In the past year, regulators turned their attention to the large financial institutions that dominate the business of physical commodities trading. With new rules penned by Congress limiting the degree to which banks can trade for their own accounts and an ongoing investigation from the Commodity Futures Trading Commission, JPMorgan Chase (NYSE:JPM) has decided it is time to get out of the physical commodities trading business. After pursuing a buyer for months, the company finally announced Wednesday morning that Mercuria Energy Group, a fast-growing Swiss trading firm, had agreed to purchase the unit for $3.5 billion in cash. Mercuria, founded by former Goldman Sachs (NYSE:GS) traders, has grown into one of the world’s four largest independent commodities traders, with offices in 28 countries and more than 1,000 employees. Subject to regulatory approval, the all-cash transaction is expected to close in the third-quarter of this year.
“Our goal from the outset was to find a buyer that was interested in preserving the value of JPMorgan’s physical business,” Blythe Masters, head of JPMorgan’s global commodities business, said in the Wednesday press release announcing the sale. “Mercuria is a global leader in the commodities markets and an excellent long-term home for these businesses.” What the statement did not explain is whether Masters, a long time veteran of the bank, would leave JPMorgan to remain with her team.
Even though JPMorgan had failed to capitalized on key opportunities, including the 2008 spike in oil prices, because it lacked the necessary infrastructure to store and ship oil and other commodities, Masters said on an April 2010 conference call that competitors were scared of the bank. “They’d better be, because this is a platform that’s going to win,” Masters said.
Her career at JPMorgan is a storied one; Masters — one of the most recognized women on Wall Street — pioneered the use of derivatives and, in the 1990s, developed and marketed credit derivatives, which soon became a new wonder of high finance. These contracts were supposed to disperse risk and promote additional lending. But in reality, in the hands of reckless buyers, they decimated balance sheets. In a 2009 list of the “100 to Blame” for the global economic crisis, Vanity Fair ranked Masters at number 65, just behind Bernard Madoff. She was also scrutinized last year when the Federal Energy Regulatory Commission accused JPMorgan of manipulating California energy markets. Originally, the agency intended to take action against the bank and Masters, who was accused of making misleading statements under oath, but eventually a $410 million settlement was reached.
The deal ends JPMorgan’s five years owning and storing raw materials, a practice that has drawn criticism from regulators. Last summer, the Commodity Futures Trading Commission (CFTC) began an examination of warehouse operations that are controlled by companies like Goldman Sachs and used to store vast amounts of aluminum. Goldman Sachs allegedly exploited industry pricing regulations by using a fleet of trucks to move 1,500-pound bars between warehouses, thereby lengthening the storage time of the commodity, increasing the prices paid by manufacturers and consumers across the country, and adding millions of dollars per year to the company’s coffers. This type of maneuvering in markets for oil, wheat, cotton, coffee, and other commodities has brought billions in profits for investment banks like Goldman, JPMorgan Chase, and Morgan Stanley (NYSE:MS).
In 2012, the ten largest Wall Street banks earned about $1 billion from physical commodity units and about $5 billion from commodity derivatives and financing, according to data from the analytics company Coalition. Goldman Sachs ranked number one in all commodities revenue, while JPMorgan ranked second. But in 2013, commodities revenue at these ten banks dropped 18 percent to $4.5 billion thanks to weak investor interest and low volatility in prices. While commodities trading lost momentum last year, regulatory changes have had a greater impact on the business, especially for JPMorgan. Stricter legislation — including the sweeping Dodd-Frank financial regulatory reform’s Volcker Rule — and increasing pressure from regulators, has made commodities trading less appealing, which prompted the bank to stop trading physical commodities ranging from petroleum products to power.
Regulators were concerned that financial institutions could control the price of the commodities in addition to trading them. The other concern is that such large-scale commodities trading by systemically important banks could put the United States financial system in danger once again. Last July, the Federal Reserve said it might even force insured lenders to get out of the business and announced it was reviewing a decade-old decision that allowed lenders, like JPMorgan and Citigroup (NYSE:C), to begin physical commodities trading because the business as “complementary” to banking. That same month, congressional hearings begin. Spurred on by industrial customers, lawmakers examined whether banks had abused their ownership of raw materials to inflate prices.
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