[Senate Hearing 113-67]
[From the U.S. Government Publishing Office]


                                                         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 /

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       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              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         DAVID VITTER, Louisiana
ROBERT MENENDEZ, New Jersey          MIKE JOHANNS, Nebraska
JON TESTER, Montana                  JERRY MORAN, Kansas
JEFF MERKLEY, Oregon                 DEAN HELLER, Nevada
KAY HAGAN, North Carolina            BOB CORKER, Tennessee
ELIZABETH WARREN, Massachusetts

              Graham Steele,  Subcommittee Staff Director

       Tonnie Wybensinger, Republican Subcommittee Staff Director

                   Kathryn Milani, Legislative Fellow

                                  (ii)



                            C O N T E N T S

                              ----------                              

                         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)


   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 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 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, 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 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 essential 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 Gramm-
Leach-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 testimony 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.
    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 bank-controlled 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.
    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 
Coca-Cola 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 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 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, starting 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 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 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.
    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.
    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.
    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?
    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 
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 the boards of railroad companies, 
steel companies, other large corporations. 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.
    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 
spokesman 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 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 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 
relationships 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 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 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 anti-competitive. 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.
    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 Glass-Steagall 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 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 Glass-Steagall 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 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 Federal 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.
    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 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. 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:]
                                 ______
                                 
                 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?abstract_id=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.
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    \1\ 12 U.S.C. Sec.  24 (Seventh).
    \2\ 12 U.S.C. Sec. Sec.  1841-43.
    \3\ 12 U.S.C. Sec.  1843(k)(1)(A).
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    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 
exception designed to allow banking organizations to take small, 
noncontrolling stakes in commercial businesses as passive investors.\4\
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    \4\ 12 U.S.C. Sec.  1843(c)(6),(7).
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    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.
---------------------------------------------------------------------------
    \5\ 12 U.S.C. Sec.  1843(k)(4)(H).
---------------------------------------------------------------------------
    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:
---------------------------------------------------------------------------
    \6\ 12 C.F.R. Part 225, Subpart J.
    \7\ The 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. Sec.  225.170.

  (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 underwriting 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\
---------------------------------------------------------------------------
    \8\ 66 Fed. Reg. 8466, 8469 (Jan. 31, 2001).
---------------------------------------------------------------------------
    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\
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    \9\ 12 C.F.R. Sec.  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. Sec.  225.171(c).
    \10\ 12 C.F.R. Sec.  225.171(b)(1).
    \11\ 12 C.F.R. Sec.  225.171(d)(2).
    \12\ 12 C.F.R. Sec.  225.171(d)(3)(i),(ii).
    \13\ 12 C.F.R. Sec.  225.171(d)(3)(iii).
    \14\ 12 C.F.R. Sec.  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 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. Sec.  1843(k)(4)(H)(iii); 12 
C.F.R. Sec.  225.171(e).
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    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\
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    \15\ 12 U.S.C. Sec.  1843(k)(1).
---------------------------------------------------------------------------
    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\
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    \16\ 12 C.F.R. Sec.  225.89(a).
---------------------------------------------------------------------------
    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\
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    \17\ 12 C.F.R. Sec.  225.89(b)(3).
    \18\ 12 U.S.C. Sec.  1843(j)(2)(A).
    \19\ Id. This list essentially reiterates the policy concerns 
underlying the principle of separation of banking from commerce.
---------------------------------------------------------------------------
    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:
---------------------------------------------------------------------------
    \20\ The 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).

        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 arrangements 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\
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    \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).

    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \23\ H.R. 10, 106th Cong. Sec.  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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \24\ 68 Fed. Reg. 68,493 (Dec. 9, 2003) (emphasis added).
---------------------------------------------------------------------------
    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.''
---------------------------------------------------------------------------
    \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).
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    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:
---------------------------------------------------------------------------
    \26\ 12 U.S.C. Sec.  1843(o).

  (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\
---------------------------------------------------------------------------
    \27\ The 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \28\ Financial 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.
    \30\ This 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.
    \31\ Goldman 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 INVESTMENT ADVISER REGULATION 
(ABA CENTER FOR CLE NAT'L INSTITUTE, NOV. 8-10, 2001), fn. 11.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \32\ S. 900, 106th Cong. (as placed on the Senate calendar, Apr. 
28, 1999).
    \33\ S. Rep. 106-44 (Apr. 28, 1999), at 3.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \34\ Saule T. Omarova, The Quiet Metamorphosis: How Derivatives 
Changed the ``Business of Banking,'' 63 U. MIAMI L. REV. 1041 (2009).
---------------------------------------------------------------------------
    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 commodity-related services to their 
clients in a more efficient manner. Finally, conducting physical 
commodity activities would enhance FHCs' understanding of the commodity 
derivatives market.
---------------------------------------------------------------------------
    \35\ Citigroup, Order Approving Notice to Engage in Activities 
Complementary to a Financial Activity, 89 Fed. Res. Bull. 508 (2003) 
[Citigroup Order].
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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 third-party 
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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \38\ The Royal Bank of Scotland Group plc, 94 Fed. Res. Bull. C60 
(2008) [RBS Order].
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \39\ Fortis 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].
    \40\ The 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.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \41\ Morgan 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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \42\ 12 U.S.C. Sec.  1843(a)(2).
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    \43\ The 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.
    \44\ Morgan 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 
exchange-traded 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 electricity-generating facilities in the United 
States and Europe.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \45\ See ``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. Sec.  1844; 12 C.F.R. Sec.  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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \53\ Morgan Stanley, FR Y-9C, March 31, 2009, Schedule HC-D, Item 
M.9.a.(2).
    \54\ Morgan Stanley, FR Y-9C, September 30, 2011, Schedule HC-D, 
Item M.9.a.(2).
    \55\ Morgan Stanley, FR Y-9C, March 31, 2012, Schedule HC-D, Item 
M.9.a.(2).
    \56\ Morgan Stanley, FR Y-9C, December 31, 2012, Schedule HC-D, 
Item M.9.a.(2).
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \57\ Goldman Sachs Group, FR Y-9C, March 31, 2009, Schedule HC-D, 
Item M.9.a.(2).
    \58\ Goldman Sachs Group, FR Y-9C, June 30, 2009, Schedule HC-D, 
Item M.9.a.(2).
    \59\ Goldman Sachs Group, FR Y-9C, December 31, 2010, Schedule HC-
D, Item M.9.a.(2).
    \60\ Goldman Sachs Group, FR Y-9C, March 31, 2012, Schedule HC-D, 
Item M.9.a.(2).
    \61\ Goldman Sachs Group, FR Y-9C, December 31, 2012, Schedule HC-
D, Item M.9.a.(2).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \62\ Similarly, the VaR data included in FHCs' SEC filings provide 
a measure of their exposure to commodity price risk.
    \63\ There 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \64\ This 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/
_library/pdf/social_acts/international_oil_market_and_oil_trading.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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \65\ Morgan Stanley May Sell Part of Commods Unit: CNBC, REUTERS, 
June 6, 2012.
    \66\ Matthew Robinson & Scott DiSavino, Deal or no deal,Morgan 
Stanley commodity trade shrinks, REUTERS, Jun. 7. 2012.
    \67\ Id.
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    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\
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    \68\ http://www.heidmar.com/what-we-do/.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \69\ http://www.transmontaigne.com/about-tmg/.
    \70\ http://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.
    \72\ http://www.forbes.com/lists/2011/21/private-companies-
11_TransMontaigne_7I0O.html. The estimate excludes the revenues 
generated by the company's publicly traded subsidiaries.
---------------------------------------------------------------------------
    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 Holdings LLC, which owns a group of 
        companies that provide international marine transportation and 
        U.S. marine logistics services.\73\
---------------------------------------------------------------------------
    \73\ Morgan 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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \74\ TransMontaigne 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.
---------------------------------------------------------------------------
    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:
---------------------------------------------------------------------------
    \75\ http://sec.gov/Archives/edgar/data/1319229/000104746912005319/
a2208753z10-ka.htm#aa3, at 73.

        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\
---------------------------------------------------------------------------
    \76\ Id.

    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \80\ J. 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \83\ Kinder 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \87\ Joe Leahy, Goldman in Deal to Buy Vale's Coal Assets, FIN. 
TIMES, May 28, 2012.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \88\ Glencore, 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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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 
Coca-Cola 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.'').
    \91\ The 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.
    \92\ Financial 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.
---------------------------------------------------------------------------
    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 
sheet-maker 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\
---------------------------------------------------------------------------
    \93\ Pratima 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.'').
    \94\ Trefis 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.'').
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    \95\ Laura Clarke & Matt Day, New Stab at Metals Gridlock, WALL ST. 
J., July 2, 2013, C1.
    \96\ Jack Farchy, LME takes aim at warehousing queues, FIN. TIMES, 
July 1, 2013.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \97\ Sambit Mohanty, JPMorgan to Start Physical Oil Trade; Eyes 
$200 Oil, REUTERS, May 15, 2008.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \98\ JPMorgan Chase & Co., 2011 Form 10-K, at 184.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \99\ Gregory 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=JPM_redesign/JPM_Content_C/
Generic_Detail_Page_Template&cid=1309472621690&c=JPM_Content
_C.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \101\ http://www.jpmorgan.com/pages/jpmorgan/investbk/solutions/
commodities/energy.

    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\
---------------------------------------------------------------------------
    \102\ Mike Jackson, Henry Bath & Son: A Company and family History 
(2010), available at http://www.henrybath.com/assets/_files/documents/
jun_11/HENRYBATH_1308588481_
Complete_Henry_Bath_History.pdf.

    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.
---------------------------------------------------------------------------
    \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.
    \104\ Louise 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.
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    \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.
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \108\ On 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.
---------------------------------------------------------------------------
    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 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 open-ended 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\
---------------------------------------------------------------------------
    \109\ While 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.
---------------------------------------------------------------------------
    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 FHC-permissible nonfinancial activities. It is not 
clear whether and how the regulatory 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\
---------------------------------------------------------------------------
    \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?abstract_
id=2126778.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \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.
    \112\ See 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. Sec.  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).
---------------------------------------------------------------------------
      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.
    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.
---------------------------------------------------------------------------
    \113\ Craig Pirrong, Energy Market Manipulation: Definition, 
Diagnosis, and Deterrence, 31 ENERGY L.J. 1, 2 (2010).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \114\ See, 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.
---------------------------------------------------------------------------
      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 century 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 
long-concealed 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\
---------------------------------------------------------------------------
    \115\ Louis D. Brandeis, OTHER PEOPLE'S MONEY: AND HOW THE BANKERS 
USE IT (1933), at 3.
    \116\ Id. at 4.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \117\ See, e.g., Simon Johnson & James Kwak, THIRTEEN BANKERS 
(2010); Matt Taibbi, Why Isn't Wall Street In Jail? ROLLING STONE, Feb. 
16, 2011.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \118\ The 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.
---------------------------------------------------------------------------
    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 effective 
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 super-intermediaries. 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.
                                 ______
                                 
                 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.
---------------------------------------------------------------------------
    \1\ My 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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \2\ Deposit 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.
---------------------------------------------------------------------------
    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 appropriate 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:
---------------------------------------------------------------------------
    \4\ 12 U.S.C. 24 (Seventh).
    \5\ Id.

        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\
---------------------------------------------------------------------------
    \6\ 513 U.S. 251, 258-259 note 2 (1995).

    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 
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\
---------------------------------------------------------------------------
    \7\ See Comptroller of the Currency, Administrator of National 
Banks, Activities Permissible for a National Bank, Cumulative, at 57-64 
(2011 Annual Edition, Apr. 2012).
    \8\ See 12 U.S.C. 24 (Seventh) (incidental powers clause); OCC 
Interpretive Letter No. 643, reprinted in Fed. Banking L. Rep. (CCH) 
para. 83,551 (July 1, 1992); OCC Interpretive Letter No. 511, reprinted 
in [1990-1991 Transfer Binder] Fed. Banking L. Rep. (CCH) para. 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.
---------------------------------------------------------------------------
    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 related-to-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\
---------------------------------------------------------------------------
    \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).
    \11\ See 12 C.F.R.  225.28(b)(8).
    \12\ 12 U.S.C.  1843(c)(2); C.F.R.  225.22(d)(1).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \13\ 12 U.S.C.  1843(k)(1).
    \14\ Id.  1843(k)(1)(B).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \15\ Id.  1843(k)(4)(F).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \16\ See, 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].
    \17\ See, e.g., Royal Bank of Scotland Group, supra note 16.
    \18\ See, e.g., id.
---------------------------------------------------------------------------
    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 activities, 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\
---------------------------------------------------------------------------
    \19\ See, e.g., Citigroup, supra note 16; JPMorgan Chase & Co., 
supra note 16; Royal Bank of Scotland Group, supra note 16.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \20\ See, e.g., id.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \21\ 12 U.S.C. 1843(k)(4)(H).
    \22\ See id.
    \23\ See 12 U.S.C.  1843(k)(4)(H); 12 C.F.R.  225.171, 225.172.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
    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 on nonbanking activities 
otherwise contained in Section 4 of the BHC Act within 5 years of 
becoming a bank holding company.\31\
---------------------------------------------------------------------------
    \27\ 12 U.S.C.  1843(o).
    \28\ Id. (emphasis added).
    \29\ Id.
    \30\ Id.  1843(n).
    \31\ See 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).
---------------------------------------------------------------------------
    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:
---------------------------------------------------------------------------
    \32\ See, 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.'').
    \33\ See, 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.)

        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\
---------------------------------------------------------------------------
    \34\ Amendment No. 9 by Senator Gramm (Mar. 4, 1999), available at 
http://banking.senate.gov/docs/reports/fsmod99/gramm9.htm.

    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\
---------------------------------------------------------------------------
    \35\ See, 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?abstract_id=2180647.
    \36\ Id.
    \37\ Id.
    \38\ Id.
    \39\ Id. at 5.
    \40\ 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 
Gramm-Leach-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\
---------------------------------------------------------------------------
    \41\ Shahien Nasiripourshahien & Zach Carterzach, Beer Brewers 
Blast Wall Street Banks over Aluminum Business Amid Congressional 
Scrutiny, HUFFINGTON POST (July 16, 2013).
    \42\ Id.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \43\ Id.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \44\ See, 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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \45\ See, e.g., Charles P. Kindleberger, A FINANCIAL HISTORY OF 
WESTERN EUROPE (1984).
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    \46\ See, 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).
    \47\ See id.
    \48\ See Ron Chernow, THE HOUSE OF MORGAN: AN AMERICAN BANKING 
DYNASTY AND THE RISE OF MODERN FINANCE 82-24 (1990).
    \49\ See, 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).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \50\ See Banking Act of 1933,  16, 20.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \51\ For 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \52\ Comments on Volcker Rule Regulations Regarding Energy 
Commodities, submitted by IHS Inc., February 2012, at 7-9.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \53\ See, e.g., Citigroup, supra note 16, JPMorgan Chase & Co., 
supra note 16; Royal Bank of Scotland, supra note 16.
---------------------------------------------------------------------------
    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 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:
---------------------------------------------------------------------------
    \54\ See Omarova, supra note 35, at 4.
    \55\ See, 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).
    \56\ See, e.g., James Leach, Regulatory Reform: Did Gramm-Leach-
Bliley contribute to the crisis?, Northwestern Financial Review 
(Oct.15, 2008).

        [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\
---------------------------------------------------------------------------
    \57\ See supra note 55.

---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
    \58\ See supra note 56.

    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 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\
---------------------------------------------------------------------------
    \59\ See Omarova, supra note 35, at 7.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \60\ See supra note 33.
    \61\ See supra note 34.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \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/
monthly_review/1971_pdf/02_1_71.pdf.
---------------------------------------------------------------------------
    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.''
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \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.
    \4\ http://www.presidency.ucsb.edu/ws/
index.php?pid=56922#axzz1aV0pqgub.
---------------------------------------------------------------------------
    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 activities 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\
---------------------------------------------------------------------------
    \5\ Federal Reserve Bulletin, Volume 94, First Quarter 2008, ``The 
Royal Bank of Scotland Group plc Edinburgh, Scotland, ``Order Approving 
Notice to Engage in Activities Complementary 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 
short-side speculative position limit on several occasions.'').
---------------------------------------------------------------------------
    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 
ring-dealing 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\
---------------------------------------------------------------------------
    \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.
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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\
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    \8\ GRAMM-LEACH-BLILEY ACT, PUBLIC LAW 106-102--NOV. 12, 1999, 
available at: http://www.gpo.gov/fdsys/pkg/PLAW-106publ102/pdf/PLAW-
106publ102.pdf.
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    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 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\
---------------------------------------------------------------------------
    \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-rule-on-big-banks-
commodity-trades-after-complaints.html.
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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.
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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 
worked\11\ 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.
---------------------------------------------------------------------------
    \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/a-shuffle-of-aluminum-but-to-banks-
pure-gold.html?ref=todayspaper&_r=0.
---------------------------------------------------------------------------
    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 resulted 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.
---------------------------------------------------------------------------
    \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-t-block-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#mi_rss=Capitol%20and%20California.
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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\
---------------------------------------------------------------------------
    \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.'')
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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.'')
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \16\ See, as example, https://www.citicapitaladvisors.com/
ciiOverview.do and https://www.JPMorgan.com/cm/
ContentServer?pagename=Chase/Href&urlname=JPMorgan/am/ia/
investment_strategies/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
JPMorgan_Detailed%20Proposal.pdf.
---------------------------------------------------------------------------
    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 ``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\
---------------------------------------------------------------------------
    \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%20JPMorgan_
Detailed%20Proposal.pdf.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \20\ PPP Failures, Scribd, last accessed July 22, 2013, available 
at: http://www.scribd.com/doc/155206053/PPP-Failures.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
    \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
JPMorgan_Detailed%20Proposal.pdf.
    \22\ FDIC 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.'')
---------------------------------------------------------------------------
    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.
    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 over-indebted 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\
---------------------------------------------------------------------------
    \23\ J.P. Morgan: a Biography, Liz Bowen, Fordham University, last 
accessed July 22, 2013, available at: http://www.fordham.edu/academics/
colleges_graduate_s/undergrad
uate_college/fordham_college_at_l/special_programs/honors_program/
hudsonfulton_cele
bra/homepage/biographies/jp_morgan_32212.asp.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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/digital_assets/publications/chicago_fed_letter/2007/
cflnovember2007_
244a.pdf.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \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).
---------------------------------------------------------------------------
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 implied 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 Government-subsidized 
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 aluminum 
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, 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 functional 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.
 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. LShould 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. LAs 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.

   LShould 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. LTo 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. LHas 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. LIn 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. LPlease further describe the potential regulatory capacity 
        challenges since you have stated regulators may be 
        incapable of effectively monitoring and overseeing 
        large financial conglomerates.

  b. LPlease 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'') 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 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 anti-competitive 
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 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-
1432_021412_105313_542080912901_1.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 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 ultra-secretive, 
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]

    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 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. LShould 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. LAs 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.

   LShould 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. LTo 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. LHas 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. LIn 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. LWhat types of considerations should legislators consider?

  b. LDo 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. LAverage LME traded price for aluminum for the following 
        years: 2009, 2010, 2011, 2012, and 2013;

  b. LAverage monthly rental-fee-for metal storage in LME 
        warehouse for the following years: 2009, 2010, 2011, 
        2012, and 2013;

  c. LAverage total costs for aluminum expenses for the 
        following years: 2009, 2010, 2011, 2012, and 2013; and

  d. LNumber 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 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        VLISSINGEN (PACORINI
                             INTERNATIONAL)               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.

   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. LThe dates of each meeting with the LME, CFTC and FCA; and

  b. LA 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. LThe 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. LMetal users could experience supply shortages and 
        increased costs if they tried to change the warehouse 
        rules.

  3. LThe 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. LDespite establishing the rules for warehouses and 
        receiving a royalty, the LME claims that it has no 
        authority over the private warehouse owners.

  5. LThe 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 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. LA daily rental to be charged for a limited period 
        following cancellation of a warrant (i.e., 30-45 days).

  ii. LDaily load out rate for each warehouse shed at each 
        official site, rather than by company at an official 
        site.

  iii. LA daily load-out rate by warehouse shed that would 
        clear the queue within a reasonable period.

  iv. LA 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.

   LWhile this proposal is still under consultation, 
        please explain why this proposal would ``make no real 
        impact'' as you stated in your testimony?

   LWhat 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 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 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.

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              Additional Material Supplied for the Record

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