tive integration of these operations may be further complicated by potential shifts 

in corporate culture. Thus, the traditionally aggressive risk-taking culture of commodity traders (think Enron) may push the already questionable ethics of bankers 

beyond the limits of prudency and legality. All of these factors present serious challenges for large financial firms’ internal governance and governability.

More importantly, mixing banking with physical commodity trading creates potentially insurmountable challenges from the perspective of regulatory efficiency and 

capacity. Direct linkages, through the common key dealer-banks, between the vitally 

important and volatile financial market with the vitally important and volatile commodity and energy market may amplify the inherent fragility of both markets, as 

well as the entire economy. Who can effectively regulate and supervise this new 

super-market? And how should it be done? 

The U.S. system of financial services regulation is already highly fragmented and 

ill-suited to detecting and reducing systemic risk across different financial markets 

and products. The expansion of FHCs’ activities into yet more new areas subject to 

extensive regulation under very different regulatory schemes—environmental regulation, workplace safety regulation, utility regulation—lays the foundation for jurisdictional conflicts on an unprecedented scale. In addition to the several Federal 

bank regulators, the SEC and CFTC, banking organizations become subject to regulation by the DOE, the FERC, the Environmental Protection Agency, the Federal 

Trade Commission, and possibly other Federal and State agencies. Yet, none of 

these many overseers are likely to see the whole picture, leaving potentially dangerous gaps in the regulation and supervision of these systemically important superintermediaries. An additional complicating factor is the high strategic and geopolitical significance of energy trading. The flow of oil and gas in global markets 

is as much a matter of foreign policy and national security as it is a matter of business. Accordingly, the State Department could also be expected to insist on a say 

in the affairs of large U.S. FHCs that import and export oil, gas, and other strategically important commodities. 

In terms of substantive regulatory oversight, the situation is equally discouraging. 

In addition to being the umbrella regulator for BHCs, the Board is now primarily 

responsible for prudential regulation and supervision of all SIFIs. As discussed 

above, physical commodities activities expose financial institutions to qualitatively 

different, and potentially catastrophic, risks. In addition, commodities operations 

create potential new channels of contagion and systemic risk transmission. Yet the 

Board is not equipped to regulate and supervise companies that own and operate 

extensive commodity trading assets: oil pipelines, marine vessels, or metal warehouses. 

It is not enough to pay lip service to these concerns by simply requiring FHCs 

to conduct their commercial activities in compliance with the applicable securities, 

commodities, energy, and other laws and regulations. Those regulatory schemes are 

not designed with SIFIs in mind and, therefore, do not address the unique risks—

enterprise-wide and systemic—posed by their activities. Realistically, however, the 

Board has little choice but rely on FHCs’ promises to comply with such parallel regulatory regimes. Without the necessary expertise and a clear legal mandate, neither 

the Board nor any other financial regulator can be expected to exercise meaningful 

oversight of large financial institutions’ commodity businesses and the risks they 

generate. This natural limit on regulatory capacity is an important reason for serious reconsideration of FHCs’ role in physical commodities markets. 

V. Conclusion 

This testimony has described the legal, regulatory, and policy aspects of an ongoing transformation of large U.S. FHCs into global merchants of physical commodities and energy. In the absence of detailed and reliable information, it is difficult 

to draw definitive conclusions as to the social efficiency and desirability of allowing 

this transformation to continue. What we can already ascertain about U.S. financial 

institutions’ physical commodity assets and activities, however, raises potentially serious public policy concerns that must be addressed through fully informed public 

deliberation. Even if big U.S. FHCs were, in fact, to scale down their physical commodity operations either in response to current regulatory developments or as a 

temporary market adjustment, it would not obviate the need for such deliberation. 

Addressing these policy concerns in a timely, open, and publicly minded manner remains a task of the utmost importance, both as an economic matter and as a matter 

of democratic governance. 

60

1My practice focuses on providing bank regulatory advice and advising on M&A and capital 

markets transactions when the target or issuer is a banking organization or other financial institution. My clients include many of the largest U.S. and non-U.S. banks, a number of regional, 

mid-size and community banks, and certain financial industry trade associations. 2Deposit insurance and access to the Federal Reserve’s discount window are often referred 

to as the Federal safety net. 3 12 U.S.C. § 371c. 

PREPARED STATEMENT OF RANDALL D. GUYNN

PARTNER AND HEAD OF THE FINANCIAL INSTITUTIONS GROUP

DAVIS POLK & WARDWELL LLP

JULY 23, 2013

Introduction 

Chairman Brown, Ranking Member Toomey, Members of the Subcommittee: My 

name is Randall Guynn, and I am a partner and head of the Financial Institutions 

Group of Davis Polk & Wardwell LLP.1 Thank you for your invitation to testify at 

this important hearing. 

My testimony will describe the laws and regulations that currently permit insured 

banks, bank holding companies, financial holding companies and their nonbank affiliates to engage as principal in futures, forwards and other commodities contracts 

and in owning or controlling physical or intangible commodities or related facilities, 

including electric power plants, commodities warehouses and oil refineries. These financial institutions are permitted to engage in commodities activities to meet the 

needs of customers, increase customer choice, increase competition, act as more effective intermediaries between producers and endusers, provide increased liquidity 

to the markets and lower prices to consumers, and increase the diversification of 

the revenue streams and exposures of these financial institutions. All things being 

equal, increased diversification of activities reduces risk, preserves capital and 

should help an institution improve its financial condition over time. 

As you will see, insured banks are the most limited in what they are permitted 

to do, are not permitted to take delivery of physical commodities and generally are 

not permitted to control related facilities such as power plants, commodities warehouses or oil refineries. Only separately incorporated, capitalized and insulated 

nonbank affiliates are permitted to exercise broader powers, and even they are subject to significant limits in doing so. These nonbank affiliates are granted broader 

powers because they are not eligible for Federal deposit insurance and do not have 

access to the Federal Reserve’s discount window.2 In addition, other Federal laws, 

including Sections 23A and 23B of the Federal Reserve Act,3 prevent insured banks 

from passing on the funding advantages of deposit insurance or giving their 

nonbank affiliates access to the discount window. These other laws also insulate insured banks against the risks of a nonbank affiliate’s commodities and other nonbanking activities. 

Even the powers of these nonbank affiliates, however, are subject to significant 

limits. Bank holding companies that do not qualify as financial holding companies, 

and their nonbank affiliates, are subject to the most severe limits. Subject to certain 

very narrow exceptions, they are not permitted to buy, sell or make or take delivery 

of physical or intangible commodities or control related facilities. 

Moreover, even financial holding companies and their nonbank affiliates must 

generally show that physical commodities activities are complementary to permissible financial activities, such as entering into futures, forwards or other commodities contracts, before being permitted to engage in such physical commodities activities. They must also show that their exercise of these powers does not pose a substantial risk to the safety or soundness of depository institutions or the financial 

system generally. They are prohibited from trading in physical commodities unless 

a derivative contract has been authorized for trading on a futures exchange by the 

Commodity Futures Trading Commission or they otherwise demonstrate that the 

particular commodity is sufficiently fungible and liquid. They are generally prohibited from owning or controlling the day-today operations of processing, storage, 

transportation or other physical or intangible commodities facilities, including electric power plants, commodities warehouses and oil refineries. They may, however, 

temporarily own or control companies that operate such facilities pursuant to the 

merchant banking power, the temporary exception for acquiring companies substantially engaged in financial activities or the exception for acquisitions in satisfaction 

of a debt previously contracted in good faith. Finally, their physical commodities activities are subject to a variety of conditions and limitations. These include approVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00064 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
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4 12 U.S.C. §24 (Seventh). 5 Id.

6 513 U.S. 251, 258–259 note 2 (1995).

7See Comptroller of the Currency, Administrator of National Banks, Activities Permissible for 

a National Bank, Cumulative, at 57–64 (2011 Annual Edition, Apr. 2012). 

priate risk management requirements, oversight by the Federal Reserve and other 

regulators, and volume limitations. 

Financial holding companies whose commodities activities are grandfathered 

under Section 4(o) of the Bank Holding Company Act are generally permitted to engage in trading, sale or investment in physical commodities activities and related 

facilities, but only subject to certain conditions and limitations. These conditions 

and limitations include appropriate risk management requirements, oversight by 

the Federal Reserve and other regulators, and volume limitations. 

All of these financial holding companies and their bank and nonbank affiliates are 

subject to generally applicable laws and regulations that govern these activities. For 

example, they must conduct their commodities activities in compliance with all applicable antitrust, securities, futures and energy laws. These include the orders, 

rules and regulations of the Government agencies, exchanges and self-regulatory organizations responsible for implementing and enforcing those laws, including the 

U.S. Department of Justice, the Federal Trade Commission, the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Energy Regulatory Commission, the National Futures Association, the CME Group, 

Intercontinental Exchange and the London Metal Exchange. 

My testimony will also describe the extent to which banks, bank holding companies, their nonbank affiliates and other nonbank financial institutions were permitted to act as principal—and were major players—in the commodities markets before the Gramm Leach Bliley Act of 1999, the Glass-Steagall Act of 1933 or even 

the National Bank Act of 1863. In fact, there has been a close relationship between 

banking and commodities since ancient times as well as in this country for most of 

the past 200 years shows that both the grandfathering provision in Section 4(o) of 

the Bank Holding Company Act and the complementary powers orders that permit 

certain nongrandfathered financial holding companies to engage in trading physical 

and energy commodities were only incremental expansions of traditional banking 

powers, not the sort of radical departure some of argued. 

I will then discuss whether commodities activities, as currently permitted by the 

law, are inconsistent with the principle of keeping banking and commerce separate. 

Finally, I will address whether insured banks or their nonbanking affiliates, including financial holding companies, should be prohibited from engaging in commodities 

activities or at least from controlling related facilities. 

II. Current State of the Law 

The National Bank Act expressly permits national banks to engage in the ‘‘business of banking,’’ as well as all activities that are ‘‘incidental’’ to that business.4 Although the National Bank Act does not define the business of banking, it provides 

a list of activities that are included within that term, including ‘‘buying and selling 

exchange, coin, and bullion’’5—that is, trading in precious metals and other commodities that function as money or monetary substitutes. In NationsBank v. VALIC,

the Supreme Court held that the business of banking is not limited to the list of 

activities in the National Bank Act: 

We expressly hold that the ‘business of banking’ is not limited to the enumerated powers in § 24 Seventh and that the Comptroller therefore has discretion to authorize activities beyond those specifically enumerated. The exercise of the Comptroller’s discretion, however, must be kept within reasonable bounds. Ventures distant from dealing in financial investment instruments—for example, operating a general travel agency—may exceed those 

bounds.’’6

In a series of orders and interpretive letters issued over time, the Office of the 

Comptroller of the Currency (‘‘OCC’’) has defined the range of activities that fall 

within the business of banking or that are incidental to it. Among the activities that 

the OCC has defined as bank-permissible are acting as principal or agent in connection with a wide range of derivative contracts, including commodities contracts, as 

long as certain risk management and other conditions are satisfied.7 National banks 

are generally not permitted to take delivery of any underlying physical or intangible 

commodities and generally are not permitted to control related facilities such as 

power plants, commodities warehouses or oil refineries. They may, however, acquire 

62

8See 12 U.S.C. 24 (Seventh) (incidental powers clause); OCC Interpretive Letter No. 643, reprinted in Fed. Banking L. Rep. (CCH) ¶ 83,551 (July 1, 1992); OCC Interpretive Letter No. 

511, reprinted in [1990–1991 Transfer Binder] Fed. Banking L. Rep. (CCH) ¶ 83,213 (June 20, 

1990); OCC Interpretive Letter No. 1007 (September 7, 2004); See also Activities Permissible for 

a National Bank, supra note 7, at 86. 9 12 U.S.C. § 1843(c)(8). 10 12 C.F.R. § 225.28(b)(8). See also Randall D. Guynn, Luigi L. De Ghenghi & Margaret E. 

Tahyar, Foreign Banks as U.S. Financial Holding Companies, in REGULATION OF FOREIGN 

BANKS & AFFILIATES IN THE UNITED STATES, § 10:4[9][a] (6th ed. 2012); Melanie L. Fein, 

FEDERAL BANK HOLDING COMPANY LAW § 18.07 (3rd ed. 2011). 11See 12 C.F.R. § 225.28(b)(8). 12 12 U.S.C. § 1843(c)(2); C.F.R. § 225.22(d)(1). 13 12 U.S.C. § 1843(k)(1). 14 Id. § 1843(k)(1)(B). 15 Id. § 1843(k)(4)(F). 16See, e.g., Citigroup, 89 Fed. Res. Bull. 508 (2003); JPMorgan Chase & Co., 92 Fed. Res. Bull. 

C57 (2006); Royal Bank of Scotland Group, 94 Fed. Res. Bul. C60 (2008). See also Guynn, De 

Ghenghi & Tahyar, supra note 10, § 10:4[9][a]. 17See, e.g., Royal Bank of Scotland Group, supra note 16. 18See, e.g., id.

temporary ownership or control of companies that operate such facilities in satisfaction of a debt previously contracted in good faith for a maximum of 10 years.8

Section 4(c)(8) of the Bank Holding Company Act of 1956 (‘‘BHC Act’’) similarly 

authorizes bank holding companies and their nonbank affiliates to engage in activities that are determined by the Board of Governors of the Federal Reserve System 

(‘‘Federal Reserve Board’’ or ‘‘Board’’) ‘‘to be so closely related to banking as to be 

a proper incident thereto.’’9 In a series of orders eventually codified in Section 

225.28(b)(8) of the Board’s Regulation Y, the Federal Reserve Board has determined 

that engaging as principal in a wide range of derivative contracts, including commodities contracts, is ‘‘closely related to banking’’ as long as certain risk-management and other conditions are satisfied.10 Subject to certain very narrow exceptions, 

Regulation Y does not permit bank holding companies or their nonbank affiliates 

to take or make delivery of physical or intangible commodities as a closely relatedto-banking activity.11 Nor are bank holding companies permitted to acquire control 

of related facilities, except temporarily in satisfaction of a debt previously contracted 

in good faith for a maximum of 10 years.12

Section 4(k)(1) of the BHC Act, which was added in 1999 by the Gramm Leach 

Bliley Act (‘‘GLB Act’’), expressly permits bank holding companies that qualify as 

financial holding companies, as well as their nonbank affiliates, to engage in activities that are ‘‘financial in nature,’’ ‘‘incidental’’ to a financial activity or ‘‘complementary’’ to a financial activity if certain conditions are satisfied.13 Among the conditions that apply to engaging in a complementary activity is that such activity can 

be and is conducted in a manner that does not pose a substantial risk to the safety 

or soundness of depository institutions or the financial system generally.14

Section 4(k)(4)(F) expressly defines financial activities for this purpose as including all of the closely related-to-banking activities in Section 225.28 of Regulation Y, 

including the commodities activities described above.15 Thus, Section 4(k)(4)(F) codified the Federal Reserve Board’s regulation as a matter of binding statutory law. 

In a series of orders issued to specific institutions after passage of the GLB Act, 

the Federal Reserve Board determined that purchasing or selling a wide range of 

physical or intangible commodities, including oil, natural gas, electric power, emissions allowances, agricultural products, metals and certain other nonfinancial commodities in the spot markets or to take or make delivery of such physical or intangible commodities pursuant to commodities contracts, is ‘‘complementary’’ to the financial activity of acting as principal with respect to commodity contracts, subject 

to certain conditions.16 Among the conditions applicable to this authority is that the 

commodities activities be limited to commodities that are sufficiently fungible and 

liquid.17 To ensure that they are, the Board has generally required financial holding 

companies requesting these expanded powers to limit their physical commodities activities to commodities for which a derivative contract has been authorized for trading on a futures exchange by the CFTC or which the Board has specifically determined to be sufficiently fungible and liquid.18

Complementary authority does not provide a basis for financial holding companies 

to own or control the day-to-day operations of processing, storage, transportation or 

other physical or intangible commodities facilities, including electric power plants, 

commodities warehouses and oil refineries. They may, however, temporarily own or 

control companies that operate such facilities pursuant to the merchant banking 

power, the temporary exception for acquiring companies engaged in nonfinancial acVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00066 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
63

19See, e.g., Citigroup, supra note 16; JPMorgan Chase & Co., supra note 16; Royal Bank of 

Scotland Group, supra note 16. 20See, e.g., id. 21 12 U.S.C. 1843(k)(4)(H). 22See id. 23See 12 U.S.C. § 1843(k)(4)(H); 12 C.F.R. §§ 225.171, 225.172. 24 12 C.F.R. § 225.85(a)(3). 25 Id. § 225.85(a)(3)(ii). 26 12 C.F.R. § 225.22(d)(1). 27 12 U.S.C. § 1843(o). 28 Id. (emphasis added). 29 Id. 30 Id. § 1843(n). 

tivities, or in satisfaction of a debt previously contracted in good faith, which are 

discussed more fully below. 

In approving the applications of certain financial holding companies to engage in 

physical commodities activities, the Board also determined that the activities would 

satisfy the requirement that they be conducted in a manner that does not pose a 

substantial risk to the safety or soundness of depository institutions or the financial 

system generally if they were conducted subject to certain conditions. These conditions include appropriate risk management requirements, oversight by the Federal 

Reserve and other regulators, and a volume limit on the extent to which balance 

sheet resources may be dedicated to these activities.19

Finally, the Board found that permitting physical commodities activities would 

likely produce public benefits in the form of increasing customer choice, competition 

and market efficiency.20 These activities almost certainly also produce public benefits in the form of providing increased liquidity to the markets and lower prices to 

consumers, and increasing the diversification of the revenue streams and exposures 

of these financial institutions. All things being equal, increased diversification of activities reduces risk, preserves capital and should help an institution improve its financial condition over time. Another important benefit of allowing financial holding 

companies to own inventory in physical commodities is that this permits them to 

finance the inventory for customers, such as airlines and refiners. 

The merchant banking power is contained in Section 4(k)(4)(H) of the BHC Act.21

It permits all financial holding companies and their nonbank affiliates to make temporary investments in any company that is engaged in nonfinancial activities or 

mixed financial and nonfinancial activities, subject to certain conditions.22 Such 

nonbanking activities would include investing in physical commodities or related facilities. The most important conditions on the merchant banking power are that 

such investments in nonfinancial companies must be made as part of a bona fide 

underwriting or merchant or investment banking purpose and generally must be divested within 10 years, and the financial holding company must not be involved in 

the routine management of the portfolio company, except temporarily if necessary 

to preserve the value of the investment.23

Financial holding companies are also permitted, under a separate authority, to acquire temporary control of any company that is engaged in both financial and nonfinancial activities, provided that the company is ‘‘substantially engaged’’ in financial activities and the company conforms, terminates or divests any nonfinancial activities within 2 years.24 A company is deemed to be ‘‘substantially engaged’’ in financial activities if at least 85 percent of its revenues and 85 percent of its assets 

are attributable to financial activities.25 Like other bank holding companies, financial holding companies and their nonbank affiliates are also permitted to acquire 

temporary control of a company that controls physical commodities or related facilities in satisfaction of a debt previously contracted in good faith for a maximum of 

10 years.26

Finally, Section 4(o) of the BHC Act, which was also added in 1999 by the GLB 

Act, contains a permanent grandfathering provision for institutions that were engaged in any commodities activities as of September 30, 1997, were not bank holding companies when the GLB Act was signed into law, but subsequently become 

bank and financial holding companies.27 Section 4(o) expressly permits any qualifying financial holding company to ‘‘continue to engage in, or directly or indirectly 

own or control shares of a company engaged in, activities related to the trading, 

sale, or investment in commodities and underlying physical properties,’’28 provided 

that not more than 5 percent of the qualifying company’s consolidated assets are 

attributable to such commodities or underlying physical properties.29 Unlike other 

grandfathering provisions such as Section 4(n) of the BHC Act,30 Section 4(o) does 

not have a time limit. Thus, it is a permanent exemption from the general requirement for a new bank holding company to conform its activities to the restrictions 

64

31See id. § 1843(a)(2) (providing a transition period of 2–5 years for new bank holding companies to conform their activities to the nonbanking activities restrictions in the BHC Act). 32See, e.g., Cong. Rec. H3141 (daily ed. May 13, 1998) (statement of Rep. Dingell) (‘‘H.R. 10 

. . . does nothing to hurt the banks. It expands the range of allowable banking activities . . . 

It creates, insofar as humanly possible, a fair two-way street for all players.’’). 33See, e.g., H.R. Rep. No. 104–127, pt. 1, at 97 (May 18, 1995) (‘‘The Committee intends that 

activities relating to the trading, sale or investment in commodities and underlying physical 

properties shall be construed broadly and shall include owning and operating properties and facilities required to extract, process, store and transport commodities.’’) (Emphasis added.) 34 Amendment No. 9 by Senator Gramm (Mar. 4, 1999), available at http://banking.senate.gov/docs/reports/fsmod99/gramm9.htm. 35See, e.g., Saule T. Omarova, The Merchants of Wall Street: Banking, Commerce, and Commodities, at 4 (draft of Nov. 24, 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstractlid=2180647. 36 Id. 37 Id. 38 Id. 39 Id. at 5. 40 Id.

on nonbanking activities otherwise contained in Section 4 of the BHC Act within 

5 years of becoming a bank holding company.31

Section 4(o) was one of several provisions in the GLB Act that were designed to 

ensure that the GLB Act would be a ‘‘two-way street’’ for commercial banks and investment banks, making it just as easy for an investment bank with a major commodities business to affiliate with an insured bank as it is for an insured bank to 

affiliate with a securities underwriting and dealing firm.32 The legislative history 

stated that the activities described in Section 4(o) should be construed broadly and 

to include at a minimum the ownership and operation of properties and facilities 

required to extract, process, store and transport commodities.33 It also explained 

that the purpose of Section 4(o) was to ensure that: 

a securities firm currently engaged in a broad range of commodities activities as part of its traditional investment banking activities, is not required 

to divest certain aspects of its business in order to participate in the new 

authorities granted under the [GLB Act].’’34

All of these financial holding companies and their bank and nonbank affiliates are 

subject to generally applicable laws and regulations that govern these activities. For 

example, they must conduct their commodities activities in compliance with all applicable antitrust, securities, futures and energy laws. These include the orders, 

rules and regulations of the Government agencies, exchanges and self-regulatory organizations responsible for implementing and enforcing those laws, including the 

U.S. Department of Justice, the Federal Trade Commission, the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Energy Regulatory Commission, the National Futures Association, the CME Group, 

Intercontinental Exchange and the London Metal Exchange. 

III. Commodities Activities Before the GLB Act 

Two of the most vocal critics of allowing financial holding companies and their 

bank and nonbank affiliates to continue to buy and sell physical and energy commodities are Professor Saule Omarova of the University of North Carolina Law 

School and Mr. Joshua Rosner, managing director of Graham Fisher & Co. In a 

widely circulated draft article, Professor Omarova has asserted that U.S. financial 

holding companies somehow waged a ‘‘quiet transformation’’ to become ‘‘global merchants of physical commodities’’ during that period.35 To Professor Omarova, this 

mixing of banking and commodities activities is a radical departure from the past 

and not an incremental expansion of traditional banking and nonbanking powers. 

She characterizes it as a serious breach of the ‘‘legal wall designed to keep them 

out of any nonfinancial business’’36 and ‘‘effectively nullifies the foundational principle of separation of banking from commerce.’’37 She argues that these physical and 

energy commodities activities ‘‘threaten to undermine the fundamental policy objectives . . . [of] ensuring the safety and soundness of the U.S. banking system, maintaining a fair and efficient flow of credit in the economy, protecting market integrity, and preventing excessive concentration of economic power.’’38 According to Professor Omarova, unless these activities are prohibited or severely curbed, financial 

holding companies will be exposed to a variety of new and excessive risks, engage 

in anticompetitive behavior and even threaten ‘‘American democracy.’’39 She sums 

up the implication of her argument as follows: ‘‘If there are good reasons to believe 

that extreme power breeds extreme abuses, the ongoing expansion of large FHCs 

into physical commodities and energy business warrants serious concern.’’40

65

41Shahien Nasiripourshahien & Zach Carterzach, Beer Brewers Blast Wall Street Banks over 

Aluminum Business Amid Congressional Scrutiny, HUFFINGTON POST (July 16, 2013). 42 Id. 43 Id. 44See, e.g., Catherin Eagleton & Jonathan Williams, MONEY: A HISTORY at 18, 22, 135, 

155–156, 196–197, 200 (The British Museum Press 2006) (grain used as money in ancient Mesopotamia and Egypt, as well as China, Korea and Japan; salt used as money in Ethiopia and 

China; shells and pieces of wood used in China, North America and Oceana). According to Milton Friedman, cigarettes were used as money in Germany after World War II. Milton Friedman, 

MONEY MISCHIEF at 14 (1992). 45See, e.g., Charles P. Kindleberger, A FINANCIAL HISTORY OF WESTERN EUROPE 

(1984). 46See, e.g., Vincent P. Carosso, INVESTMENT BANKING IN AMERICA: A HISTORY (1970); 

BRAY HAMMOND, BANKS AND POLITICS IN AMERICA: FROM THE REVOLUTION TO 

THE CIVIL WAR (1957). 47See id.

Mr. Rosner has expressed similar views. As reported in the Huffington Post, Mr. 

Rosner has stated that ‘‘[i]f banks own storage, distribution, transmission or generating assets, they have the ability to manipulate prices for the benefit of their own 

balance sheet, to the disadvantage of the public interest, which is why they were 

prohibited from such activities after the Great Depression to the passage of GrammLeach-Bliley in 1999.’’41 Professor Omarova and Mr. Rosner also reportedly told the 

Huffington Post that traders at banks that own physical commodities business have 

a natural incentive to use inside knowledge gleaned from their co-workers to reap 

profits from trades of derivatives tied to the underlying commodities.42

Not only does Professor Omarova’s law review article reflect a deep distrust of the 

motives and behavior of financial holding companies and their employees, but she 

has also reportedly been severely critical about the Federal Reserve Board’s lack of 

transparency about the commodities activities of these firms. According to the Huffington Post, Professor Omarova has said that ‘‘[t]he Fed has absolutely not been 

transparent’’ and that ‘‘[t]he Fed is like the Kremlin: They do their magic and then 

tell people like me to go away.’’43

Before addressing whether today’s commodities activities are inconsistent with 

the principle of keeping banking separate from commerce and whether there is sufficient evidence to justify prohibiting or severely curbing these powers, let me first 

straighten out a few historical facts about the relationship between banking and 

physical commodities activities. First, there has been a close relationship between 

banking and physical commodities since the dawn of history. The essence of banking 

is the creation of money through the maturity transformation process. By funding 

themselves with demand or other short-term deposits or other liabilities (including 

the issuance of paper currency) and then making medium- to long-term loans, commercial banks participate in the money and credit creation processes. 

Physical commodities such as grain, salt, shells and pieces of wood were among 

the first forms of money in ancient Mesopotamia, Egypt, China, Korea, Japan, 

North America, Ethiopia, and Oceana, and some of these commodities continued to 

be used as money until quite recently in certain places.44 While not as durable as 

gold or silver, or as reliable and easy to move as coins, paper or electronic money 

issued by commercial banks, these physical commodities nevertheless had the essential characteristics that made them an efficient medium of exchange and store of 

value (i.e., money)—fungibility, divisibility and relative liquidity. These ancient 

forms of money made trading much more efficient than in a barter economy where 

nonfungible and nondivisible goods and services are exchanged. 

Second, the modern history of banking (and money) began with grain merchants 

in Lombardy creating markets in grain and other commodities, financing crops, 

holding gold (another commodity) of others for settlement of their grain transactions 

and trading in gold while it was on deposit.45

Third, U.S. banks and other financial institutions were major players in the commodities markets during the 19th century. National banks were expressly permitted 

to trade in gold, silver and other precious metals commodities. Many of the major 

U.S. merchant banks of the 19th century started as dry goods and commodity traders, which expanded into banking in somewhat similar ways and for somewhat similar reasons as their Lombard predecessors from centuries earlier.46 These commodity traders turned bankers include Lazard Brothers and Brown Brothers.47 The 

private banking partnership of J. Pierpont Morgan, Sr. engaged in wholesale or 

merchant banking, which included the buying and selling of physical commodities 

and related facilities. To take just one famous example, a trust controlled by J.P. 

Morgan purchased Andrew Carnegie’s steel company in 1901 and combined it with 

66

48See Ron Chernow, THE HOUSE OF MORGAN: AN AMERICAN BANKING DYNASTY 

AND THE RISE OF MODERN FINANCE 82–24 (1990). 49See, e.g., Milton Friedman and Anna Jacobson Schwartz, A MONETARY HISTORY OF 

THE UNITED STATES, 1867–1960 (1963) (using statistics of pig iron to estimate the growth 

or contraction of the economy during the Great Depression). 50See Banking Act of 1933, §§ 16, 20. 51For example, Goldman Sachs acquired commodities trading firm J. Aron & Co. in 1981, and 

that same year, the commodities trading firm Phibro Corporation acquired Salomon Brothers 

to form Phibro-Salomon Inc. In 1984, Morgan Stanley formed the Natural Gas Clearinghouse 

with law firm Akin Gump and Transco Energy, and in 1985, Morgan Stanley expanded commodities coverage from metals options to oil markets. Changing Landscape: Energyrisk.com, July 

2009 (at 26). Prior to the financial institutions’ arrival, the commodities markets were best described, according to Henrik Wareborn, head of commodities trading at Natixis, as a shadowy 

place dominated by physical merchants and cartels, which was opened up and transformed 

thanks to the entry of European banks and U.S. investment banks. Insight: Banks struggle to 

adapt or survive in commodities: Reuters, November 5, 2012. 52 Comments on Volcker Rule Regulations Regarding Energy Commodities, submitted by IHS 

Inc., February 2012, at 7–9. 53See, e.g., Citigroup, supra note 16, JPMorgan Chase & Co., supra note 16; Royal Bank of 

Scotland, supra note 16. 

other steel companies to form U.S. Steel.48 Pig iron and steel were the most important commodities of the day, just as important then as energy is today.49 In short, 

U.S. banks and other financial institutions were actively involved in the commodities markets before the Glass-Steagall Act of 1933 or even the National Bank Act 

of 1863. 

Fourth, the Glass-Steagall Act did not prohibit or otherwise limit banks from engaging in commodities activities or affiliating with commodities firms. It only prohibited banks from dealing in securities or having affiliates that were principally 

engaged in underwriting or dealing of corporate debt and equity securities.50

Fifth, while the BHC Act limited the authority of bank holding companies and 

their nonbank affiliates to engage in commodities activities or to own or control commodities firms, U.S. banks, bank holding companies and investment banks were not 

entirely locked out of the physical or energy commodities markets before the GLB 

Act in 1999. The National Bank Act continued to permit national banks to buy and 

sell gold, silver and other precious metals. More importantly, Goldman Sachs, Morgan Stanley and various other investment banks emerged as major players in the 

physical commodities in the 1980s,51 nearly 20 years before passage of the GLB Act 

and nearly 30 years before Goldman Sachs and Morgan Stanley became bank holding companies. 

Since then, financial institutions have assumed key roles in satisfying customer 

needs, offering services that enable more cost-effective commodity price hedging and 

secured financing for a broad range of participants in the commodities sector. In 

fact, reducing financial institution participation in the commodities sector would 

likely reduce liquidity on exchanges and in over-the-counter markets, and even the 

availability of some commodities hedging, financing and other intermediation services. A retrenchment could lead to increased prices and greater price volatility, 

among other consequences.52

Moreover, these investment banks had a strong track record of conducting these 

commodities activities in an efficient, profitable, fair, responsible, and safe and 

sound manner, without any material violations of applicable laws or regulations or 

losses as a result of natural catastrophes. I am not aware of any evidence that their 

activities undermined the safety or soundness of the U.S. financial system, resulted 

in an unfair or inefficient flow of credit, involved any material anticompetitive behavior or insider trading, or otherwise resulted in other harmful effects on the financial system or the wider economy, much less threatened the end of American 

democracy. 

Indeed, their significant involvement and strong risk-management record in conducting commodities activities was almost certainly one of the reasons why Section 

4(o) was considered to be such an acceptable and important way to ensure that the 

GLB Act would provide a ‘‘two-way’’ street of opportunities to investment banks as 

well as commercial banks. It also was almost certainly one of the reasons why the 

Federal Reserve Board determined that physical and energy commodities could be 

traded by nongrandfathered financial holding companies as a complement to their 

existing financial activities, that such activities would produce public benefits that 

outweighed their potential adverse effects and that they could otherwise be conducted in a manner that would not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.53

In short, the close relationship between banking and commodities activities since 

ancient times as well as in this country for most of the past 200 years shows that 

67

54See Omarova, supra note 35, at 4. 55See, e.g., James A. Leach, The Mixing of Banking and Commerce, in Proceedings of the 43rd 

Annual Conference on Banking Structure and Competition, Federal Reserve Bank of Chicago 

(May 2007). 56See, e.g., James Leach, Regulatory Reform: Did Gramm-Leach-Bliley contribute to the crisis?,

Northwestern Financial Review (Oct.15, 2008). 57See supra note 55. 58See supra note 56.

both Section 4(o) of the BHC Act and the complementary powers orders that permit 

certain nongrandfathered financial holding companies to engage in trading physical 

and energy commodities were only incremental expansions of traditional banking 

powers rather than a radical departure as Professor Omarova has argued. While 

electricity and oil are modern commodities, they are not fundamentally different 

from the traditional bank-eligible commodities such as gold and silver in the sense 

that they are fungible, divisible and relatively liquid. 

IV. The Principle of Keeping Banking and Commerce Separate 

The principle of keeping banking separate from commerce can be a useful way to 

simplify the otherwise complex U.S. banking laws. Certainly, the basic structure of 

the National Bank Act and the BHC Act reflects this general principle. But this 

general principle is not a binding legal rule and does not create an impermeable 

wall, and reasonable people can disagree as to where the line is and should be 

drawn. 

For example, Professor Omarova argues that the current commodities powers of 

the grandfathered and nongrandfathered financial holding companies are radically 

inconsistent with this principle.54 Yet former Representative James Leach, who has 

long been one of the most vociferous and consistent champions of the separation between banking and commerce,55 does not believe that the merchant banking power 

or the physical commodities power under either the complementary power orders or 

Section 4(o) of the BHC Act are inconsistent with this principle.56 Thus, he defended 

the general principle in words that are strikingly similar to those used by Professor 

Omarova in her forthcoming article: 

[T]here are few broad principles that could hurriedly be legislated, which 

could in shorter order change the fabric of American democracy as well as 

the economy, than adoption of a new radical approach to this issue [i.e.,

mixing commerce and banking].57

Yet, he said this about its application to the GLB Act:

Fortunately, despite the active advocacy of many in Congress and early on 

support of the Treasury and partial support in the Fed (both later reconsidered), the commerce and banking breach did not occur.58

I agree with former Congressman Leach that the merchant banking power and 

the physical commodities powers under either the complementary powers orders or 

Section 4(o) of the BHC Act are fully consistent with the historic principle of keeping banking separate from commerce. The merchant banking power permits 

nonbank affiliates of insured banks to engage in the traditional financial activity of 

providing capital to small and medium-sized companies, without becoming involved 

in the routine day-to-day management of these companies and with a clear fixed 

time horizon. The physical commodities power is only an incremental expansion of 

the physical commodities powers that banks or their nonbank affiliates have exercised in this country for more than 200 years. If the authority to buy and sell electricity or oil is relatively new, it is probably because they are relatively modern commodities. In addition, it was only relatively recently that that futures contracts in 

these commodities have been authorized for trading on a futures exchange by the 

CFTC or otherwise become sufficiently fungible and liquid. Once they satisfied these 

criteria, however, it was natural that the Federal Reserve would permit trading in 

them as a complement to the financial activity of trading in their related derivative 

contracts. 

V. Should Existing Commodities Powers be Repealed or Scaled Back? 

Professor Omarova has argued that the existing commodities powers of financial 

holding companies should be repealed or severely scaled back to be consistent with 

her concept of the ‘‘foundational principle’’ of the separation of banking from commerce. She has said that ‘‘[t]here is a particular urgency to focusing’’ on whether 

financial holding companies should be allowed to continue engaging in physical and 

energy commodities activities since Goldman Sachs and Morgan Stanley are ‘‘approaching the end of their 5-year grace period during which they must either divest 

68

59See Omarova, supra note 35, at 7. 60See supra note 33. 61See supra note 34. 

their impermissible commercial businesses or find legal authority under the [BHC 

Act] for keeping them. In the fall of 2013, the Board will have to determine whether 

these firms may continue their existing commodities operations and, if so, under 

what conditions.’’59

Before addressing this argument on the merits, let me explain why there is no 

urgency at all to this issue, at least not for the reason Professor Omarova gives. 

Goldman Sachs and Morgan Stanley are indeed approaching the end of the 5-year 

transition period for conforming their activities to the activities restrictions in the 

BHC Act. But that deadline is irrelevant to the grandfathered commodities activities 

of Goldman Sachs and Morgan Stanley because the grandfathering provisions of 

Section 4(o) of the BHC Act have no time limit and do not provide the Federal Reserve Board with the discretion to limit their effect. 

Professor Omarova’s argument that the existing commodities powers of the financial holding companies should be repealed or scaled back is based on seven basic 

predictions:

• Otherwise, financial holding companies will continue to face a variety of new 

and excessive risks that will threaten the safety and soundness of the U.S. financial system.

• The fair and efficient flow of credit in the economy will be threatened.

• Market integrity will be at risk.

• Financial holding companies have or will continue to gain and may abuse market power.

• Traders at financial holding companies will use inside information to engage in 

illegal insider trading.

• American democracy will be at risk.

The Congress that included Section 4(o) in the GLB Act clearly had a different 

view of the benefits and risks of commodities activities than Professor Omarova. 

That Congress said that the grandfathered activities ‘‘shall’’ be broadly construed,60

and that the purpose of the permanent grandfathering provision was to allow qualifying financial holding companies to continue engaging in commodities activities as 

long as certain conditions were satisfied.61 The Federal Reserve that issued the complementary powers orders also had a very different view of the benefits and risks 

of permitting financial holding companies and their nonbank affiliates to buy and 

sell physical and energy commodities. The Federal Reserve Board, applying the 

standard in the BHC Act, found that the public benefits from those activities in 

terms of increased customer choice and increased competition outweighed their 

risks, provided they were conducted in accordance with certain limitations and conditions discussed in Section II of this testimony. 

This Subcommittee should not take action to repeal or curb the existing commodities powers of financial holding companies, including any temporary or permanent 

authority to own companies that control electric power plants, commodities warehouses or oil refineries, unless and until critics provide substantial evidence that 

such powers cannot be exercised without creating a substantial risk to the safety 

or soundness of depository institutions or the financial system generally. It should 

not be enough for critics to merely provide speculative assertions of potential adverse consequences. Nor should this Subcommittee take action to repeal or cut back 

on those powers solely because certain financial institutions or their employees may 

from time to time violate any generally applicable laws or regulations that govern 

commodities activities, such as applicable antitrust, securities, futures or energy 

laws. There is currently no reason to believe that such laws and regulations, and 

the vigilant actions of the Government agencies, exchanges and self-regulatory organizations responsible for implementing and enforcing those laws, would not be sufficient to deter or remedy any such compliance issues. Nor is there reason to believe 

that such issues would never occur if these types of assets were owned only by entities not subject to comprehensive Federal regulation, as all bank holding companies 

are. 

VI. Conclusion 

In conclusion, insured banks, bank holding companies, financial holding companies and their nonbank affiliates are currently permitted to engage as principal in 

futures, forwards and other commodities contracts and, in some cases, owning or 

controlling physical or intangible commodities or related facilities, including electric 

69

1 (DOC 02–1–71) The 1970 Amendments to the Bank Holding Company Act: Opportunities to 

Diversify By ALFRED HAYES President, Federal Reserve Bank of New York, speech before the 

New York Scale Bankers Association in New York City on January 25. 1971, MONTHLY REVIEW. FEBRUARY 1971 available at: http://www.newyorkfed.org/research/monthlylreview/

1971lpdf/02l1l71.pdf. 2 ‘‘BUSINESS FORUM: DOES THE U.S. NEED SUPERBANKS? Why Bigger Isn’t Better in 

Banking’’, Thomas Olson, The New York Times, June 28,1987 available at: http://

www.nytimes.com/1987/06/28/business/business-forum-does-the-us-need-superbanks-why-bigger-isn-t-better-in-banking.html.

power plants, commodities warehouses and oil refineries, subject to certain conditions. Both Congress and the Federal Reserve have previously found that the public 

benefits of these activities outweigh their potential adverse effects. This Subcommittee should not take action to repeal or curb those powers unless and until 

critics provide substantial evidence that such powers cannot be exercised without 

creating a substantial risk to the safety or soundness of depository institutions or 

the financial system generally. 

PREPARED STATEMENT OF JOSHUA ROSNER

MANAGING DIRECTOR, GRAHAM FISHER & CO.

JULY 23, 2013

Banking and Commerce: 

Chairman Brown, Ranking Member Toomey, and Members of the Subcommittee, 

thank you for inviting me to testify today on this important subject. 

We stand on the other side of the largest financial crisis since the Great Depression, a crisis that occurred less than a decade after the repeal and erosion of long 

standing separations of commercial and investment banking and of banking and 

nonfinancial business. 

Since 2003, our Government and central bank have allowed an unprecedented 

mixing of banking and commerce. So far, that grand experiment has gone better for 

the banks than it has for consumers. Electricity users appear to pay more because 

of Wall Street involvement, aluminum for airplanes and soda cans costs more, and 

some say gasoline at the pump costs more—without any measurable benefit to anyone but the banks. This is partially the result of unilateral decisionmaking by the 

Federal Reserve, which Congress empowers to use its judgment to grant exemptions 

to a half-century-old law. Our largest bank holding companies now seek further control over other nonfinancial infrastructure assets through the long-term leasing and 

control over America’s patrimony, in return for short-term influxes of cash. We’re 

on the threshold of a new Gilded Age, where the fruits of all are enjoyed by a few. 

Only Congress can prevent this unfortunate consolidation of American business. 

The Federal Reserve Board should not allow banks to be in businesses that don’t 

directly support the resilience of the payments system or the stability of FDIC insured deposits. ‘‘Left unchecked, the trend toward the combining of banking and 

business could lead to the formation of a relatively small number of power centers 

dominating the American economy. This must not be permitted to happen; it would 

be bad for banking, bad for business, and bad for borrowers and consumers.’’1

President Richard M. Nixon said that in 1969. At the time, a generation had enjoyed relative tranquility in the banking system. That was because in 1935, Congress recognized risks associated with the combination of commercial banking and 

investment banking. And in 1956, recognizing failures to protect the public interest 

from the competitive and systemic risks arising from bank’s control of nonfinancial 

businesses, Congress then passed legislation to prevent bank holding companies 

from exercising such control. Nixon’s remarks came as Congress debated closing a 

loophole in the 1956 Act, and in 1970, Congress did just that. 

The line did not hold. 

In 1987, as rumors began to circulate that the White House was considering supporting the creation of ‘‘financial leviathans’’ or ‘‘Super banks’’,2 Federal Reserve 

Chairman Volcker echoed Nixon’s warning of two decades earlier: ‘‘Widespread affiliations of commercial firms and banks [carry] the ultimate risk of concentrating 

banking resources into a very few hands, with decisions affecting these resources 

influenced by the commercial ownership links, resulting in inevitable conflicts of interest and impairment of impartial lending judgment.’’

At the time, large U.S. banks claimed prohibitions against the combination of 

commercial and investment banks and commercial banks and nonfinancial businesses were putting the United States’ economy at a competitive disadvantage to 

the Japanese banks—then the largest and most concentrated in the world and also 

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3 ‘‘Citicorp and Travelers Plan to Merge in Record $70 Billion Deal: A New No. 1: Financial 

Giants Unite’’, The New York Times, Mitchell Martin, April 7, 1998, available at: http://

www.nytimes.com/1998/04/07/news/07iht-citi.t.html. 4http://www.presidency.ucsb.edu/ws/index.php?pid=56922#axzz1aV0pqgub.

5Federal Reserve Bulletin, Volume 94, First Quarter 2008, ‘‘The Royal Bank of Scotland 

Group plc Edinburgh, Scotland, ‘‘Order Approving Notice to Engage in Activities Complementary 

at disadvantage to the German banks which had no such structural restrictions. 

Volcker’s response was clear: ‘‘I have not heard any concern over the years that 

American banks are not active competitors internationally. They have been at the 

cutting edge of international banking competition and we have very active international competitors among the American banks’’. But the United States’ ‘‘money 

center’’ banks were not ready to give up. 

On April 7, 1998, in defiance of Glass-Steagall, Citibank announced a merger with 

Travelers Group, creating the world’s largest financial services company.3 In 1999, 

with the passage of Gramm-Leach-Bliley, banks were given the ability to combine 

commercial and investment banking and, as a result, were able to expand more 

deeply into nonfinancial businesses. At the November 12, 1999 signing ceremony, 

President Clinton offered the promise that ‘‘this historic legislation will modernize 

our financial services laws, stimulating greater innovation and competition in the 

financial services industry’’ and ‘‘Removal of barriers to competition will enhance 

the stability of our financial services system’’.4

Unfortunately, less than a decade after those words were uttered, our financial 

services industry was more concentrated, more cartel-like and less stable. The result 

was the biggest financial calamity since the Great Depression. While the actions of 

many parties, from policymakers and banks, investors and consumers all led us to 

crisis the fact remains that structured products innovated and sold as a result of 

the combination of commercial and investment banking, devastated Main Street 

USA and ravaged consumers and businesses alike. Banks, which had previously 

been prevented from investment banking activities, had stimulated demand for 

faulty mortgage products. When the house of cards collapsed, the Federal Reserve 

and FDIC were called on to support activities that are clearly outside of their legal 

purpose. 

In 2003, with the stroke of a pen, the Federal Reserve razed the walls between 

deposits and commerce with its approval of Citi’s ownership of Phibro, a nonfinancial business. It did so again, in 2005, when it approved JPM’s entry into the 

physical commodities business. This kind of unilateral extra-legal decisionmaking by 

an entity not directly accountable to voters or Congress or even the executive branch 

has proven perilous to the public and anti-democratic. Lawmakers ought to remove 

the Federal Reserve’s right to rewrite securities laws. 

Today, regulators remain unprepared for the future demands that will be put on 

them and have failed to even manage those early forays that are primary to the 

discussion today. With ‘‘systemically important financial institutions’’(SIFIs) involvement in global and regulated nonfinancial assets there are now too many regulators 

across too many jurisdictions for the public to hope for any regulatory effectiveness. 

While the Federal Reserve remains the primary regulator of our federally chartered 

bank holding companies, today these banks operate businesses overseen by the Federal Energy Regulatory Commission, State utility regulators, the Commodity Futures Trading Commission, the Securities and Exchange Commission, commodity exchanges and their international counterparts. 

In 2005, the Federal Reserve decided that JPMorgan’s ownership of commodities 

would be ancillary to their financial business. They determined that: ‘‘Based on JPM 

Chase’s policies and procedures for monitoring and controlling the risks of Commodity Trading Activities, the Board concludes that consummation of the proposal 

does not pose a substantial risk to the safety or soundness of depository institutions 

or the financial system generally and can reasonably be expected to produce benefits 

to the public that outweigh any potential adverse effects. 

In issuing their approval, they took pains to make it clear that: ‘‘To minimize the 

exposure of JPM Chase to additional risks, including storage risk, transportation 

risk, and legal and environmental risks, JPM Chase would not be authorized (i) to 

own, operate, or invest in facilities for the extraction, transportation, storage, or distribution of commodities; or (ii) to process, refine, or otherwise alter commodities.’’

Yet that is precisely what JPM proceeded to do. 

In 2008, RBS sought Federal Reserve Board approval proposed to enter into physical commodity trading including in certain commodities not approved by the CFTC 

for trading on a futures exchange, long-term energy supply contracts, energy tolling 

and energy management services. The Federal Reserve ruled 5 that each of these acVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00074 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
71

to a Financial Activity’’, available at: http://www.federalreserve.gov/pubs/bulletin/2008/legal/

q108/order7.htm. 6 Note: UNITED STATES OF AMERICA Before the COMMODITY FUTURES TRADING 

COMMISSION, CFTC Docket No. 12–37, ‘‘ORDER INSTITUTING PROCEEDINGS PURSUANT 

TO.’’ Last modified 2012, available at: http://www.cftc.gov/ucm/groups/public/

@lrenforcementactions/documents/legalpleading/enfJPMorganorder092712.pdf (On September 

27, 2012, the CFTC issued an Order against JPMorgan for violations of Section 4a(b)(2) of the 

Commodity Exchange Act: ‘‘deficiency in its newly created automated position limit monitoring 

system for the commodity business . . . used by commodity traders to track their current positions in particular futures contracts . . . after learning of this deficiency, JPMCB utilized a manual position limit monitoring procedure pending correction of the automated monitoring system. 

Despite adoption of this manual position limit monitoring procedure, JPMCB violated its shortside speculative position limit on several occasions.’’). 7 House of Commons of the United Kingdom, Select Committee on Science and Technology, 

‘‘Strategically important metals—Science and Technology Committee’’, ‘‘Examination of Witnesses (Question Numbers 70–107)’’, February 16, 2011, available at: http://

www.publications.parliament.uk/pa/cm201012/cmselect/cmsctech/726/11021602.htm. 8GRAMM–LEACH–BLILEY ACT, PUBLIC LAW 106–102—NOV. 12, 1999, available at: 

http://www.gpo.gov/fdsys/pkg/PLAW-106publ102/pdf/PLAW-106publ102.pdf.

tivities would be ancillary to their financial services businesses assuming certain 

safety and oversight regimes, including the ability to ensure proper position limits, 

were in place.6

Between 2008 and 2010, through its purchase of Bear Stearns and parts of RBS 

Sempra, JPMorgan acquired a number of power plants, electricity tolling agreements, and the metals concentrates and warehouses of Henry Bath. 

By 2011, warnings were being sounded before the United Kingdom’s House of 

Commons: ‘‘I believe there is a lot we can do just by enforcing correct commercial 

law. For example, on the London Metal Exchange there are four very large companies that own the very warehouses that people deliver metal into. J.P. Morgan[2] 

is one of them. They own a company called Henry Bath. They are, therefore, a ringdealing member of the exchange and they also own the warehouse. That is restrictive. They were also reported, at one point, to have had 50 percent of the stock of 

the metal on the London Metal Exchange. That is manipulative. These are things 

that we can do something about here. That would mean the copper price probably 

would not be $10,000 a tonne, which is higher than for some forms of titanium. That 

price is not down to the fact that the metal is not being mined, it is because of such 

actions.’’7

Limits on Nonfinancial Assets: 

Among the key legal requirements that the Federal Reserve must address when 

considering Gramm-Leach-Bliley Act’s allowance of ‘nonfinancial activities’ is: ‘‘the 

attributed aggregate consolidated assets of the company held by the holding company pursuant to this subsection, and not otherwise permitted to be held by a financial holding company, are equal to not more than 5 percent of the total consolidated 

assets of the bank holding company, except that the Board may increase that percentage by such amounts and under such circumstances as the Board considers appropriate, consistent with the purposes of this Act’’.8

When Banks are as large as they are able to lever as much as they do, perhaps 

we should consider whether 5 percent is still an appropriate threshold. When one 

company can have its hands on 50 percent of all metals on LME and still be less 

than 5 percent of total assets, the question becomes one of competition rather than 

arbitrary thresholds. 

Moreover, given the various forms of ‘‘control’’, one should ask how much can that 

threshold can be gamed and what the banks are counting as being in their control? 

As we have now seen, the banks may abide by the letter of the regulation but not 

its spirit, finding various loopholes to exploit as they conduct their business. 

Such is the approach of Goldman when it states that their warehouse unit, Metro, 

never owns the metal in its sheds, rather it merely stores it. After all, it is prohibited from owning metal it stores. Similarly, JPMorgan’s ‘‘tolling agreements’’ with 

electricity generators are a means for them to buy and sell power without having 

to own it. Five-percent appears to be an arbitrary number and easily manipulated 

as a liar loan. 

Even if the Federal Reserve was serious about its efforts to limit nonfinancial activities, the task may be too large because of all of the legal loopholes available to 

banks, witnessed by the proliferation of shell companies, differing ownership structures and subsidiaries. According to research from the Federal Reserve Bank of New 

72

9 ‘‘Fed Reviews Rule on Big Banks’ Commodity Trades After Complaints’’, Bloomberg, Bob 

Ivry, July 20, 2013 available at: http://www.bloomberg.com/news/2013-07-20/fed-reviews-ruleon-big-banks-commodity-trades-after-complaints.html. 10 ‘‘Citi Finalizes SIV Wind-down by Agreeing to Purchase All Remaining Assets’’, Citigroup, 

Press Release, November 19, 2008, available at: http://www.citigroup.com/citi/press/2008/

081119a.htm. 11 ‘‘A Shuffle of Aluminum, but to Banks, Pure Gold’’, The New York Times, David 

Kocieniewski, July 20, 2013, available at: https://www.nytimes.com/2013/07/21/business/ashuffle-of-aluminum-but-to-banks-pure-gold.html?ref=todayspaper&lr=0. 12 ‘‘JPMorgan Unit Can’t Block Calif. Power Project, FERC Says’’, Law 360, Daniel Wilson, 

January 07, 2013, available at: http://www.law360.com/articles/405284/JPMorgan-unit-can-tblock-calif-power-project-ferc-says. 13 ‘‘Feds rule JPMorgan can’t block California power plant changes.’’ The Sacramento Bee, 

Mary Lynne Vellinga, January 5, 2013, available at: http://www.sacbee.com/2013/01/05/

5093370/feds-rule-JPMorgan-cant-block.html#milrss=Capitol%20and%20California.

York, the four biggest bank holding companies had, combined, about 3,000 subsidiaries in 1990. By 2011, the top four had more than 11,000.9

The Risks are Real: 

As we have witnessed during and since the financial crisis, when business-line 

profitability declines or regulatory or reputational risks rise banks tend to exit markets. 

In the world of narrow banking this behavior would pose little risk to our system 

of financial intermediation. Unfortunately, in the various businesses within investment banking, and in critical nonfinancial businesses, withdrawals of liquidity that 

are manageable during normal periods create dislocations during crisis. Contagion 

and the failure of firms within an industry are acceptable realities within a competitive economy. However, we must guard against the risk that such dislocations lead 

to contagion within our banking sector, where the explicit guarantees of depositors 

and direct access to the Federal Reserve’s discount window engender systemic risks 

to the public. 

Conflict between the private motives of managements, with their primary obligation to shareholders, and the public interest are not rare. They exist and are the 

fundamental reason for regulation within industries. Where these conflicts lead to 

abuses that circumvent regulation they often can lead to failure, as was the case 

with Enron. Unfortunately, where Enron could be shut down easily, the reality is 

that our systemically important financial institutions are more complex. Unlike a 

bank, Enron did not have ability to drive capital away from competitors and this 

reduces the development of natural competitors and possible successor firms. Enron 

did not have the explicit guarantee that backs the deposits of our banks or the implied guarantees still conferred by the market, even in the wake of the Dodd-Frank 

Act. While banks have four types of risk, only the failure of reputational risk management drives necessary collapse. Enron’s reputational risk posed no systemic risk. 

While operational, liquidity and credit risks can cause the downfall of a firm the 

value of the core assets can typically be transferred, even at a loss, to other industry 

participants. Unfortunately, reputational risk within a systemically important financial institution can result in requirements that the firm backstop assets, even those 

that were legally isolated. In 2008 Citi was obligated to guarantee and then repurchase $17.4 billion of structured investment vehicles (SIVs).10 As a result, the failure of the Federal Government to backstop a firm’s reputation against such losses 

during a time of crisis could exacerbate panics and lead to contagion and the creation of larger systemic problems. 

While there is no suggestion that the current reputational problems in banks’ 

nonfinancial businesses are of a scale that could create a systemic crisis, the possibility of such failures occurring in the future must still be considered by prudential 

regulators and policymakers. 

This past weekend the New York Times demonstrated how Goldman Sachs became a key middleman in the aluminum industry, possibly adding cost to consumers 

without any real benefit . The warehouse business worked11 fine without them; now, 

with their presence in the market, it can be argued that it is neither better nor 

more efficient, only more expensive. 

Similarly, in January 2013, the FERC took action against the JPMorgan for its 

attempts at preventing the implementation of State-requested changes to two Huntington Beach, California, power plants owned by AES Corporation.12 The State 

deemed the work necessary in order to replace lost power capacity that resulted 

from the shutdown of the San Onofre nuclear plant.13 JPM sought to prevent the 

changes and claimed its marketing contract with AES gave them the right to veto 

the work. While the bank’s motives were not stated it is reasonable to consider that 

the firm sought to profit from the higher peak energy prices that would have reVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00076 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
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14 Rosner, Joshua, Housing in the New Millennium: A Home Without Equity is Just a Rental 

with Debt, June 29, 2001, p.5. Available at SSRN: http://ssrn.com/abstract=1162456 or http:/

/dx.doi.org/10.2139/ssrn.1162456 (See: ‘‘In an effort to restore the promises of the ‘‘American 

dream’’, the Clinton Administration embarked on a major initiative to increase homeownership. 

In 1993, the Census Bureau recommended ways to do so. Lowering down payment requirements 

and increasing available down payment subsidies were suggested. In early 1994, HUD Secretary 

Henry Cisneros met with leaders of major national organizations from the housing industry. By 

early fall, the Clinton Administration, along with over 50 public and private organizations 

agreed on ‘working groups’, a basic framework and the core objectives of what they named the 

‘‘National Homeownership Strategy’’. The creators of the strategy of the National Partners in 

Homeownership (‘NPH’) include, among others: HUD, Federal Deposit Insurance Company, 

Fannie Mae, Freddie Mac, the Mortgage Bankers Association, the American Institute of Architects, America’s Community Bankers, the U.S. Dept. of Treasury and the National Association 

of Realtors. Their primary goal was ‘‘reaching all-time high national homeownership levels by 

the end of the century’’. This was to be achieved by ‘‘making homeownership more affordable, 

expanding creative financing, simplifying the home buying process, reducing transaction costs, 

changing conventional methods of design and building less expensive houses, among other 

means’’.4 It was almost unprecedented for regulators to partner this closely with those that they 

have been charged to regulate.’’) 15 Citi Capital Advisors, Overview, last accessed July 22, 2013, available at: https://

www.citicapitaladvisors.com/ciiOverview.do (See: ‘‘Citi Infrastructure Investors (CII) manages 

Citi Infrastructure Partners (CIP), a multi-billion infrastructure fund that has controlling interests in mature transportation and utility infrastructure assets. CIP’s portfolio includes: Kelda, 

owner of Yorkshire Water, a regulated UK water and sewer company; Itinere Infraestructuras 

S.A., a Spanish toll road concessionaire; DP World Australia, a container terminal business in 

Australia; and Vantage Airport Group, an airport investment and management company with 

airports in Canada and the UK.’’) 16See, as example, https://www.citicapitaladvisors.com/ciiOverview.do and https://

www.JPMorgan.com/cm/ContentServer?pagename=Chase/Href&urlname=JPMorgan/am/ia/

investmentlstrategies/investmentsGroupLHK and http://www.morganstanley.com/infrastructure/portfolio.html and http://www.goldmansachs.com/what-we-do/investing-and-lending/direct-private-investing/equity-folder/gs-infrastructure-partners.html. 17 JPMorgan IIF Acquisitions LLC Maher Terminals, LLC, Letter to: Mr. Ryan Pedraza Program Manager, Virginia Office of Transportation Public-Private Partnerships, last accessed July 

22, 2013, available at: http://www.vappta.org/resources/RREEF%20and%20

JPMorganlDetailed%20Proposal.pdf.

sulted from its actions to prevent new capacity from coming on line. While the Federal Reserve, as the primary regulator of the holding company, had authorities over 

the bank’s activities it appears not to have asserted any authority. 

The Goal is Control Rather than Consolidating Ownership: 

Today, there are few financial assets classes left to support growth of the size necessary to generate returns proportional to our largest banks’ needs. Seeking new returns, our largest and most systemically interconnected banking firms, under the 

guise of infrastructure development, are turning their focus to an expansion of their 

control of nonfinancial assets. Bank ownership and control of physical commodities 

and the warehouses that store those commodities is the subject that brings us here 

today, but they are only a small part of the larger systemic risks being created by 

those excursions across the commercial divide. 

Our largest bank holding companies now seek to ‘‘control’’ other nonfinancial infrastructure assets and will again wrap their intentions in the flag of this great Nation—arguing that ‘‘public private partnerships’’ are the key to redevelopment of our 

infrastructure. This is the same strategy employed, through the largest public-private partnership in our history, the National Partners in Homeownership, which 

was supposed to be the key to a stable future for homeowners.14

The benefits and risks of public investment in essential infrastructure, as well as 

the privatization of nonessential and nonutility infrastructure, can be debated. The 

control of assets in which the public has funded and invested, often for generations, 

by our largest financial firms should give elected officials and regulators pause. 

Today, the Asset Management units of several of these firms are seeking ‘‘controlling interests’’ nonfinancial assets without ownership 15 of those assets. 

To effect these goals the firms are pitching pension and other investors on investments in the leasing, operation and control of infrastructure assets. To date, these 

firms have attained ‘‘controlling interests’’16 and have ‘‘active control strategies’’17—

in the United States and abroad. They currently control ports, airports, electric utilities, water utilities, sewer utilities, wind power farms, parking meters, solar power 

generation, parking garages, rail leasing, charter schools and other assets. 

According to the firms’ own marketing materials, these assets are attractive, because of the ‘‘monopolistic’’ and ‘‘quasi-monopolistic’’ nature of the assets. They can 

‘‘support more debt/leverage without incurring more risk than real estate’’ and have 

74

18 CIPFA Scotland Asset Management Workshop, ‘‘Investing in Infrastructure’’, JPMorgan, 

Larry Kohn, Managing Director, March 1, 2007, last accessed July 22, 2013, available at: http:/

/www.slideshare.net/Jacknickelson/cipfa-scotland-asset-management-workshop-investing-in. 19 JPMorgan IIF Acquisitions LLC Maher Terminals, LLC, Letter to: Mr. Ryan Pedraza Program Manager, Virginia Office of Transportation Public-Private Partnerships, last accessed July 

22, 2013, available at: http://www.vappta.org/resources/RREEF%20and%20JPMorganl Detailed%20Proposal.pdf. 20PPP Failures, Scribd, last accessed July 22, 2013, available at: http://www.scribd.com/doc/

155206053/PPP-Failures. 21 JPMorgan IIF Acquisitions LLC Maher Terminals, LLC, Letter to: Mr. Ryan Pedraza Program Manager, Virginia Office of Transportation Public-Private Partnerships, last accessed July 

22, 2013, available at: http://www.vappta.org/resources/RREEF%20and%20

JPMorganlDetailed%20Proposal.pdf. 22FDIC Banking Review, ‘‘The Future of Banking in America The Mixing of Banking and 

Commerce’’, Current Policy Issues, Christine E. Blair, last updated February 11, 2005, last 

accessed July 22, 2013, available at: http://www.fdic.gov/bank/analytical/banking/2005jan/

article3.html#30 (See: ‘‘Several banks have recently faced losses from lines of credit that were 

extended to corporate customers in return for receiving that corporation’s underwriting business. 

In this sense, legal tying or cross-selling can lead to losses that could threaten the bank’s safety 

and soundness.’’) 

‘‘attractive inflation protection characteristics’’.18 Though the firms have control over 

these assets and are responsible for the management and operations of the assets, 

investors in the funds in fact, own the assets. Through their control, these firms can 

target majority and control positions to enable the implementation of their business 

plans and other strategic initiatives via a disciplined ‘‘active asset management approach.’’19

There are Substantial Public Policy Issues to be Considered: 

Besides the reputational risks of the projects failing,20 leaving investors with 

losses and municipalities with long-term leases and the possibility of limited refinancing opportunities, there are other risks to the bank operators that should be 

of concern. 

Conflicts of Interest 

While, as example, JPMorgan claims to be ‘‘a long-term infrastructure owner who 

understands its responsibilities to all stakeholders’’21 the reality is, that as a fiduciary, there are internal conflicts in these transactions. The firms have a fiduciary 

obligation that may be unmanageable to pension and other investors—as they did 

during the expansion of the Residential Mortgage Backed Securities (RMBS) and 

Collateralized Debt Obligation (CDO) markets. Even if these investments are legally 

isolated, as we witnessed with Citi’s SIVs, the firm may be pressed or required to 

reconsolidate. Moreover, contractual obligations to the lessor, operating and contracted partners (that may also be investment-banking clients 22) and obligations to 

customers of the operating entity all pose risks that become difficult for a bank 

holding company to manage. 

Furthermore, in a concentrated financial industry, the presence of a bank affiliate 

as an operator of nonfinancial businesses poses significant risks to competition. 

These risks include:

• Informational advantage that can result from ineffective controls and therefore 

allow a firm’s trading desk to gain market information about underlying financial contracts or securities that can be used to benefit the firm or its customers 

or disadvantage customers and competitors.

• The risk that a firm that controls an electric utility and also, through a separate affiliate, has tolling agreements, can manipulate the availability of energy 

for advantage.

• The risk that a bank may choose to deny lending or underwriting to a competitor of their commercial affiliate.

• The risk that a bank may choose to lend, at preferential rates, to a commercial 

affiliate.

• The risk that a bank may, legally or illegally, tie loans to the purchase of a 

commercial affiliate’s products. 

Concentration of Economic Power Within Banking 

When Glass-Steagall was enacted, recent history served as a reminder of the risks 

that existed with the combination of banking and commerce and with the concentration of power within a small number of financial companies. The need to protect 

against these dual risks remains as much of an imperative today as it did then. 

75

23 J.P. Morgan: a Biography, Liz Bowen, Fordham University, last accessed July 22, 2013, 

available at: http://www.fordham.edu/academics/collegeslgraduatels/undergrad uatelcollege/fordhamlcollegelatll/speciallprograms/honorslprogram/hudsonfultonlcele

bra/homepage/biographies/jplmorganl32212.asp. 24 Chicago Fed Letter, ‘‘The Mixing of Banking and Commerce: A conference summary’’, 

Nisreen H. Darwish, Douglas D. Evanoff, Essays on Issues, The Federal Reserve Bank of Chicago, Number 244a, November 2007, last accessed July 22, 2013, available at: http://

qa.chicagofed.org/digitallassets/publications/chicagolfedlletter/2007/cflnovember2007l 244a.pdf. 25 CIPFA Scotland Asset Management Workshop, ‘‘Investing in Infrastructure’’, JPMorgan, 

Larry Kohn, Managing Director, March 1, 2007, last accessed July 22, 2013, available at: http:/

/www.slideshare.net/Jacknickelson/cipfa-scotland-asset-management-workshop-investing-in p.4 

(See: Debt represents 84 percent of Skyway’s $1.83 billion concession price. Under a concession 

structure, the private sector concessionaire captures projected revenue growth in exchange for 

assuming operating risk). 

Only a generation before the Great Depression, J.P. Morgan began to amass his 

power over both banking and, with the powers of the purse, commerce. The overindebted railroad industry, plagued by falling rates provided Morgan with an opportunity and by 1900 he had consolidated the industry and controlled one-sixth of the 

Nation’s rail network. 

Soon, he turned his attention to the control of the electricity and steel industries. 

‘‘As a result of this extreme consolidation, most of which occurred under Morgan’s 

watch, businesses depended on Wall Street and Morgan’s money. Because most had 

no choice but to give up managerial control, it was the bankers who approved mergers, handled legal matters, underwrote securities, appointed managers and framed 

policies. Even more importantly, the bankers set initial stock values for companies 

and marketed them on an international level. Therefore, if a company did not get 

Morgan’s approval, it did not make it to market; it was doomed.’’23

In the aftermath of the crisis, with our largest financial institutions having become ever larger and more concentrated, there is an opportunity for those firms designated as SIFIs to use their market power to subvert and distort competition and 

development in the real economy. Moreover, if they are allowed to control vast networks of nonfinancial assets, either as principal or agent, they will have the power 

to pick winners and losers in the commercial world, not based on the productivity 

or competitive advantages of those firm’s operations but as a result of their own 

profit motives. 

As Cam Fine of the ICBA warned in 2007: ‘‘Over time, the individual, the small 

business owner, small towns, and rural countryside will suffer economically. More 

power will devolve to fewer and fewer hands, and economic diversity will whither, 

and with it, choices. While population centers may flourish, the decline of rural and 

small town America will accelerate . . . The less advantaged of our society will become even more disadvantaged.’’24

Others have argued that the strong regulatory oversight by U.S. regulators and 

the clear separation of banking and affiliates ameliorate these risks but their arguments were largely disproved during the crisis as bank holding companies demonstrated that their first the impulse was to use bank resources in support of failing 

commercial affiliates, potentially jeopardizing the bank’s safety and soundness. Such 

an effort was followed by a focused effort to move affiliate obligations into the banks 

to be supported by the FDIC and the Federal Reserve. 

Catastrophic Risk 

By allowing bank holding companies to ‘‘control’’ these assets and accept the operating risks of those assets, regulators are supporting the accumulation of potentially 

catastrophic and systemic risks associated with the underlying operations . Imagine 

if a systemically important financial institution 25 was in the business of transporting oil and was unfortunate enough to own the Exxon Valdez? The systemic implications to the financial system and un-priced risks to counterparties could result 

in the risk of a series of systemically significant failures. 

Conclusion 

While our banks claim they provide efficiencies and that they must be able to 

compete with the largest global banks it must be pointed out that many of these 

efficiencies were merely an arbitrage with the benefits accruing to executives and 

losses apportioned to investors and the public. 

European governments have, through actions and deeds in Greece, Ireland, Cyprus, Italy and elsewhere, explicitly accepted their banks as sovereign obligations. 

In the United States both parties have stated their intent, whether or not we have 

yet become successful in our efforts, that never again will our banks receive any imVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00079 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
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plied or explicit Government support for activities outside of the narrow banking 

function of deposit insurance. 

With that goal clearly stated we must recognize the most troubling issue here before us today is that dominance of global banks in our country has set us down a 

slippery slope where those firms can justify, and convince captured regulators, that 

whatever they do is in the national interest. And in a way, they are right about 

that because, should they fail, the entire country will pay the price for it. Make no 

mistake about that—there is no other way to deal with such a calamity. 

The growth of big banks is a case of too much of a good thing metastasizing into 

a bad thing. What started out with a limited safety net designed to protect the payments system and to provide a safe place for small, unsophisticated depositors to 

place their savings has morphed into an anticompetitive system where Governmentsubsidized banks can use unfair advantage to enter and dominate any market or 

business, financial or nonfinancial, that they choose. This is inconsistent with those 

concepts of competition and creative destruction that have done so well for our country. 

Let me make it clear, the people running these banks are smart, smarter than 

many of us. The problem isn’t that they are dumb, malevolent, unpatriotic or dishonest. The real problem has three components:

• First, they are human, which means they are fallible and they will fail, repeatedly, just like the rest of us;

• Second, they are motivated by corporate values, which don’t allow them to sacrifice or compromise to protect public interests, even if they would personally 

be inclined to;

• Third, they are huge and of such size because they enjoy public safety net benefits that foster unlimited growth, which includes the sort of inappropriate 

growth in nonbanking businesses discussed here today.

There is much for people across the political spectrum to dislike about this. SIFI 

activity in the energy markets and other commercial markets paints a clear picture 

of what we should not allow banks to do. Government-subsidized businesses should 

be boring, low profit, and limited by original purpose. 

Reflecting on the Federal Reserve Board’s 2005 letter allowing JPMorgan to hold 

physical commodities while prohibiting them from storing those commodities should 

lead legislators to reconsider the authorities they have vested in the Fed regarding 

these activities. One has to look with concern at the poor job of the Fed in policing 

the limitations of their order allowing banks to enter commodity businesses. Still, 

let us move past that and on to the real issue. The Federal Reserve Board should 

not be allowing banks to be in businesses that don’t directly support the resilience 

of the payments system or the stability of FDIC insured deposits. 

There is a lot of undoing to be done in banking. The public good and the benefits 

to Main Street and free enterprise, rather than enrichment of SIFI executives, must 

be our primary focus. 

PREPARED STATEMENT OF TIMOTHY WEINER

GLOBAL RISK MANAGER, COMMODITIES AND METALS

MILLERCOORS LLC

JULY 23, 2013

Good morning Mr. Chairman and Members of the Committee. My name is Tim 

Weiner. I am the Global Risk Manager of Commodities and Metals for MillerCoors, 

a U.S. brewing company headquartered in Chicago, IL. 

MillerCoors employs 8,800 people here in the United States, working in eight 

breweries in Irwindale, CA, Trenton, OH, Eden, NC, Fort Worth, TX, Albany, GA, 

Elkton, VA, Golden, CO, and Milwaukee, WI. We also operate the Leinenkugel’s 

craft brewery in Chippewa Falls, WI, and the Blue Moon Brewing Company in Denver, CO. We sell our products in all 50 States and we contract brew for export 

through associates. MillerCoors insists on building its brands the right way: through 

brewing quality, responsible marketing, sales, environmental and community impact. 

This year, MillerCoors will brew and ship in excess of 60 million barrels of beer 

within the United States. Our company will package about 60 percent of that beer 

in aluminum cans and aluminum bottles. That’s the equivalent of about 4,000 747 

jumbo jets worth of aluminum each year. Beer in aluminum containers has a long 

history within our company. In fact, Bill Coors invented the seamless two-piece aluVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00080 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
77

minum container in 1958 and started the first aluminum can recycling program 55 

years ago. 

To make our cans, we need aluminum—a lot of aluminum. In the extensive portfolio of commodities that we manage, aluminum is our single largest price risk. That 

risk, and the importance of aluminum to our business, is why I am here today. As 

a representative of MillerCoors, I will share with you my company’s concerns about 

the warehousing practices conducted by members of the London Metal Exchange 

(LME). I will explain how the LME’s rules allow those unfair practices to impact 

U.S. manufacturing. I will explain why U.S. legislators and regulators, including the 

Federal Reserve, should strengthen their oversight of bank holding company activities, which are creating an economic anomaly in the aluminum and other base metal 

markets. 

Mr. Chairman, my statement is neither an indictment of free market principles 

nor the existing exchange traded futures system here in the United States, which 

we use regularly to hedge our commodity price risks and volatility. In fact, our hope 

is the LME system could one day function as transparently and efficiently as the 

exchanges here in the United States. 

Before I begin, my concerns are not unique to MillerCoors or even the beer industry. MillerCoors is just one of a number of companies that purchase aluminum for 

the production of a number of everyday products used by Americans, from beer and 

soda cans to automobiles and airplanes. MillerCoors is joined in airing its concerns 

about the LME by a range of companies from a variety of business sectors, including 

The Coca-Cola Company, Novelis, Ball Corp., Rexam, Dr. Pepper Snapple Group, 

D.G. Yuengling Brewing Company, North America Breweries, Rogue Brewery and 

Reynolds Consumer Products to name just a few. 

The risk management team at MillerCoors also manages the risk for the other 

commodities we use to brew beer and the energy to power our eight breweries. 

Those include barley, corn, natural gas, electricity to fuel our breweries and diesel 

fuel for our trucking operations. We spend billions of dollars annually on these commodities, and must manage the risk of price fluctuations to be an efficient brewer. 

In order to properly manage this risk, we created strict governance in the form of 

a commodity risk policy that clearly forbids speculation in our hedging program, as 

we are not a trading operation. 

Historically, consumers and suppliers purchased aluminum directly from aluminum producers. The LME was always a market of last resort—where aluminum 

producers would go to sell their stock in times of oversupply and where aluminum 

users would go to buy metal in times of extreme shortage. This is a key function 

of all exchanges. However, Mr. Chairman, over the past few years, the market for 

aluminum and other base metals has drastically changed. My company and other 

manufacturers can no longer plan to buy the aluminum we need directly from aluminum producers. 

I am not an expert in the Bank Holding Company Act, but I understand under 

that statute, the Federal Reserve has the authority to decide whether commercial 

and physical commodity activities like the LME warehouses are appropriate lines 

of businesses. Under this Federal Reserve exemption, U.S. bank holding companies 

have effective control of the LME, and they have created a bottleneck which limits 

the supply of aluminum. Aluminum prices in general and for can sheet in particular 

have remained inflated relative to the massive oversupply and record production. 

What’s supposed to happen under these economic conditions? When supplies rise 

while demand is flat to down, prices should fall. 

Instead, what’s happening is that the aluminum we are purchasing is being held 

up in warehouses controlled and owned by U.S. bank holding companies, who are 

members of the LME, and set the rules for their own warehouses. These bank holding companies are slowing the load-out of physical aluminum from these warehouses 

to ensure that they receive increased rent for an extended period time. Aluminum 

users like MillerCoors are being forced to wait in some cases over 18 months to take 

physical delivery due to the LME warehouse practices or pay the high physical premium to get aluminum today. This does not happen with any of the other commodities we purchase. When we buy barley we receive prompt delivery, the same with 

corn, natural gas and other commodities. It is only with aluminum purchased 

through the LME that our property is held for an extraordinary period of time, with 

the penalty of paying additional rent and premiums to the warehouse owners, until 

we get access to the metal we have purchased. 

What’s most concerning is that all the key elements of the LME (ownership/

warehousing/policy control) for aluminum and other base metals worldwide, are controlled by the same entities—bank holding companies. 

The practical effect of these LME warehouse rules is to essentially create a funnel, with a wide end at entry and a very narrow end exiting out. At the wide end, 

78

there is a massive supply of metal going into these warehouses, at the rate of tens 

of thousands of metric tons per day. At the narrow end, the LME warehouses, such 

as those in Detroit, use minimum load-out rates as maximums, releasing no more 

than 3,000 MT/day. Just imagine a warehouse with a big garage door marked ‘‘in’’ 

and the small front door of your house marked ‘‘out.’’ A lot more metal goes into 

the warehouse than comes out. U.S. manufacturers want to take possession of their 

metal, but cannot because the LME rules allow the warehouses to collect rent for 

every day, month and year that the aluminum sits in these LME warehouses. The 

current system does not work. It has cost MillerCoors tens of millions of dollars in 

excess premiums over the last several years with no end in sight. My company and 

others estimate that last year alone, the LME warehouse rules have imposed an additional $3 billion expense on companies that purchase aluminum. 

As I stated earlier, my job is to reduce commercial risk associated with our business. We are challenged in managing our aluminum costs due to these LME warehouse practices. Aluminum prices have become inflated and this flows directly 

through to the price of can sheet. Let me restate one very important point. Although 

the LME has ordered strict minimum release requirements for warehouses controlled by LME members, those minimums are being treated as maximums and continue to restrict the flow of metal out to the market. No matter what the markets 

demand, the approved LME warehouses only release the minimum required amount 

of metal each day, which is public record. This only increases the length of the 

queues waiting for delivery. The warehouses are not responding to ordinary supply/

demand market conditions in part because of two things.

1. The fact that the bank holding companies that are members of the LME also 

comprise the LME Warehouse Rules and Regulations committee and also own 

a number of LME-certified warehouses. This structure is unprecedented in 

other global futures exchanges. Specifically, the largest LME principal through 

December 2012 was Goldman Sachs, which through its ownership of Metro 

International Trade Services owns one of the largest warehouse complexes in 

the LME system. They control 29 of the 37 warehouse locations at the LME 

approved warehouse site in Detroit. This site houses approximately one quarter of the aluminum stored in LME facilities globally and over 70 percent of 

the available aluminum in North America. Henry Bath (100 percent owned by 

JPMorgan), Glencore and other trading companies also own LME warehouses.

2. There is no clear ‘‘regulator’’ or oversight of the London Metal Exchange warehouses, the LME itself is a self-regulated entity. In addition to direct talks 

with the LME, both formal and informal, we have urged regulators in the 

United States, the United Kingdom and the European Union to give thoughtful 

consideration to the effect of LME business practices on the industries that 

rely on a supply of aluminum priced by reasonable market conditions. Specifically, we have asked the UK Financial Services Authority (recently reorganized 

as the Financial Control Authority) and the CFTC to regulate the LME system 

as it pertains to the commodity metals market. Both agencies have indicated 

they are uncertain whether they have the regulatory authority necessary.

On the commercial side, my company and other aluminum users have attempted 

over the last year to resolve our concerns directly with the LME. We offered up sensible and reasonable recommendations to expedite and improve the current LME 

business practices and mitigate their adverse impact on aluminum purchasers. We 

specifically asked the LME to amend their rules to allow:

• A daily rental to be charged for a limited period following cancellation of a warrant (i.e., 30–45 days).

• A daily load out rate for each warehouse shed at each official site, rather than 

by company at an official site.

• A daily load-out rate by warehouse shed that would clear the queue within a 

reasonable period.

• A review and adjustment of load-out rates more frequently so that bottlenecks 

do not persist.

The LME dismissed our proposals. The changes they have made and recently proposed to increase the daily load-out rates are minimal and would seem to make no 

real impact, but we look forward to submitting comments on their proposed rule 

changes. 

In closing, in the view of MillerCoors and other companies in similar situations, 

the LME’s current practices must be changed. We simply ask for the same regulatory and legislative oversight of the LME that other U.S. futures exchanges receive in order to level the playing field and ensure a transparent balanced funcVerDate 0ct 09 2002 15:58 Jan 31, 2014 Jkt 000000 PO 00000 Frm 00082 Fmt 6633 Sfmt 6621 S:\DOCS\82568.TXT SHERYL
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tional market for buyers and sellers. This oversight will restore the free market 

functioning of the LME, which will regain our confidence in the institution and permit us to successfully brew, ship and sell our fine beers. 

On behalf of MillerCoors and any other companies adversely impacted by the 

practices of the LME, I thank the Committee for allowing me to appear and testify 

today. I am happy to answer any questions that you have. 

(81)

RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM SAULE T. OMAROVA 

Q.1.a.–b. The ‘‘grandfathering’’ provision in the Bank Holding 

Company Act was clearly included in the Gramm-Leach-Bliley Act 

by interested parties who foresaw that investment banks would 

someday want access to the Federal Reserve’s discount window and 

other facilities. Regulators point out that it is a statutory exemption, and argue that they cannot prevent eligible institutions from 

engaging in many nonfinancial activities. The language is arguably 

ambiguous and open to a narrow interpretation by the Federal Reserve, if it wanted to do so.

a. Should the Federal Reserve take a tougher line by narrowing 

the scope of nonfinancial activities that financial holding companies can engage in—both under section 4(k) and 4(o)?

b. As a policy matter, what value does the 4(o) provision add to 

enable regulatory safety, soundness and capacity?

A.1.a.–b. Did not respond by publication deadline.

Q.2. The Federal Reserve has other tools to address nonfinancial 

activities that it finds disconcerting or impermissible. For example, 

Section 5 of the Bank Holding Company Act authorizes the Fed to 

force a bank holding company to divest a nonbank subsidiary that 

‘‘constitutes a serious risk to the financial safety, soundness or stability’’ of any bank subsidiary.

• Should the Federal Reserve use this section 5 authority to 

force financial holding companies to divest themselves of subsidiaries that expose it to risks—for example, an oil spill or an 

oil tank explosion—that are not the typical purview of banking 

regulators?

A.2. Did not respond by publication deadline.

Q.3.a.–c. The Federal Reserve order approving Goldman Sachs’ formation into a bank holding company states ‘‘ . . . Goldman expects 

promptly to file an election to become a financial holding company 

pursuant to sections 4(k) and (l) of the BHC Act and section 225.82 

of the Board’s Regulation Y. Section 4 of the BHC Act by its terms 

provides any company that becomes a bank holding company 2 

years to conform its nonbanking investments and activities to the 

requirements of section 4 of the BHC Act, with the possibility of 

three 1-year extensions. Goldman must conform to the BHC Act 

any impermissible nonfinancial activities it may conduct within the 

time requirements of the Act.’’

a. To the best of your knowledge, has the Federal Reserve Board 

developed a list or given any written guidance of what constitutes as ‘‘impermissible nonfinancial activities’’ at any point 

during the 2-year conformance period?

82

b. Has the Federal Reserve Board determined any of the assets 

held by the two former investment banks, Goldman Sachs and 

Morgan Stanley, as ‘‘an impermissible nonbanking activity’’ 

after they were made into federally insured FHCs in 2008?

c. In essence, is it fair to say the Board legally transformed the 

two largest investment banks into financial holding companies 

in 2008, and then allowed them to continue to operate as investment banks by enabling them to hold and acquire traditionally impermissible nonbanking commercial and physical 

commodities assets?

A.3.a.–c. Did not respond by publication deadline.

Q.4.a.–b. You have stated, ‘‘ . . . it is virtually impossible to glean 

even a broad overall picture of Goldman Sachs, Morgan Stanley 

and JPMorgan’s physical commodities and energy activities from 

their public filings with the Securities and Exchange Commission 

and Federal bank regulators . . . [this] added complexity makes 

the financial system less stable and more difficult to supervise.’’

a. Please further describe the potential regulatory capacity challenges since you have stated regulators may be incapable of 

effectively monitoring and overseeing large financial conglomerates.

b. Please describe the operational and supervisory risks at the 

institutional level that may arise given the increased complexity from traditionally nonbank, physical commodity and 

energy holding.

A.4.a.–b. Did not respond by publication deadline. 

RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM RANDALL D. GUYNN 

Q.1. You state in your written testimony that ‘‘ . . . financial institutions are permitted to engage in commodities activities to meet 

the needs of customers, increase customer competition, act as more 

effective intermediaries between producers and endusers, provide 

increased liquidity to the markets and lower prices to consumers, 

and increase the diversification of the revenue streams and exposures of the financial institutions.’’

What evidence exists to prove that this statement holds true in 

reality?

A.1. Since these questions and answers are for the record, let me 

first note some slight but material errors in the question regarding 

the actual words I used in my written testimony, as well as provide 

some context for the passage. 

The actual statement in my written testimony read as follows:

These financial institutions are permitted to engage in commodities activities to meet the needs of customers, increase customer choice, increase competition, act as more effective intermediaries between producers and end 

users, provide increased liquidity to the markets and lower prices to consumers, and increase the diversification of the revenue streams and exposures of these financial institutions.

As made clear by the totality of my written statement and the 

context of this passage, this passage was describing the findings 

made by the Office of the Comptroller of the Currency (the ‘‘OCC’’) 

83

in its various orders determining that national banks are permitted 

to buy and sell futures, forwards and other commodities contracts 

as a component or incident of the business of banking, subject to 

certain risk-mitigating limitations and conditions. It was also describing the findings by the Board of Governors of the Federal Reserve (the ‘‘Federal Reserve Board’’) in its various orders as to why 

certain financial holding companies and their nonbank affiliates 

(but not their insured bank affiliates) are permitted to make or 

take delivery of, or otherwise own or control, certain physical or intangible commodities, and to have certain relationships with commodities storage, generation, refining, transportation or other related facilities, subject to certain risk-mitigating limitations and 

conditions, as a complement to the financial activity of buying and 

selling commodities contracts. Among the risk-mitigating conditions imposed by the Federal Reserve Board in its complementary 

powers orders is that the power to make or take delivery, or otherwise own or control, physical commodities is limited to commodities 

that are sufficiently fungible and liquid. 

See, e.g., Randall D. Guynn, Luigi L. DeGhenghi & Margaret E. 

Tahyar, Foreign Banks as U.S. Financial Holding Companies, in 

REGULATION OF FOREIGN BANKS & AFFILIATES IN THE 

UNITED STATES §§ 11:2[3], 11:4[9], pp. 957–960, 1025–1029 

(Randall D. Guynn, Editor, 7th edition 2013); Gibson Dunn, Federal Reserve to Re-evaluate the Permissibility of Physical Commodities Trading: The Rationale Historically and Today (July 22, 

2013). 

As made clear later in my written testimony, these findings are 

the considered findings of the OCC and the Federal Reserve Board, 

and were balanced against their findings about the potential adverse effects of these activities and the ability of various risk-mitigating limitations and conditions to address those potential adverse 

effects. I do not know whether the OCC or the Federal Reserve 

Board conducted any empirical studies to test whether these findings held true in reality or whether the applicants for the particular orders provided any empirical evidence to support these 

findings in their application materials. 

Most of these findings are obviously true, however, based on 

widely accepted, fundamental principles of basic economics. As a 

result, most people would find it unnecessary and even a waste of 

public and private resources to conduct or require costly empirical 

studies to support them. 

Let me give a few examples. One set of findings is that allowing 

insured banks or their nonbank affiliates to enter into commodities 

contracts with customers, including allowing certain nonbank affiliates to make or take physical delivery or otherwise own or control 

physical commodities that are sufficiently fungible and liquid, will 

‘‘meet the needs of customers, increase customer choice, increase 

competition, . . . provide increased liquidity to the markets and 

lower prices to consumers.’’ These findings are obviously true under 

virtually all likely circumstances. 

For example, if a customer like JetBlue has the option to hedge 

its exposure to the volatility of jet fuel prices or finance its inventory of jet fuel by entering into contracts with insured banks or 

their nonbank affiliates, its needs will be met better and it will 

84

have more choice in counterparties and financial products than if 

banks and their nonbank affiliates are not permitted to enter or 

are forced to exit the commodities markets. Similarly, absent anticompetitive behavior that is adequately prohibited by our antitrust 

laws, the commodities markets will be more competitive, not less 

competitive, if banks and their nonbank affiliates are allowed to 

enter and remain in the commodities markets, and are not forced 

to exit them, compared to a world in which competitors in commodities markets are protected by regulatory barriers to entry that 

keep banks or their nonbank affiliates out of that market or regulatory mandates that force them to exit. See, e.g., Gregory Meyer, 

A ban on banks holding physical commodities could backfire, FINANCIAL TIMES (July 26, 2013). Indeed, the very heart of our 

antitrust (pro-competition) laws is to break down barriers to entry 

or mandates to exit, prevent excessive concentrations of market 

share and otherwise foster free and robust competition from the 

greatest number of competitors. See, e.g., Robert H. Bork, THE 

ANTITRUST PARADOX (1978). 

A consequence of making commodities markets more competitive 

is that the prices to consumers (meaning endusers) will be lower 

than if the markets were less competitive as a result of regulatory 

barriers to entry or mandates to exit. It is well established that 

prices will be lower in a more competitive market compared to 

those in a less competitive market. See, e.g., James R. Kearl, ECONOMICS AND PUBLIC POLICY: AN ANALYTICAL APPROACH, 

p. 225 (6th ed. 2011). Thus, one consequence of forcing banks and 

their nonbank affiliates to exit any of these markets will be to reduce the number of competitors and possibly competition in general, which would almost certainly result in higher commodities 

prices for end users than in a world in which banks and their 

nonbank affiliates are allowed to compete freely with everyone else. 

I am confident that empirical evidence exists to support the finding 

that prices are lower in competitive markets than in noncompetitive markets, but it seems unnecessary to require or spend any significant time searching for empirical evidence to support the basic 

proposition that prices are generally lower in competitive than in 

uncompetitive markets. 

Another consequence of making commodities markets more competitive is that they will be more liquid and efficient. A more liquid 

commodities market means that the spread between bid and ask 

prices of a particular commodity will be lower, and that larger 

quantities of the commodity can be bought or sold without affecting 

the then current market price of the commodity. Markets are generally considered to be more efficient the more liquid they are. Indeed, in the most idealized and efficient market model—the perfectly competitive market model—perfect liquidity is simply assumed when the market is in long-term equilibrium—there is no 

spread between bid and ask prices and individuals can buy and sell 

virtually any quantity without moving market prices. All individual 

consumers and producers are assumed to be price takers in such 

an idealized market. See, e.g., James R. Kearl, ECONOMICS AND 

PUBLIC POLICY: AN ANALYTICAL APPROACH, p. 157 (6th ed. 

2011). Perhaps the actual market that is closest to the perfectly 

competitive model is the market for U.S. Treasury securities, which 

85

is considered to be among the most liquid and efficient markets in 

the world. 

Although the finding about increased liquidity almost certainly 

flows from the finding about increased competition in the commodities markets, it is my understanding that reliable empirical studies have been conducted to support the finding that allowing insured banks and their nonbank affiliates to participate in certain 

commodities markets will ‘‘provide increased liquidity to the markets.’’ For example, IHS Inc. included such empirical data with respect to the liquidity of the markets for energy commodities in its 

comments on the proposed regulations implementing the Volcker 

Rule. See IHS Inc., Comments on Volcker Rule Regulations Regarding Energy Commodities (Feb. 2012), available at http://

www.Federalreserve.gov/SECRS/2012/March/20120321/R-1432/

R-1432l021412l105313l542080912901l1.pdf.

It is also a truism that allowing banks and their nonbank affiliates to compete in the commodities markets will ‘‘increase the diversification of the revenue streams and exposures of financial institutions,’’ compared to the level of diversification of their revenue 

streams and exposures based on their other activities alone. Adding 

a revenue stream from and exposures to a new activity that is different from their existing activities necessarily increases the diversification of their revenue streams and exposures. 

Finally, allowing certain nonbank affiliates (but not insured 

banks) to make or take physical delivery or otherwise own or control physical commodities will allow financial holding companies to 

‘‘act as more effective intermediaries between producers and 

endusers.’’ While the validity of this finding may not be as self-evident as some of the other findings without empirical proof, I understand that allowing nonbank affiliates to make or take physical delivery, or otherwise own or control physical commodities, in addition to trading in commodities derivative contracts, helps to improve the efficiency of both the derivatives markets and the cash 

markets, fostering a greater convergence between the prices in both 

markets. Like the convergence between bid and ask prices in any 

market, a convergence between prices in the derivatives and cash 

markets for a particular commodity generally makes both markets 

more efficient and beneficial for both producers such as small jet 

fuel refineries and end users such as JetBlue in my example above. 

Thus, allowing certain nonbank affiliates to make or take physical 

delivery or otherwise own or control physical commodities, in addition to buying and selling commodity derivative contracts, helps 

them to be more effective intermediaries between producers and 

endusers. If the Subcommittee desires more empirical evidence to 

support this finding about improved intermediation, it may be 

worthwhile to ask the Federal Reserve Board, the General Accounting Office or a financial industry trade organization to undertake 

an empirical study of the evidence supporting this finding. 

Rather than focus on whether sufficient empirical evidence exists 

to support the considered findings of the OCC and the Federal Reserve Board, the Subcommittee might consider asking whether 

there is any empirical evidence to support any of the potential adverse effects that were alleged by some of the other witnesses at 

the hearing and whether a world in which banks and their 

86

nonbank affiliates are forced to exit the commodities markets is 

better than a world in which they are permitted to compete, subject 

to appropriate risk-mitigating limitations and conditions. See, e.g.,

Gregory Meyer, A ban on banks holding physical commodities could 

backfire, FINANCIAL TIMES (July 26, 2013). 

For example, one of the witnesses criticized the U.S. financial 

holding companies (‘‘FHCs’’) engaged in commodities activities for 

their alleged lack of transparency in disclosing material information about their commodities activities. Set aside the fact that she 

was not alleging that the disclosure was insufficient to satisfy the 

FHCs’ disclosure obligations to investors as publicly traded companies under the U.S. securities laws or that her main frustration 

seemed to be that the disclosure was not sufficient to satisfy her 

curiosity as an academic about their activities. Rather than offer a 

surgical solution to this alleged problem, she offered a blunderbuss 

approach: just force them to exit the commodities markets altogether. But this blunderbuss approach would actually decrease 

rather than increase the transparency of the commodities markets 

if she is right about the players who otherwise dominate the global 

commodities markets. Why? Because she also said that the world’s 

commodities markets, including the U.S. markets, are otherwise 

dominated by ultra-secretive, privately held foreign commodities 

firms that are even less transparent about their commodities activities than the publicly traded and highly regulated U.S. FHCs 

that were the main targets of her criticism. Here is what she said 

in her written testimony about those otherwise allegedly dominant 

players:

A handful of large, mostly Switzerland-based commodities trading houses—

including Glencore, Vitol, Trafigura, Mercuria, and Gunvor—dominate the 

global trade in oil and gas, petroleum products, coal, metals, and other 

products. Nearly all of these publicity-shy commodities trading firms are 

privately owned. They do not publicly report results of their financial operations and generally refrain from disclosing information about the structure 

or performance of their investments. Secrecy has always been an important 

attribute of the traditional commodities trading business, in which access 

to information is vital to commercial success and having informational advantage often translates into windfall profits.

Written Testimony of Saule T. Omarova, Associate Professor of 

Law, University of North Carolina at Chapel Hill, Before the Senate Committee on Banking, Housing, and Urban Affairs, Subcommittee on Financial Institutions and Consumer Protection, p. 

12 (July 23, 2013). 

If this assertion is true that the world’s commodities markets are 

otherwise dominated by these ultra-secretive, privately held commodities firms—and I am not sure it is—then there is no more 

sure-fire way to eliminate whatever transparency exists, and also 

decrease competition, reduce liquidity and increase prices in these 

markets, than by forcing the publicly traded and highly regulated 

U.S. FHCs to sell their commodities businesses, since these ultrasecretive, privately held foreign players may be the most likely 

buyers.

Q.2.a. You further state that ‘‘ . . . all things being equal, increased diversification of activities reduces risk, preserves capital 

and should help an institution improve its financial condition over 

time.’’ [Emphasis added]

87

Are there cases in which a financial holding companies physical 

commodity and energy assets could present a risk to the institutions safety and soundness?

A.2.a. As noted in my written testimony, the Federal Reserve 

Board issued a series of complementary powers orders allowing certain financial holding companies to make or take physical delivery 

of, and otherwise control, certain physical or intangible commodities, subject to certain risk-mitigating limitations and conditions 

including a requirement that the commodities involved are sufficiently fungible and liquid. While these complementary powers orders allowed them to enter into certain relationships with commodities storage, generation, refining, transportation or other related 

facilities, they did not permit these FHCs to own or otherwise control these facilities as a complement to their financial activities. All 

FHCs including these FHCs, however, are generally permitted by 

Section 4(k)(4)(H) of the Bank Holding Company Act of 1956 (the 

‘‘BHC Act’’) to make temporary ‘‘merchant banking’’ investments in 

companies that own or control such facilities, provided they comply 

with the conditions and limitations applicable to such investments. 

These conditions and limitations generally include a 10-year maximum holding period and a prohibition on engaging in the routine 

management of these companies, subject to certain narrow exceptions. See Sections 225.171 and 225.172 of the Federal Reserve 

Board’s Regulation Y, 12 C.F.R. §§ 225.172, 225.172. FHCs are also 

permitted to make temporary investments in companies that own 

or control such facilities, provided the companies are ‘‘substantially 

engaged’’ in activities that are financial in nature or incidental to 

a financial activity. See Section 225.85(a)(3) of the Federal Reserve 

Board’s Regulation Y, 12 C.F.R. § 225.85(a)(3). 

Congress also permanently grandfathered the commodities activities of certain companies that became financial holding companies 

after 1999, such as Goldman Sachs and Morgan Stanley. That 

grandfathering provision is contained in Section 4(o) of the BHC 

Act. The grandfathering provision applies to both owning and controlling physical and intangible commodities, as well as any commodities storage, generation, refining, transportation or other related facilities, subject to certain risk-mitigating limitations and 

conditions. 

See, e.g., Randall D. Guynn, Luigi L. DeGhenghi & Margaret E. 

Tahyar, Foreign Banks as U.S. Financial Holding Companies, in 

REGULATION OF FOREIGN BANKS & AFFILIATES IN THE 

UNITED STATES §§ 11:2[3], 11:4[9], pp. 957–960, 1025–1029 

(Randall D. Guynn, Editor, 7th edition 2013); Gibson Dunn, Federal Reserve to Re-evaluate the Permissibility of Physical Commodities Trading: The Rationale Historically and Today (July 22, 

2013). 

If an FHC fails to comply with the risk-mitigating limitations 

and conditions contained in its complementary powers order or Section 4(o) of the BHC Act, or otherwise fails to have an effective 

risk-management program with respect to its commodities activities, it is possible that its positions in physical commodity or energy assets could present a risk to its safety and soundness. I am 

not aware of any empirical evidence, however, that shows that the 

risks of holding physical commodity or energy assets is inherently 

88

greater than holding unsecured commercial loans or engaging in a 

variety of other traditional banking or other financial activities. Indeed, holding long-term loans (or more recently the sovereign debt 

of certain nations) has been the source of more losses and more 

bank failures over the centuries than virtually any other asset or 

activity. 

Moreover, as noted in my written testimony and in my answer 

to Question 1 above, allowing banks and their nonbank affiliates to 

engage in commodities activities, in addition to all their other permissible activities, will increase the diversification of their revenue 

streams and their exposures to risk. It has long been well-established that, all things being equal, increased diversification of investments or activities reduces risk. See, e.g., Harry M. Markowitz, 

PORTFOLIO SELECTION: EFFICIENT DIVERSIFICATION OF 

INVESTMENTS (Wiley 1959); Paul Samuelson, General Proof that 

Diversification Pays, JOURNAL OF FINANCE AND QUANTITATIVE ANALYSIS (Mar. 1967). Such a reduction in risk should 

result in lower net losses, as the losses from one activity are offset 

by gains in another activity. See Markowitz and Samuelson. This, 

in turn, should help diversified institutions to protect and even improve their financial condition over time.

Q.2.b. Do you have any concerns about the Federal Reserve’s regulatory capacity, i.e., that bank examiners may be incapable of effectively monitor these financial conglomerates?

A.2.b. Obviously, it is important for the Federal Reserve Board to 

have the capacity to effectively monitor and supervise FHCs engaged in a diversified range of activities. But the diversity of those 

activities is as much a risk-reducing benefit for the reasons stated 

in my answers to Question 2.a. above as the complexity of these institutions may be a challenge to effective supervision. It may be 

more useful to ask the Federal Reserve Board to do a self-assessment of its own capacity to monitor and supervise diversified financial institutions. That is likely to be far more useful than any observation I could make.

Q.2.c. If so, what are your concerns? If you do not have any concerns, please explain why.

A.2.c. Please see my response to Question 2.b. above. 

RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM JOSHUA ROSNER 

Q.1.a.–b. The ‘‘grandfathering’’ provision in the Bank Holding 

Company Act was clearly included in the Gramm-Leach-Bliley Act 

by interested parties who foresaw that investment banks would 

someday want access to the Federal Reserve’s discount window and 

other facilities. Regulators point out that it is a statutory exemption, and argue that they cannot prevent eligible institutions from 

engaging in many nonfinancial activities. The language is arguably 

ambiguous and open to a narrow interpretation by the Federal Reserve, if it wanted to do so.

a. Should the Federal Reserve take a tougher line by narrowing 

the scope of nonfinancial activities that financial holding companies can engage in—both under section 4(k) and 4(o)?

89

b. As a policy matter, what value does the 4(o) provision add to 

enable regulatory safety, soundness and capacity?

A.1.a.–b. Did not respond by publication deadline.

Q.2. The Federal Reserve has other tools to address nonfinancial 

activities that it finds disconcerting or impermissible. For example, 

Section 5 of the Bank Holding Company Act authorizes the Fed to 

force a bank holding company to divest a nonbank subsidiary that 

‘‘constitutes a serious risk to the financial safety, soundness or stability’’ of any bank subsidiary.

• Should the Federal Reserve use this section 5 authority to 

force financial holding companies to divest themselves of subsidiaries that expose it to risks—for example, an oil spill or an 

oil tank explosion—that are not the typical purview of banking 

regulators?

A.2. Did not respond by publication deadline.

Q.3.a.–c. The Federal Reserve order approving Goldman Sachs’ formation into a bank holding company states ‘‘ . . . Goldman expects 

promptly to file an election to become a financial holding company 

pursuant to sections 4(k) and (l) of the BHC Act and section 225.82 

of the Board’s Regulation Y. Section 4 of the BHC Act by its terms 

provides any company that becomes a bank holding company 2 

years to conform its nonbanking investments and activities to the 

requirements of section 4 of the BHC Act, with the possibility of 

three 1-year extensions. Goldman must conform to the BHC Act 

any impermissible nonfinancial activities it may conduct within the 

time requirements of the Act.’’

a. To the best of your knowledge, has the Federal Reserve Board 

developed a list or given any written guidance of what constitutes as ‘‘impermissible nonfinancial activities’’ at any point 

during the 2-year conformance period?

b. Has the Federal Reserve Board determined any of the assets 

held by the two former investment banks, Goldman Sachs and 

Morgan Stanley, as ‘‘an impermissible nonbanking activity’’ 

after they were made into federally insured FHCs in 2008?

c. In essence, is it fair to say the Board legally transformed the 

two largest investment banks into financial holding companies 

in 2008, and then allowed them to continue to operate as investment banks by enabling them to hold and acquire traditionally impermissible nonbanking commercial and physical 

commodities assets?

A.3.a.–c. Did not respond by publication deadline.

Q.4.a.–b. In your testimony you note, ‘‘ . . . reflecting on the Federal Reserve Board’s 2005 letter allowing JPMorgan to hold physical commodities while prohibiting them from storing those commodities should lead legislators to reconsider the authorities they 

have vested in the Fed regarding these activities. One has to look 

with concern at the poor job of the Fed in policing the limitations 

of their order allowing banks to enter commodity businesses.’’

a. What types of considerations should legislators consider?

90

b. Do you believe the Federal Reserve Board has the appropriate 

legislative tools to regulate financial holding companies and 

determine certain commodity and energy assets are impressible?

A.4.a.–b. Did not respond by publication deadline. 

RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN BROWN 

FROM TIMOTHY WEINER 

Q.1.a.–d. For the record, please provide the following information:

a. Average LME traded price for aluminum for the following 

years: 2009, 2010, 2011, 2012, and 2013;

b. Average monthly rental-fee-for metal storage in LME warehouse for the following years: 2009, 2010, 2011, 2012, and 

2013;

c. Average total costs for aluminum expenses for the following 

years: 2009, 2010, 2011, 2012, and 2013; and

d. Number of months to receive the physical delivery of aluminum from the LME warehouses for the following years: 

2009, 2010, 2011, 2012, and 2013. 

Average LME traded price for aluminum from 2009–2013

A.1.a. Table 1 below shows the London Metals Exchange (LME) 

price, Midwest Premium (MWP) and all-in Midwest Transaction 

Price (MWTP=LME+MWP) for 2009–2013. While the underlying 

LME price has changed very little over this period, the MWP has 

more than doubled. We trace this increase to the purchase of key 

LME warehouses by large financial institutions and LME rules 

that allow warehouses to restrict outflow from warehouses thus allowing them to increase the queues and hold rent-earning metal 

longer. As the queues extend, the rent charges increase, which 

means the warehouses can fund larger payments to producers as 

incentives to direct metal into LME warehouses and way from the 

spot market. Aluminum users must pay the MWP on top of the 

LME price to obtain metal directly from a producer. This practice 

adversely affects the available direct supply of metal.

TABLE 1: London Metals Exchange (LME) price, Midwest Premium (MWP) and all-in Midwest 

Transaction Price (MWTP=LME+MWP) for 2009–2013. 

Annual Averages 2009 2010 2011 2012 2013

LME ($/MT) $1,665 $2,173 $2,398 $2,019 $1,858

MWP ($/MT) $105 $138 $169 $218 $258

MWTP ($/MT) $1,769 $2,311 $2,567 $2,238 $2,116

Source: LME, Platts 

Average monthly rental-fee-for metal storage in LME warehouse 

from 2009–2013

A.1.b. Table 2 below shows the daily rents due on metal stored in 

LME warehouses. These rents inflate the cost of aluminum as end 

users choosing to purchase through the LME systems must wait a 

long time to receive metal, and end users who cannot afford to wait 

in an LME warehouse queue must pay increased costs to obtain a 

91

direct supply of metal outside the LME. The inflated rents allow 

the warehouses to reap a significant profit on warehouse operations 

despite incentives paid to producers to drive metal into those warehouses and royalty payments made to the LME. The inflated rents 

increased with the acquisition of LME warehouse ownership by 

large financial institutions. Again, however, aluminum users must 

match these inflated prices to get more timely physical delivery of 

metal.

TABLE 2: LME WAREHOUSE RENTS FOR PRIMARY ALUMINUM 

(rates in USD per mton per day*) 

DETROIT (METRO INTERNATIONAL) VLISSINGEN (PACORINI METALS) 

2009 $0.38 $0.38

2010 $0.40 $0.40

2011 $0.41 $0.45

2012 $0.45 $0.45

2013 $0.48 $0.48

Source: HARBOR Aluminum 

*Applicable from April 1st of specified year, to March 31st of following year. 

Average total costs for aluminum expenses from 2009–2013

A.1.c. We will assume that the question is asking the all-in cost 

for aluminum. Aluminum users consider the average total cost of 

aluminum to be the all-in Midwest Transaction Price, which is the 

London Metals Exchange (LME) price plus the Midwest Premium 

(MWP), because that is the price aluminum users actually have to 

pay to obtain metal. Aluminum supply contracts reference the LME 

price, and whether they buy through the LME or directly, aluminum users must pay that price plus the MWP to obtain aluminum. In other words, to obtain any supply, aluminum users 

must pay rent to an LME warehouse or match the incentives offered to producers by LME warehouse owners. Payment of incentives to producers makes sense in times of undersupply, but the 

United States has been in a period of serious over-supply of aluminum for the entire period. Table 1 above shows the all-in Midwest Transaction Price (MWTP=LME+MWP) for each year from 

2009–2013. 

Number of months to receive the physical delivery of aluminum 

from the LME warehouses from 2009–2013

A.1.d. One of the reasons the LME system is not a good option for 

aluminum users is that it takes an exceptionally long time to get 

physical delivery of metal. Curiously, while demand for metal is 

low and inventories in LME warehouses are at an all-time high, 

Table 3 below shows that delays in physical delivery (queues) of 

metals from two key LME warehouses (Detroit and Vlissingen) continued to increase between 2009–2013. There is a correlation between the timing of the delays and the acquisition of LME warehouse ownership by large financial institutions. These delays affect 

pricing for all purchasers whether they buy metal through the 

LME or acquire metal directly by paying the Midwest Premium 

shown in Table 1.

92

TABLE 3: MAXIMUM LOAD-OUT QUEUES FROM KEY LME WAREHOUSING LOCATIONS 

(calculated at end of period; calendar days) 

DETROIT VLISSINGEN

2009 44 3

2010 71 1

2011 117 280

2012 490 420

H1 2013 539 564

Source: HARBOR Aluminum

Q.2. In your written testimony, you stated you met with the LME, 

U.S., UK and EU financial and banking regulators. You indicated 

both the U.S. and UK regulatory agencies, the Commodity Futures 

Trading Commission (CFTC) and Financial Conduct Authority 

(FCA), ‘‘indicated they are uncertain whether they have the regulatory authority necessary.’’ For the record, please provide the following details:

a. The dates of each meeting with the LME, CFTC and FCA; 

and

b. A description of each meeting’s outcomes, including any justifications or explanations for the state of the issue.

A.2. Meeting with LME: There was a single October 2012 meeting 

with LME CEO Martin Abbott and his deputy Diarmuid 

O’Hegarty. Charles Li, CEO, Hong Kong Exchange (HKE) also participated. The meeting occurred prior to completion of a planned acquisition of the LME by the HKE. The LME representatives indicated they did not intend to adjust current LME practices or make 

institutional changes. The key takeaways from the meeting were:

1. The LME representatives do not believe the current system 

harms metal users because it is possible to acquire metal. You 

have to be willing to wait in a long queue and pay rent or pay 

a premium to avoid the queue, but it is not impossible to obtain metal, therefore the system does not harm metal users.

2. Metal users could experience supply shortages and increased 

costs if they tried to change the warehouse rules.

3. The warehouses claim that while they have no trouble loading 

metal into their facilities, they apparently lack the infrastructure and driver work rules necessary to load out metal in a 

timely manner.

4. Despite establishing the rules for warehouses and receiving a 

royalty, the LME claims that it has no authority over the private warehouse owners.

5. The LME representatives see no conflicts of interest in terms 

of who runs the Exchange, who owns the warehouses, and 

how the warehouses operate.

Meetings with FCA: There was an October 2012 meeting with 

representatives of the UK Financial Services Administration (FSA), 

which is now the Financial Controls Authority (FCA), regarding 

regulatory oversight activities focused on LME warehouses. The 

FCA responded that it did not know whether it had authority over 

the physical delivery of metal or the LME warehouse system. More 

93

recently, in July 2013, different FCA representatives said that they 

expect to find opportunities to accelerate regulatory oversight activities focused on LME warehouse changes. These FCA representatives were aware of the scope of recent regulatory/legislative activities undertaken by the U.S. Government to investigate the matter and possibly clarify regulatory jurisdiction. 

Meetings with CFTC: There have been several meetings with 

CFTC Commissioners and their staffs and representatives of the 

CFTC Office of International Affairs, Enforcement Division and 

Surveillance Branch, among others, since last year. In December 

2012, we understood that the Enforcement Division would look into 

the issue of the agency’s jurisdictional authority. In March 2013, 

we learned that CFTC was not certain as to its authority over the 

physical delivery of metal or the warehouse system of the LME. In 

June 2013, we learned that there was strong interest in oversight 

and enforcement activities. From published news reports, we understand that the CFTC has opened an investigation.

Q.3. In your written testimony, you offer recommendations to improve the LME’s business practices and expedite the delivery of 

LME warehoused aluminum. These recommendations specifically 

requested that the LME amend their rules to allow:

i. A daily rental to be charged for a limited period following cancellation of a warrant (i.e., 30–45 days).

ii. Daily load out rate for each warehouse shed at each official 

site, rather than by company at an official site.

iii. A daily load-out rate by warehouse shed that would clear the 

queue within a reasonable period.

iv. A review and adjustment of load-out rates more frequently so 

that bottlenecks do not persist.

Please describe the LME ’s reaction to your proposal and any explanations the LME provided for ‘‘dismissing’’ your efforts.

A.3. The LME’s response was polite, but clearly communicated that 

what we were asking was, in their view, not achievable. We were 

very clear that similar to other exchanges, we wanted the LME to 

be a transparent, open and free centralized place for price discovery where buyers and sellers can come together for this price 

discovery and timely delivery of goods purchased.

Q.4. The LME issued a proposal to decrease existing queues and 

prevent new queues from forming on July 1, 2013. The proposal 

targets warehouses with queues of more than 100 calendar days, 

and would require warehouses to deliver out at least 1,500 tons per 

day more than the amount it loads in.

• While this proposal is still under consultation, please explain 

why this proposal would ‘‘make no real impact’’ as you stated 

in your testimony?

• What consultative input have you provided the LME?

A.4. As you state, this is only a proposal and there is no guarantee 

that the LME will make any changes. The proposed changes, even 

if adopted, would not go into effect, at the earliest, until April of 

2014 with the market not feeling the effects until well into 2015 

at the earliest. The likelihood of the warehouse rents increasing is 

94

very likely. The proposal does not address this situation. The warehouses could increase rents to compensate for revenues lost if the 

queues are no longer exaggerated. They could simply charge a 

higher rent for a shorter period. Moreover, while the proposal 

might cause warehouse owners to cease paying incentives to producers and traders to bring metal into LME warehouses, they could 

keep current queues in place for years by loading out minimums 

at the new 1,500MT/day rate, which is half the current rate. 

As the LME load out minimums have become the maximums, so 

too would the 100-day minimum queues for all warehouses. We 

ask, why any queues at all? Why would the LME want to delay delivery into the hands of owners of property purchased through their 

exchange? The rules of other exchanges require reasonable delivery 

times, and the LME could do the same. 

There is nothing addressing the conflicts of interest of being a 

shareholder/member/rulemaker and warehouse owner. 

Attached are comments recently sent to the LME regarding the 

proposed warehouse rule changes.

Q.5. In your testimony you stated ‘‘ . . . several banks and a few 

trading companies have cornered the market on aluminum and 

other base metal trading . . . These banks are using a Federal Reserve exemption currently allowed under the Bank Holding Company Act . . . [and] through their effective control of the LME, 

they have created an artificial bottleneck or shortage of aluminum.’’ Furthermore, ‘‘they are distorting access to aluminum and 

through their warehousing practices are artificially impacting the 

price of aluminum and driving premiums to historic highs.’’ Recent 

media reports suggest that Goldman Sachs has explored selling its 

metals warehousing business, Metro International Inc. Goldman 

Sachs has also said that it will make physical aluminum available 

for immediate delivery. Does this outcome solve the artificial shortages in the aluminum market?

A.5. No, this outcome will not solve the artificial shortages in the 

aluminum market. LME warehouse rules have to change before 

that can happen. Take, for example, Metro, the warehouse system 

in Detroit, owned 100 percent by Goldman Sachs. The Metro warehouse system has 29 separate warehouse sheds, and 27 of these 

sheds hold well over 1 million metric tons of aluminum, close to 25 

percent of all the aluminum in the LME warehouse system and 

over 70 percent of all the available aluminum in North America. 

Goldman may want to sell the business, but a sale by itself of a 

business hold over 70 percent of all the available aluminum in 

North America, does nothing to address the underlying issues giving rise to that stockpile and will not alleviate the artificial shortage. Once you look at it closely, Goldman’s offer to deliver metal 

in the queue to consumers as a priority over others in the queue 

is also meaningless. Goldman knows that no actual consumers 

have metal in any Goldman queue, because no actual consumers 

can afford to tie up their money for the 18 months it takes to get 

metal out of the Goldman queue under ordinary circumstances. The 

interesting question to ask is why Goldman extended this offer only 

to consumers they knew were not in the queue? They did not offer 

to load out aluminum to anyone waiting in the queue. Is Goldman 

95

just going to require everyone else to wait 18 months and charge 

them rent the whole time? Goldman made a very specific public 

offer to release specific metal to specific people knowing that the 

offer was no offer at all, and to avoid the real question—why does 

70 percent of all the available aluminum in North America sit in 

an 18-month queue under Goldman’s control.

Q.6. What concerns, if any, do you have with Goldman Sachs plans 

to exit the aluminum warehousing market?

A.6. The problems could remain if the LME warehouse rules and 

the practices of those warehouses remain unchanged. Logical warehouse rule changes as we have suggested, in line with other exchanges, are essential prior to any sale of the warehouses by any 

U.S. financial institution.

96


82568-1.eps

.\Ll..\IE\T.\Il.SERS GROl'P 5ep,"ml",, 70n 

Via email (matthew.chamberlain@lme.com). 

Matthew Chamberlin 

Head of Strategy and Implementation 

London Metal Exchange 

56 Leadenhall Street 

London, EC3A 2DX, UK 

RE: 13/208:A201:W076 

Dear Mr. Chanlberlin: 

Attached is a submission by the Aluminium Users Group (AUG) regarding the 1 July 

2013 LME proposal for a linked load-in, load-out mechanism for LME Licensed Facilities. 

As the rules of the Exchange and the practices of the LME Licensed Facilities, 

especially those affecting the ready supply of metal, have a significant impact on all 

aluminium users, AUG has long advocated for reform of warehouse rules and greater 

transparency in LME operations and practices. As we understand it, in an effort to alleviate 

the queues, the LME proposes to measure all of the metal loaded into each Licensed Facility 

over a three-month period, and to require facilities with queues longer than 100 calendar days 

to deliver out additional metal based on a fornlUla established by the LME. 

By its July 1 announcement, the LME invited all interested parties to submit 

comments on the proposal on or before 30 September 2013. The attached document reflects 

the AUG's comments, concerns, questions and recommendations. Because the proposal, if 

adopted in its current form, may have a significant impact on aluminium users, we request a 

meeting to discuss the proposal and our concerns in greater depth. For ease of scheduling, 

please use the following people as points of contact: 

Mary Jane Saunders 

Vice President & General Counsel 

Beer Institute 

122 C Street, NW, Suite 350 

Washington, DC 20001 

Email: mj saunders@BeerInstitute.org 

Tel: + 1 (0)(202) 737-2337 

Amy Hancock 

Deputy General Counsel 

American Beverage Association 

1101 Sixteenth Street, NW 

Washington, DC 20036 

Email: ahancock@ameribev.org 

Tel: + 1 (0) (202) 463-6786 

1 
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82568-2.eps

.\LUl\II'iU:\I USERS GROllP S'p"ml",9 ) 011 

Thank you for your consideration and we look forward to a constructive dialogue on 

this matter. 

Respectfully submitted, 

Aluminium Users Group 

cc: Martin Abbott 

Charles Li 

Garry Jones 

2 
98


82568-3.eps

ALl MINlJ:\llJSERS GROl P Sep"mb" 9 2013 

I Linked load-in, load-out 

AUG previously expressed concern that policies and procedures developed and 

followed by the LME and actions and activities of common members of the LME and owners 

ofLME Licensed Facilities adversely affect the ready supply and pricing of non-ferrous 

metals. We believe that the current system is dysfunctional and prone to manipulation. We 

also believe that left uncorrected, the deficiencies in the current system could cause long-term 

harm to the entire aluminum market. We want more transparent and efficient physical 

delivery settlement with an end to the lengthy queues. We want the Exchange to adopt 

operational practices that are consistent with the operational practices of other commodity 

exchanges, and we want the Exchange to act in a timely manner. A system that meets these 

goals will lead to renewed aluminum user confidence in the Exchange. A system that does 

not meet these goals will only lead to more dysfunction, more manipulation, and more harm. 

AUG applauds the LME for trying to address the lengthy queues with the proposed 

linked load-in, load-out mechanism, but the proposal falls short in terms of providing an 

efficient function for physical delivery settlement for the following reasons: 

The proposal suggests that it is reasonable for an aluminum user to wait for metal in a 

queue lasting at least 100 days. The framework of regulations within a commodity 

exchange should facilitate physical delivery within the period relevant to the original 

derivative position, not an arbitrary period that may artificially delay delivery and 

increase user cost. 

A rule allowing a warehouse to hold metal in a queue as long as 100 days adds no 

measurable value to the aluminum or supply chain. The LME should not sanction 

queues of this sort especially since they essentially lead to a price floor in the 

premium for physical delivery of metal. 

In its current form, the proposal could lead to refusal of new metal at warehouses or a 

shift of metal to non-LME Licensed Facilities while not actually alleviating the 

queues for metal remaining in the warehouses. This would not facilitate more efficient 

physical delivery settlement, and would decrease rather than increase transparency in 

warehouse operations. Increases in warehouse capacity have been rapid and 

seemingly unconstrained at certain locations since 2009, and the LME should take 

3 
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82568-4.eps

ALU:\Ir",U:\I USERS GROUP 5cp""''''' , ?013 

steps to ensure that the proposal does not become a vehicle for further manipulation in 

this manner. 

The proposal does not address the problem of warehouse locations treating the 

minimum daily load out requirement as a combined requirement for all 

warehouse/shed locations at a single LME approved geographic location. The LME 

should clarify that the minimum load-out requirement and linked load-in, load-out 

rules, if adopted, apply to each individual warehouse/shed at a single geographic 

location. 

The proposal does not address the issue ofre-tendering of warrants for metal resting 

in the queue. If the LME does not require an accounting of this metal as part ofthe 

load-in, load-out mechanism, metal could effectively stay in the LME loop forever 

and never leave the warehouse. The LME should clarify that metal that is retendered 

will be counted as tonnage delivered into the Licensed Facility. 

I Recommendations 

To facilitate more transparent and efficient physical delivery settlement, we urge the 

LME to implement the following rules for all Licensed Facilities: 

All shipments into or out of the Licensed Facility should be on a first-come, firstserve, non-discriminatory basis. 

No Licensed Facility should constrain or promote the movement of metal into or out 

of the Licensed Facility by: 

1. giving exceptional inducements or incentives for delivery of metal into 

a Licensed Facility; 

2. imposing unreasonable charges for depositing, storage or removal of 

metal into or out of the Licensed Facility; 

4 
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ALlJMINlJl\llJSERS GROlJP S.p"m'", 9,20U 

3. taking or failing to take any action that affects a customer's ability to 

schedule the delivery or removal of metal from the Licensed Facility in 

a timely and efficient manner; or 

4. treating the minimum daily load-out requirement as a combined 

requirement for all warehouses/sheds at a single geographic site, The 

LME should clarify that the requirement applies to each individual 

warehouse/shed at each LME approved location. 

In the event a Licensed Facility fails to permit the withdrawal of metal by a warrant 

holder within five (5) business days after the holder tenders the warrant to the 

Licensed Facility (properly endorsed and all storage charges paid), the LME should 

require the Licensed Facility to provide immediate notice, in writing, of the reason(s) 

for the delay. Upon receipt of such notification, the Exchange, at its discretion, may 

direct, in writing, the Licensed Facility not to accept any more metal for deposit until 

further notice. 

In the event that written shipping instructions for registered metal are received by the 

Licensed Facility by the 20th day of the month, all registered metal must be released 

for shipment no later than the close of business on the last day of that month, 

provided, however, that the warrant holder pays all storage charges and presents the 

Licensed Facility with all documents necessary to establish good title. 

If a Licensed Facility fails to release any registered metal as provided above, and 

assuming that the warrant holder or the warrant holder's agent is not the cause of the 

delay, the LME should prohibit the Licensed Facility from charging the warrant 

holder additional storage charges with respect to the metal. We recognize that LME 

has previously said it cannot impose specific rental rate limits on Licensed Facilities. 

The aforementioned proposal addresses that concern in that it is time-based limit 

within the contract, not a limit on the rental rate. This approach is also consistent with 

operational practices of other commodity exchanges. 

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82568-6.eps

ALU:\IINll\ll SERS GROUP S'p"", b" 9 lD13 

For repeated failure to pennit the withdrawal of metal in a timely manner without 

good cause, the LME should tenninate its relationship with a Licensed Facility. 

Some may argue that given current stockpiles of metal at various Licensed Facilities, 

change should occur very slowly. Change is necessary and will only be meaningful if the 

implemented in a timely manner. We believe the following implementation schedule is 

reasonable: 

Allow warehouses a 3-month period (I October to 31 December 2013) to eliminate 

current queues prior to implementation of the new rules. This is an ample period to 

load-out or re-warrant metal. 

Implement the new model effective from I January 2014. 

To ensure that manipulation of the new model does not occur, we also believe that it is 

necessary to improve transparency at the Exchange through: 

More balanced representation of the key market participants 

(UsersISmeltersrrraders/Warehousemen) on LME committees; 

Implementation of a Commitment of Traders report similar to the CFTC Commitment 

of Traders; 

More visible infonnation on warehouse rules regarding 

o regularity and duration of audits; 

o structure and content of audits; and 

o statement on results of audit, including remedial actions, if any; 

Increased scrutiny of new capacity and monopolization of delivery locations; 

Enhanced firewalls between related parties that are both common members of the 

LME and owners of LME Licensed Facilities, stricter conflict of interest rules, and 

more regular review of the same; and 

A clearly defined process for dispute resolution, managed by an independent third 

party. 

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82568-7.eps

ALlJMINl M l'SERS GROlJP Sep"mb,,92013 

Finally, and although the purpose of this consultation process is not to assess 

regulation ofthe LME, we encourage the Exchange to support more coordinated regulatory 

oversight of its practices, including LME warehouse rules. While regulators in the United 

States, UK and EU are now examining warehonse rules and practices, the framework for 

regulator monitoring of physical delivery rules, new capacity approvals, and warehouse 

requirements varies in terms offunctionaljurisdiction and geographic scope. We encourage 

the LME to work towards a coordinated regulatory framework across countries and regions. 

This will help guard against manipulation of LME rules and ensure a fair and open 

marketplace for metal. We also believe that the LME should engage regulators in 

establishing and monitoring rules regarding firewalls between related parties (common 

members of the LME and owners ofLME Licensed Facilities) due to the implications on 

conflict of interest and competition. 

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ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD


82568-8.eps

StatelUent for the Record 

U.S. Senate COlUlIlittee on Banking, Housing and rban Affairs, 

SubcolUlIlittee on financial Institutions and ConsulUer Protection 

"ExalUining financial Holding COlUpanies: Should Banks Control Power Plants, 

" arehouses, and Oil Refineries?" 

23 July 2013 

As the orld '~ leading producer of primary and fabricated aluminum, as well as the world's 

largest miner of bauxite and refiner of alumina, Alcoa appreciates the, opportunity to ~ubmit this 

statement for the record in connection with the July 23, 2013 he.aring before the, Senate, Banking 

Committee, Subcommittee on Financial Institutions and Consumer Protection entitled 

'Examining Financial Holding Companies: Should Banks Control Power Plants, \\ arehouses, 

and Oil Refineries?" 

Alcoa ai ~ for the Committee's consideration the need for increase.d transparency at the 

London Met.al Exchange (LME), which sets the price of aluminum and other non-ferrous metals. 

Stated simply, the LME does not provide the same quality of information and level of 

transparency as required by other commodities exchanges, such as those fa lling under the scope 

of the U.S. Commodity Futures Trading Commis.;ion (CFTC). Alcoa believes that this is~ue 

warrants further attention. 

The dramatic increase in trading volume on the LME in recent years is predominantly due to the 

increased trading activity from fmancial 'tor~ who do not participate in the underlying 

physical markets. \\ hile Alcoa recognizes that financial investors are. a reality of the current 

economy, it is imperative that those, who participate in the physical aluminum market have 

coufidenc.e in the price setting mechanism of the LME. 

Improved transparency into the sources of trading on the L 1E, which gives all parties concerned 

the. benefit of information that is commonly ac,c.e.;;ible to market palticipants in other 

commodities, is an essential first step toward improving confidence in the marketplace that the 

L iE continue- to be the b~t source of price discovery for aluminum. 

To this end, it is Alcoa '~ vie\1i that the LME should establish reporting similar to the CFTC'& 

Commitment ofTraders (COT) repo!1s, to improve the understanding in the marketplace of the 

impact and relative influence that fmancial investors have on the price discovery process. This 

type of information, and gre.ater transparency, lioldd lead to more clarity on how the rapid 

gro\l·th in speculative trading may be influencing price. 

Enhancing the availability and quality of information for all physical commoditie.s that underlie. a 

financial market contract will improve the reliability of price discovery in financial markets.