[Senate Hearing 113-501, Volume 1]
[From the U.S. Government Publishing Office]
S. Hrg. 113-501
WALL STREET BANK INVOLVEMENT
WITH PHYSICAL COMMODITIES
=======================================================================
HEARINGS
before the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
VOLUME 1 OF 2
__________
NOVEMBER 20 and 21, 2014
__________
Available via the World Wide Web: http://www.fdsys.gov
Printed for the use of the
Committee on Homeland Security and Governmental Affairs
S. Hrg. 113-501
WALL STREET BANK INVOLVEMENT
WITH PHYSICAL COMMODITIES
=======================================================================
HEARINGS
before the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
----------
VOLUME 1 OF 2
----------
NOVEMBER 20 and 21, 2014
----------
Available via the World Wide Web: http://www.fdsys.gov
Printed for the use of the
Committee on Homeland Security and Governmental Affairs
______
U.S, GOVERNMENT PRINTING OFFICE
91-653 PDF WASHINGTON : 2014
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
THOMAS R. CARPER, Delaware, Chairman
CARL LEVIN, Michigan TOM COBURN, Oklahoma
MARK L. PRYOR, Arkansas JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri ROB PORTMAN, Ohio
JON TESTER, Montana RAND PAUL, Kentucky
MARK BEGICH, Alaska MICHAEL B. ENZI, Wyoming
TAMMY BALDWIN, Wisconsin KELLY AYOTTE, New Hampshire
HEIDI HEITKAMP, North Dakota
Gabrielle A. Batkin, Staff Director
Keith B. Ashdown, Minority Staff Director
Laura W. Kilbride, Chief Clerk
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
CARL LEVIN, Michigan, Chairman
MARK L. PRYOR, Arkansas JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri ROB PORTMAN, Ohio
JON TESTER, Montana RAND PAUL, Kentucky
TAMMY BALDWIN, Wisconsin KELLY AYOTTE, New Hampshire
HEIDI HEITKAMP, North Dakota
Elise J. Bean, Staff Director and Chief Counsel
Tyler Gellash, Senior Counsel
Henry J. Kerner, Minority Staff Director and Chief Counsel
Michael Lueptow, Counsel to the Minority
Mary D. Robertson, Chief Clerk
Patricia R. Hogan, Publications Clerk
C O N T E N T S
------
Opening statements:
Page
Senator Levin................................................ 1, 95
Senator McCain............................................... 7, 98
Senator Portman.............................................. 23
Senator Baldwin.............................................. 33
WITNESSES
Thursday, November 20, 2014
Christopher Wibbelman, President and Chief Executive Officer,
Metro International Trade Services LLC, Allen Park, Michigan... 10
Jacques Gabillon, Head, Global Commodities Principal Investment
Group, Goldman Sachs and Co., London, England.................. 11
Jorge Vazquez, Founder and Managing Director, Harbor Aluminum
Intelligence LLC, Austin, Texas................................ 56
Nick Madden, Senior Vice President and Chief Supply Chain
Officer, Novelis Inc., Atlanta, Georgia........................ 57
Simon Greenshields, Global Co-Head of Commodities, Morgan
Stanley, New York, New York.................................... 68
Gregory A. Agran, Co-Head, Global Commidities Group, Goldman
Sachs and Co., New York, New York.............................. 69
John Anderson, Co-Head, Global Commodities Group, JPMorgan Chase
and Co., New York, New York.................................... 71
Friday, November 21, 2014
Saule T. Omarova, Professor of Law, Cornell University, Ithaca,
New York....................................................... 99
Chiara Trabucchi, Principal, Industrial Economics, Incorporated,
Cambridge, Massachusetts....................................... 101
Hon. Daniel K. Tarullo, Member, Board of Governors of the Federal
Reserve System, Washington, DC................................. 119
Larry D. Gasteiger, Acting Director, Office of Enforcement,
Federal Energy Regulatory Commission, Washington, DC........... 120
Alphabetical List of Witnesses
Agran, Gregory A.:
Testimony.................................................... 69
Prepared statement........................................... 274
Anderson, John:
Testimony.................................................... 71
Prepared statement........................................... 277
Gabillon, Jacques:
Testimony.................................................... 11
Prepared statement with an attached chart.................... 142
Gasteiger, Larry D.:
Testimony.................................................... 120
Prepared statement........................................... 325
Greenshields, Simon:
Testimony.................................................... 68
Prepared statement........................................... 268
Madden, Nick:
Testimony.................................................... 57
Prepared statement........................................... 164
Omarova, Saule T.:
Testimony.................................................... 99
Prepared statement........................................... 282
Tarullo, Hon. Daniel K.:
Testimony.................................................... 119
Prepared statement........................................... 313
Trabucchi, Chiara:
Testimony.................................................... 101
Prepared statement........................................... 302
Vazquez, Jorge:
Testimony.................................................... 56
Prepared statement........................................... 148
Wibbelman, Christopher:
Testimony.................................................... 10
Prepared statement........................................... 139
APPENDIX
Report by the Permanent Subcommittee on Investigations Majority
and Minority Staff entitled ``Wall Street Bank Involvement With
Physical Commodities,'' November 20 and 21, 2014............... 341
EXHIBIT LIST
VOLUME 1
1. a. GGlobal LME Aluminum Stocks, chart prepared by the
Permanent Subcommittee on Investigations....................... 816
b. GMetro Freight Incentives, chart prepared by Goldman
Sachs. [Source: Goldman Sachs Counsel letter to the Permanent
Subcommittee on Investigations, GSPSICOMMODS00046232, included
in Exhibit 39]................................................. 817
c. GAluminum Tonnage Shipped (Metro Warehouse (Detroit) to
Metro Warehouse (Detroit)), chart prepared by Goldman Sachs.
[Source: Goldman Sachs Counsel letter to the Permanent
Subcommittee on Investigations, PSI-GoldmanSachs-20-000002].... 818
d. GGoldman Employees Who Served As Metro Board Members, 2009
to 2014, chart prepared by the Permanent Subcommittee on
Investigations................................................. 819
e. GAluminum Merry Go Round Transactions, chart prepared by
the Permanent Subcommittee on Investigations................... 820
f. GDetroit Queue and Platts MW Aluminum Premium, chart
prepared by the Permanent Subcommittee on Investigations....... 821
g. GWentworth Ownership Structure, chart prepared by the
Permanent Subcommittee on Investigations....................... 822
h. GOverview of North America Gas, Power and PI Assets, as of
03/31/2011, chart prepared by JPMorgan. [FRB-PSI-623097,
included in Exhibit 58]........................................ 823
i. GJPMorgan internal email, dated October 2010, re: Please
sir! mor BCR!!!!............................................... 824
j. GExcerpts from 2013 CNR Financial Statement, prepared by
CNR. [GSPSICOMMODS00046374, included in Exhibit 17]............ 825
k. GQueue Length, chart prepared by the Permanent
Subcommittee on Investigations................................. 826
Documents Related to Goldman Sachs/General:
2. GExcerpts of Goldman Sachs responses to questions from the
Federal Reserve on 4(o) Commodities Activities, dated May 26,
2011, re: 1997 v. 2010 physical commodity activities. [FRB-PSI-
200600-602, 608-610]........................................... 827
3. GExcerpts from Goldman Sachs Presentation, Federal Reserve
Bank of New York Discovery Review: Global Commodities - US
Natural Gas & Power, dated March 2010, (Financial vs. Physical
Trades FY 2009). [FRB-PSI-400006, 008]......................... 833
4. GGoldman Sachs Presentation, Global Commodities, Presentation
to the Board of Directors of The Goldman Sachs Group, Inc.,
dated October 2011, including Metro, CNR and Cogentrix
highlights. [FRB-PSI-700011-030]............................... 835
5. GExcerpts from Goldman Sachs Memorandum, dated July 2012, re:
Firmwide Client and Business Standards Committee Meeting, (...
Merchant Banking include CNR, Metro and Vale. ... *** ...
Nufcor - treated as part of firm's own activities). [FRB-PSI-
200984, 994-996, 998-1001, 1004, 1006-007]..................... 855
6. GGoldman Sachs Memorandum to the Federal Reserve, dated July
2013, re: commodity-related activities, including
environmental/catastrophic risk. [FRB-PSI-201245-268].......... 866
7. GGoldman Sachs Presentation, Global Commodities & Global
Special Situations Group, Presentation to the Board of
Directors of The Goldman Sachs Group, Inc., dated September
2013, including Metro and CNR (short coal hedge) highlights.
[FRB-PSI-400077-098]........................................... 889
8. GConsolidated Holding Company Report of Equity Investments in
Nonfinancial Companies - FR Y-12, dated June 30, 2014, prepared
by The Goldman Sachs Group, regarding its merchant banking
investments. [FRB-PSI-800013-016].............................. 910
Documents Related to Goldman Sachs Involvement with Uranium:
9. GGoldman Sachs New Product Memorandum, dated December 2008,
re: Uranium Trading. [FRB-PSI-400039-052]...................... 914
10. GGoldman Sachs Physical Commodity Review Committee: Meeting
Minutes, dated May 2013, re: enriched uranium (UF6). [FRB-PSI-
400053-055].................................................... 928
11. GNufcor - Structure Chart, prepared by Goldman Sachs.
[GSPSICOM-MODS00046240]........................................ 931
12. GExcerpts from Goldman Sachs counsel letter to the
Subcommittee, dated October 2014, re: Nufcor, attached chart,
Nufcor Uranium Utility Supply Contracts at the time of the
Nufcor Acquisition (June 30, 2009)). [PSI-GoldmanSachs-21-
000001-010 and GSPSICOMMODS00046532-533]....................... 932
Documents Related to Goldman Sachs Involvement with Coal:
13. GCNR Structure Chart, prepared by Goldman Sachs.
[GSPSICOMMODS-00046318]........................................ 944
14. GExcerpt from Coalcorp Mining Inc., Notice of Special Meeting
of Shareholders to be Held on February 11, 2010 and Management
Information Circular. [PSI-CI-01-000001-003, 019-020, 025-028]. 945
15. GGoldman Sachs submission to the Federal Reserve, Report of
Changes in Organizational Structure - FR Y-10, dated April
2010, re: CNR. [GSPSICOMMODS00046301-303]...................... 954
16. GExcerpt from C.I. Colombian Natural Resources I SAS and J.
Aron & Company Marketing Agreement, dated September 2011.
[GSPSI-COMMODS00046496-501, 509]............................... 957
17. GExcerpt from C.I. Colombian Natural Resources I S.A.S,
Financial Statements for the years ended on the 31st of
December of 2013 and 2012 and Statutory Auditor's Report, dated
March 2014. [GSPSICOM-MODS00046366-367, 369, 373-376, 382-383,
391-395]....................................................... 964
18. GGoldman Sachs counsel letter to the Subcommittee, dated
October 2014, re: CNR and Nufcor. [PSI-GoldmanSachs-19-000001-
009]........................................................... 978
19. GGoldman Sachs counsel letter to the Subcommittee, dated
November 2014 (... J. Aron acted as the exclusive marketing and
sales agent for CNR.). [PSI-GoldmanSachs-25-000001-003]........ 987
20. GGoldman Sachs Metals & Mining, Background to Environmental
and Social Due Diligence, last updated 2012. [FRB-PSI-300221-
230]........................................................... 990
Documents Related to Goldman Sachs Involvement with Aluminum:
21. GExcerpt from Goldman Sachs counsel letter to the
Subcommittee, dated October 2014, including chart, Aluminum
Tonnage Shipped (Metro Warehouse (Detroit) to Metro Warehouse
(Detroit)). [PSI-GoldmanSachs-20-000001-002]................... 1000
22. a. GInvoice List of Glencore Ltd. and Red Kite Master Fund
Limited. [GSPSICOMMODS00046871-872]............................ 1002
b. GGlencore Ltd. invoice to Metro International Trade, dated
June 21, 2013, in the amount of $9,909,280.66.
[GSPSICOMMODS00046873]......................................... 1004
c. GGlencore Ltd. invoice to Metro International Trade, dated
June 21, 2013, in the amount of $402,190.77.
[GSPSICOMMODS00046874]......................................... 1005
d. GGlencore Ltd. invoice to Metro International Trade, dated
September 24, 2013, in the amount of $321,105.33.
[GSPSICOMMODS00046875]......................................... 1006
e. GRed Kite Master Fund Limited invoice to Metro
International Trade, dated November 13, 2012, in the amount of
$5,735,700. [GSPSICOMMODS00046876]............................. 1007
f. GRed Kite Master Fund Limited invoice to Metro
International Trade, dated December 20, 2012, in the amount of
$632,720. [GSPSI-COMMODS00046877].............................. 1008
g. GRed Kite Master Fund Limited invoice to Metro
International Trade, dated January 28, 2014, in the amount of
$2,932,731.43. [GSPSI-COMMODS00046878]......................... 1009
h. GRed Kite Master Fund Limited invoice to Metro
International Trade, dated January 28, 2014, in the amount of
$14,084,464.63. [GSPSICOMMODS00046879]......................... 1010
23. GWarrant Finance Agreement, DB Energy Trading LLC and Metro
International Trade Services LLC, dated September 2010.
[GSPSICOMMODS-0047434-447]..................................... 1011
24. GExcerpt from Goldman Sachs Presentation, MITSI Holdings LLC,
Board of Directors Meeting, dated December 2012, slide entitled
Overview Off-warrant Deals, re: Red Kite deals.
[GSPSICOMMODS00009348]......................................... 1025
25. GMetro internal email, dated November 2012, re: Detroit Ali -
off warrant storage deal. [GSPSICOMMODS00046684-686]........... 1026
26. GGlencore/Metro email exchange, dated April 2013, re: New
Deal 09 Glencore Detroit (... all 91,000 mt for Glencore
scheduled to ship outbound in May/June will do so as scheduled
but will go to other Metro locations in Detroit (we of course
decide) and remain off warrant until June/July 2013 at which
point the material will be rewarranted.). [PSICOMMODS00046687-
691]........................................................... 1029
27. GCharts related to last Red Kite deal and Glencore deal,
prepared by Metro for LME in 2014. [GSPSICOMMODS00046666-683].. 1034
28. GMetro internal email, dated December 2010, re: Montreal (...
blocking others. *** ... Q management.). [GSPSICOMMODS00047422] 1052
29. GMetro internal email, dated February 2012, re: Stemcor 12 kt
to Detroit (... queue management.). [GSPSICOMMODS00047423-429]. 1053
30. GMetro internal email of Michael Whelan, dated June 2013, re:
Resignation (I have some questions and concerns regarding the
Chinese Wall Policy that is in place which regulates the
interaction between Metro International, its customers, and J
Aron. This morning's confrontation was extremely questionable.)
[GSPSICOMMODS00047430]......................................... 1060
31. GMetro International Trade Services (2011-2013) and (2014),
charts regarding agreements of sharing physical premiums.
[GSPSICOMMODS-00046531, 46630]................................. 1061
32. GGoldman Sachs chart, Metro International Trade Services,
Management Brief, June 2011 (Extraordinary income from
counterparties sharing physical premium with Metro ...).
[GSPSICOMMODS00009668]......................................... 1063
33. GLME counsel letter to the Subcommittee, dated November 2014
(... while the LME would view such behavior as a contravention
of the ``spirit'' of the relevant requirements, it may be
difficult to argue that it constituted a contravention of the
``letter'' of those requirements.). [LME_PSI0002459-462]....... 1064
34. GAluminum Users Group Memorandum, dated October 2012 (The
LME's terminal market model ... is broken.). [PSI-
AlumUsersGroup-01-000010-012].................................. 1068
35. GGoldman Sachs Presentation to Firmwide Client and Business
Standards Committee, Metro International Trade Services, dated
August 2011, including slide entitled, Metro Financial Summary.
[FRB-PSI-707486-500]........................................... 1071
36. a. GGoldman Sachs Presentation, MITSI Holdings LLC, Board of
Directors Meeting, dated December 2011, including slide
entitled Current Deal Pipeline. [GSPSICOMMODS00009287-309]..... 1086
b. GGoldman Sachs Presentation, MITSI Holdings LLC, Board of
Directors Meeting, dated March 2012, including slides entitled
Current Deal Pipeline and Overview Off-warrant Deals.
[GSPSICOMMODS-00009423-449].................................... 1109
c. GGoldman Sachs Presentation, MITSI Holdings LLC, Board of
Directors Meeting, dated December 2012, including slides
entitled Current Deal Pipeline and Overview Off-warrant Deals.
[GSPSICOMMODS-00009332-353].................................... 1136
d. GGoldman Sachs Presentation, MITSI Holdings LLC, Board of
Directors Meeting, dated March 2013, including slides entitled
Current Deal Pipeline and Metro's Annual Financial Performance.
[GSPSICOMMODS-00009355-377].................................... 1157
37. GLondon Metal Exchange (LME) document listing Terms and
conditions applicable to all LME listed warehouse companies,
dated April 2014. [LME_PSI0001406-427]......................... 1178
38. a. GConflict Management Procedures Between Metro and Other GS
Businesses and Personnel, Policy Issued To: Global Commodities
Sales and Trading, Global Commodities Principal Investment,
Metro Board Members, Metro Management and Staff, dated February
2010. [FRB-PSI-602457-471]..................................... 1200
b. GInformation Barrier Policy: Metro and Other GS Businesses
and Personnel, For: Global Commodities Sales and Trading,
Global Commodities Principal Investments, Metro Board Members,
Metro Management and Staff, dated March 2014.
[GSPSICOMMODS00004059-076]..................................... 1215
39. GExcerpt from Goldman Sachs counsel letter to the
Subcommittee, dated September 2014, including table listing
Total Annual Freight Allowance Paid by Metro and Annual Freight
Allowance Paid by Metro to J. Aron. [PSI-GoldmanSachs-15-000001
and GSPSICOMMODS00046232-233].................................. 1233
40. GExcerpts from Goldman Sachs counsel letter to the
Subcommittee, dated August 2014, including list of authorized
Goldman Sachs employees given access to confidential
information. [PSI-GoldmanSachs-17-000001 and
GSPSICOMMODS00046225-226]...................................... 1236
Documents Related to Morgan Stanley/General:
41. GMorgan Stanley Presentation, Global Commodities Overview,
dated May 2009. [FRB-PSI-618889-908]........................... 1239
42. GMorgan Stanley Presentation, Morgan Stanley Commodities,
Business Overview, dated February 2013, prepared for the
Permanent Subcommittee on Investigations. [PSI-MorganStanley-
01-000001-027]................................................. 1259
43. GConsolidated Holding Company Report of Equity Investments in
Nonfinancial Companies - FR Y-12, dated June 30, 2014, prepared
by Morgan Stanley, regarding its merchant banking investments.
[FRB-PSI-800009-012]........................................... 1286
Documents Related to Morgan Stanley Involvement with Natural Gas:
44. GExcerpt from Morgan Stanley Presentation, Federal Reserve
Bank of New York, Morgan Stanley Infrastructure Platform
Review, prepared by Morgan Stanley, dated September 2013. [FRB-
PSI-400321-329, 331 333, 341, 351-352, 365-366]................ 1290
45. a. GApplication of Wentworth Gas Marketing LLC for Long-Term
Authorization to Export Compressed Natural Gas, submitted to
the Department of Energy, Office of Fossil Energy, dated May
2014........................................................... 1307
b. GDepartment of Energy, Office of Fossil Energy, In re
Wentworth Gas Marketing LLC, Order Granting Long-Term
Authorization To Export Compressed Natural Gas, dated October
2014. [PSI-DOE-01-000004-016].................................. 1326
46. GExcerpt from Morgan Stanley Presentation, Morgan Stanley
Infrastructure Partners, Overview of Southern Star, dated
August 2014. [MS-PSI-00000001-016, 019-020, 023-027, 035, 037]. 1339
47. GMorgan Stanley counsel letter to the Subcommittee, dated
September 2014, re: ... Morgan Stanley's purchase of the
Deutsche Bank natural portfolio and involvement with Wentworth
Holdings, LLC. [PSI-MorganStanley-13-000001-009]............... 1364
48. GExcerpt from Morgan Stanley Presentation, Morgan Stanley
Infrastructure Partners, Southern Star Follow Up Questions,
dated October 2014. [MS-PSI-00000455-460, 465-469, 472-475].... 1373
Documents Related to Morgan Stanley Involvement with Crude Oil:
49. GExcerpts from Morgan Stanley counsel letter to the
Subcommittee, dated October 2014, re: early New York oil
storage. [PSI-MorganStanley-17-000001-002]..................... 1387
50. GExcerpts from Morgan Stanley counsel letter to the
Subcommittee, dated June 2013, re: TransMontaigne. [PSI-
MorganStanley-06-000001-004]................................... 1389
51. GExcerpts from Morgan Stanley counsel letter to the
Subcommittee, dated October 2014, re: oil storage data,
revenue, and Olco Petroleum Group. [PSI-MorganStanley-19-
000001-003].................................................... 1393
Documents Related to Morgan Stanley Involvement with Jet Fuel:
52. GExcerpts from Jet Fuel Supply Agreement between Morgan
Stanley Capital Group Inc. and United Airlines, Inc. and United
Aviation Fuels Corporation, dated September 2003. [PSI-
UnitedAirlines-01-000003, 013, 016, 020-022]................... 1396
53. GMorgan Stanley counsel letter to the Subcommittee, dated
September 2014, re: Emirates. [PSI-MorganStanley-15-000001-004] 1402
54. GEmirates counsel letter to the Subcommittee, dated October
2014, re: jet fuel purchases and hedges. [PSI-Emirates-01-
000001-004].................................................... 1406
55. GEmirates counsel letter to the Subcommittee, dated October
2014, re: jet fuel purchases and hedges. [PSI-Emirates-02-
000001-007].................................................... 1410
Documents Related to JPMorgan Chase/General:
56. a. GNotice to the Board of Governors of the Federal Reserve
System by JPMorgan Chase & Co., submitted July 21, 2005,
requesting complementary authority for physical commodity
activities. [PSI-FederalReserve-01-000004-028]................. 1417
b. GNotice to the Board of Governors of the Federal Reserve
System by JPMorgan Chase & Co., submitted November 25, 2008,
requesting complementary authority for refining activities.
[PSI-Federal Reserve-01-000553-558]............................ 1442
57. GFederal Reserve letter to JPMorgan Chase, dated April 20,
2009, granting complementary authority, re: refining
activities. [PSI-FRB-11-000001-002]............................ 1448
58. GJPMorgan Presentation, Global Commodities - Operating Risk,
dated April 2011. [FRB-PSI-623086-127]......................... 1450
59. GJPMorgan Chase physical inventory positions, 2008-2012.
[JPM-COMM-PSI-000015-016]...................................... 1491
60. GMerchant Banking Investment in Henry Bath, undated, prepared
by JPMorgan. [FRB-PSI-000580-582].............................. 1493
61. GExcerpt from JPMorgan Presentation, Commodities Physical
Operating Risk, Update to CIBRC, dated January 2013, with slide
entitled Physical Operating Risk Review of Project Liberty.
[FRB-PSI-301379, 381].......................................... 1496
62. GConsolidated Holding Company Report of Equity Investments in
Nonfinancial Companies - FR Y-12, dated June 30, 2014, prepared
by JPMorgan, regarding its merchant banking investments. [FRB-
PSI-800005-008]................................................ 1498
63. GExcerpts from Global & Regional Investment Bank League
Tables - 1H2014, dated September 2014, prepared by Coalition
Analytics Intelligence. [PSI-Coalition-01-000019-021].......... 1502
64. GJPMorgan Chase counsel letter to the Subcommittee, dated
June 2014, re: J.P.Morgan Ventures Energy Corporation (JPMVEC).
[PSI-JPMC-11-000001-002]....................................... 1505
65. GJPMorgan Chase counsel letter to the Subcommittee, dated
October 2014, re: JPMVEC and Project Liberty. [PSI-
JPMorganChase-14-000001-009]................................... 1507
66. GJPMorgan Chase counsel letter to the Subcommittee, dated
October 2014, re: various commodity issues. [PSI-JPMorgan-15-
000001-008].................................................... 1516
Documents Related to JPMorgan Chase Involvement with Electricity:
67. GPower Plants Owned or Controlled via Tolling Agreements,
2008 to present, chart prepared by JPMorgan. [JPM-COMM-PSI-
000022-025].................................................... 1524
68. GFederal Reserve Bank of New York letter to JPMorgan Chase,
dated March 2008, granting 2-year grace period for power plants
and other assets acquired from The Bear Stearns Companies Inc.
[FRB-PSI-900001-003]........................................... 1528
69. GExcerpts from JPMorgan Presentation, Global Commodities Deep
Dive Risk Review, dated October 2009. [FRB-PSI-200634-638, 640-
642, 644-645, 649-655]......................................... 1531
70. a. GNotice to the Board of Governors of the Federal Reserve
System by JPMorgan Chase & Co., submitted December 30, 2009,
requesting complementary authority for energy management
activities. [PSI-FederalReserve-01-000561-567]................. 1548
b. GNotice to the Board of Governors of the Federal Reserve
System by JPMorgan Chase & Co., submitted December 30, 2009,
requesting complementary authority for tolling activities.
[PSI-FederalReserve-02-000012-033]............................. 1555
71. GJPMorgan letter to the Federal Reserve, dated February 2010,
requesting extension and additional complementary authority.
[FRB-PSI-300286-290]........................................... 1577
72. GFederal Reserve letter to JPMorgan Chase, dated June 2010,
granting complementary authority regarding power plants. [FRB-
PSI-302571-580]................................................ 1582
73. GJPMorgan Transaction Overview, dated August 2010, regarding
purchase of Kinder Morgan Power Plant. [FRB-PSI-300066]........ 1592
74. GUndated document prepared by JPMorgan regarding power plant
restructuring. [FRB-PSI-300352-353]............................ 1593
75. GJPMorgan Presentation, Commodities Operational Risk Capital,
dated May 2011. [FRB-PSI-300727-736]........................... 1595
76. GJPMorgan internal email, dated April 2010, re: Resume for
Power, attaching resume of John Howard Bartholomew (Identified
a flaw in the market mechanism Bid Cost Recovery that is
causing the CAISO to misallocate millions of dollars.). [PSI-
FERC-02-000009-010]............................................ 1605
77. GJPMorgan internal email, dated October 2010, re: Please sir!
mor BCR!!!! [PSI-FERC-02-000042]............................... 1607
78. GJPMorgan internal email from Francis Dunleavy to Blythe
Masters, dated March 2011, re: CAISO update (I will handle it
but it may not be pretty.). [PSI-FERC-02-000067]............... 1608
Documents Related to JPMorgan Chase Involvement with Copper:
79. GJPMorgan Presentation, JPM Commodity Capabilities, dated
January 2012. [FRB-PSI-200832-865]............................. 1609
80. GExcerpt from JPMorgan Presentation, FED/OCC Quarterly
Meeting, dated February 2013, including slide entitled,
Physical Inventory Limits from FED & OCC. [FRB-PSI-301443, 447] 1639
81. GFederal Reserve email to the Subcommittee, dated October
2014, re: treating copper as ``bullion.'' [PSI-FRB-16-000001].. 1641
82. GJPMorgan counsel email to the Subcommittee, dated October
2014, re: metals trading desk. [PSI-JPMorgan-16-000001]........ 1642
83. GJPMorgan counsel letter to the Subcommittee, dated October
2014, re: JPMorgan copper activities. [PSI-JPMorgan-18-000001-
008 and JPM-COMM-PSI-000064-066]............................... 1643
84. GOCC Interpretive Letter No. 553, dated May 1991, re:
treating platinum as bullion. [PSI-OCC-01-000112-113].......... 1651
85. GOCC Interpretive Letter No. 693, dated December 1995, re:
treating copper as bullion. [PSI-OCC-01-000135-141]............ 1653
86. a. GComment Letter from Senator Carl Levin to the Securities
and Exchange Commission, dated, July 2012, re: JPM XF Physical
Copper Trust Pursuant to NYSE Area Equities Rule 8.201......... 1660
b. GComment Letter from Senator Carl Levin to the Securities
and Exchange Commission, dated, March 2013, re: JPM XF Physical
Copper Trust, Form S-1 Registration Statement.................. 1667
87. GComment Letter from law firm representing copper fabricating
companies to the Securities and Exchange Commission, dated July
2012, re: rule change allowing copper ETF. [PSI-
VandenbergFeliu_to_SEC(July2012)-000001-005]................... 1682
88. GLME email to the Subcommittee, dated November 2014: re:
LME's Public Warrant Banding Report, dated December 15, 2010.
[PSI-LME-06-000001]............................................ 1687
Documents Related to JPMorgan Chase Involvement with Size
Limits:
89. GMethodology for Calculating Capacity Payments for Purposes
of 5% Limit, undated, prepared by JPMorgan. [FRB-PSI-300345-
347]........................................................... 1688
90. GExcerpt from JPMorgan Presentation, FED/OCC/FDIC Quarterly
Meeting, dated September 2013, Physical Inventory Limits from
FED & OCC. [FRB-PSI-301383, 387]............................... 1691
91. GExcerpt from JPMorgan Chase counsel letter to the
Subcommittee, dated October 2014, including chart with
inventory levels for copper, platinum, and palladium as of
September 28, 2012 held by JPMorgan Chase Bank. [PSI-JPMorgan-
15-000001 and JPM-COMM-PSI-000048-049]......................... 1693
92. GJPMorgan internal email, dated January 2012, re:
Consolidated OCC Summary 10 Jan 2012, providing inventory
levels for metals held by JPMorgan Chase Bank. [OCC-PSI-
00000336]...................................................... 1696
93. GJPMorgan internal email, dated January 2012, re:
Consolidated OCC Summary 19 Jan 2012 (... took further action
yesterday to lend 100k tonnes of materials to the market as
well as sell 400k tonnes of material to JPMVEC.). [OCC-PSI-
00000344]...................................................... 1697
94. GJPMorgan internal email, dated January 2012, re:
Consolidated OCC Summary 19 Jan 2012 (It will not happen again
that you learn about it after the fact when it is an issue
within our control.). [OCC-PSI-00000340]....................... 1698
95. GJPMorgan internal email, dated February 2012, re: 5% Limit
Calculation (Following are our current and proposed
methodologies for calculating the [OCC] 5% limit.). [OCC-PSI-
00000324]...................................................... 1699
96. GJPMorgan Chase counsel email to the Subcommittee, dated
November 2014, (JPMCB's daily aluminum inventory values and the
corresponding LME cash price for aluminum.). [PSI-JPMorgan-23-
000001]........................................................ 1700
97. GExcerpt from JPMorgan Chase counsel letter to the
Subcommittee, dated October 2014, re: aluminum trades and 5%
limit. [PSI-JPMorgan-17-000001-002]............................ 1701
98. GExcerpt from JPMorgan Chase counsel letter to the
Subcommittee, dated November 2014, re: JPMCB aluminum holdings.
[PSI-JPMorgan-19-000001-003]................................... 1703
99. a. GMetro legal counsel letter to LME, dated January 27,
2014. [GSPSICOMMODS00046661-665]............................... 1706
b. GMetro legal counsel letter to LME, dated April 15, 2014.
[GSPSICOMMODS00046834-848]..................................... 1711
100.a. GResponses of Hon. Daniel K. Tarullo, Federal Reserve
System, to supplemental questions for the record from Senator
Carl Levin..................................................... 1726
b. GResponses of Chiara Trabucchi, Industrial Economics,
Incorporated, to supplemental questions for the record from
Senator Carl Levin............................................. 1735
101.a. GResponses of Gregory A. Agran, Goldman Sachs & Co., to
supplemental questions for the record from Senator Kelly
Ayotte......................................................... 1739
b. GResponses of John Anderson, JPMorgan Chase & Co., to
supplemental questions for the record from Senator Kelly
Ayotte......................................................... 1745
c. GResponses of Simon Greenshields, Morgan Stanley, to
supplemental questions for the record from Senator Kelly
Ayotte......................................................... 1751
102.a. GResponses of Jorge Vazquez, Harbor Aluminum Intelligence
Unit, LLC, to supplemental questions for the record from
Senator Tammy Baldwin.......................................... 1754
b. GResponses of Nick Madden, Novelis, Inc., to supplemental
questions for the record from Senator Tammy Baldwin............ 1759
VOLUME 2
103. GDocument Locator List and documents cited in footnotes to
``Wall Street Bank Involvement With Physical Commodities,'' the
Report released in conjunction with the Subcommittee hearing on
November 20 and 21, 2014. The Document Locator List provides
the Bates numbers or a description of the documents cited in
the Report and the hearing record page number where the
document can be located. Not included are documents related to
Subcommittee interviews, which are not available to the public,
and widely available public documents.......................... 1763
WALL STREET BANK INVOLVEMENT
WITH PHYSICAL COMMODITIES
----------
THURSDAY, NOVEMBER 20, 2014
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:34 a.m., in
room SD-106, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
Present: Senators Levin, Pryor, Baldwin, McCain, and
Portman.
Staff present: Elise J. Bean, Staff Director and Chief
Counsel; Mary D. Robertson, Chief Clerk; Tyler Gellasch, Senior
Counsel; Adam Henderson, Professional Staff Member; Angela
Messenger, Detailee (GAO); Joel Churches, Detailee (IRS); Ahmad
Sarsour, Detailee (FDIC); Tom McDonald, Law Clerk; Tiffany
Eisenbise, Law Clerk; Tiffany Greaves, Law Clerk; Ken Reidy
(Sen. Baldwin); Henry J. Kerner, Staff Director and Chief
Counsel to the Minority; Michael Lueptow, Counsel to the
Minority; Scott Wittmann, Research Assistant to the Minority;
Elise Mullen, Research Assistant to the Minority; Kyle Brosnan,
Law Clerk to the Minority; Christina Bortz, Law Clerk to the
Minority; Jennifer Junger, Law Clerk to the Minority; Ferdinand
Kramer, Law Clerk to the Minority; Chapin Gregor, Law Clerk to
the Minority; and Derek Lyons (Sen. Portman).
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Good morning, everybody.
Today, the Subcommittee meets to discuss the product of a
2-year investigation into Wall Street bank involvement with
physical commodities. Our 396-page bipartisan Report with
nearly 800 pages of exhibits provides facts and details that,
for too long, have been missing from the public debate about
the growing role of large Wall Street banks in sectors of the
economy outside of banking--in this case, activities involving
physical commodities such as oil, metal, coal, and
electricity--while at the same time trading in financial
instruments whose value could be affected by a bank's
involvement with those physical commodities.
For more than a century, the United States, by law and
practice, has worked to maintain the separation of banking from
commerce, directing banks to concentrate on taking deposits,
transferring funds, and providing credit, and to avoid
commercial activities like supplying oil, producing
electricity, or storing aluminum. The principle of separating
banking from commerce wisely seeks to reduce risk to the
economy and risk to the integrity of commodity markets.
Our investigation found that this principle has eroded and,
predictably, that erosion has increased risk for the economy,
markets, industry, and consumers. We found that banks--and for
clarity's sake, I will use that term generically to refer to
federally insured banks and their holding companies registered
with the Federal Reserve--we found that banks have vastly
accelerated their physical commodity activities, and are
competing directly with commercial businesses that lack the big
banks' easy access to government-subsidized capital. At the
same time, these banks have taken on dramatic new risks--risks
that, because of the size of these banks, fall not just on
them, but on the larger financial system and, therefore, our
entire economy. In addition, their activities raise significant
questions about whether banks are profiting at the expense of
end-users who must wait longer and pay more for critical raw
materials. And they give Wall Street the opportunity to use
valuable non-public information to gain unfair trading
advantages or to profit from the manipulation of prices.
Today's hearing will focus on the activities of three major
banks--Goldman Sachs, JPMorgan Chase, and Morgan Stanley--that
over the last 10 years have become very active in physical
commodity markets.
If you like what Wall Street did for the housing market,
you will love what Wall Street is doing for commodities. Some
of the same people who brought us the synthetic mortgage-backed
security--and with it, the term ``toxic asset'' and the recent
financial crisis--now dominate the commodities futures markets.
Producers and end users once held 70 percent of commodities
futures; by 2011, that had fallen to about 30 percent, with the
majority of futures held by speculators looking to profit from
price volatility. This means commodities markets are
increasingly unable to fulfill their purpose--which is to allow
end-users, from shipbuilders to beverage companies, and from
automakers to airlines, to manage their risks.
These Wall Street banks have stored and sold aluminum,
operated coal mines and metal warehouses, stockpiled aluminum
and copper, operated oil and gas storage facilities and
pipelines, planned a compressed natural gas facility, supplied
oil refineries, sold jet fuel to airlines, and operated power
plants. They have acquired staggeringly large positions and
executed massive trades in oil, metal, and other physical
commodities. While Wall Street's growing role in physical
commodities has been discussed and debated, the scope of this
involvement, and the potential for abuse, have not been widely
known.
Those physical commodity activities bring with them many
risks. Goldman Sachs' involvement with uranium and coal mines
exposed it to the kinds of environmental and catastrophic-event
risks that traditional banks do not usually face. Morgan
Stanley used shell companies in its plans to build a compressed
natural gas plant, exposing itself then to direct liability
should disaster strike. The Federal Reserve recently reported:
``[C]atastrophes involving environmentally sensitive
commodities may cause fatalities and economic damages well in
excess of the market value of the commodities involved or the
committed capital and insurance policies of market
participants.'' Should a catastrophe occur, it could undermine
a bank or spur fears that it might fail, sparking a bank run, a
shut-down of lending, and turmoil in the U.S. economy.
Wall Street has made legal arguments contending that its
liability risk is limited and manageable. But at times even the
banks acknowledge that they could be held liable if they, for
example, are negligent in managing these activities. And even
if courts eventually upheld a bank's legal defense, even the
possibility of liability judgments on the scale of a Deepwater
Horizon or Exxon Valdez could freeze a bank's access to capital
and risk a Lehman Brothers-style crisis.
And there is much more. Bank involvement with physical
commodities also raises concerns about unfair trading. In some
cases, banks have been implicated in outright market
manipulation. JPMorgan recently paid $410 million to settle
charges by the Federal Energy Regulatory Commission that it
used manipulative bidding schemes at its power plants to elicit
$124 million in excessive electricity payments in California
and Michigan.
Activities involving physical commodities also give Wall
Street banks access to valuable non-public information with
which they can profit in physical and financial commodity
markets at the expense of other market participants. The banks
and their regulator, the Federal Reserve, acknowledge as much.
JPMorgan, in a 2005 application for authority to make physical
commodities investments, said that its plan would ``provide
access to information regarding the full array of actual
[production] and end-user activity in those markets.'' And it
went on: ``The information gathered through this increased
market participation will help improve projections of forward
and financial activity and supply vital price and risk
management information that JPM Chase can use to improve its
financial commodities derivative offerings.''
Similarly, a Morgan Stanley executive publicly spoke of the
advantage of its involvement in oil storage and pipelines:
``We're right there seeing terminals filling up and emptying.''
And a Fed analysis of Morgan Stanley and Goldman Sachs said the
banks' physical commodities activities provided ``important
asymmetrical information--which a market participant without
physical infrastructure would not necessarily be privy to.''
Our bipartisan Report contains nine case studies
illustrating the risks and unfair trading concerns raised by
bank involvement with physical commodities. Each is worthy of
its own hearing. Today we will examine activities at three
banks, and we will highlight one case study in particular, to
demonstrate how actions taken by a single financial
institution--in this case Goldman Sachs--in a single
commodity--aluminum--has given that Wall Street giant the
ability to affect prices and supplies of that commodity while
trading in financial instruments related to that commodity.
In 2010, Goldman Sachs bought a company called Metro
International Trade Services, which owns a global network of
warehouses certified by the London Metal Exchange, or LME, the
world's largest market for trading metals. LME certification
means that Metro can store metal that has been warranted as
meeting LME standards for quality and quantity and is approved
for use in settling LME aluminum trades. Under Goldman's
ownership, Metro mounted an unprecedented effort to dominate
the North American market for storing aluminum. By early this
year, Goldman's warehouses in the Detroit area held nearly 1.6
million metric tons of aluminum--roughly 25 percent of the
annual aluminum consumption in North America--and 85 percent of
the LME-warranted aluminum in the United States.
Now, why is this important? Because aluminum warehouses
owned by Goldman, and overseen by a board consisting entirely
of Goldman employees, manipulated their operations in a way
that impacted the price of aluminum for consumers, while at the
same time Goldman was trading in aluminum-related financial
products.
Goldman's subsidiary achieved this dominant position
through aggressive incentives for metal owners to store
aluminum in its warehouses--incentives that appear to be
inconsistent with the LME's prohibition on ``exceptional
inducements.'' One set of incentives involved a series of
``merry-go-round'' transactions that bottled up millions of
tons of aluminum and appears to have affected prices for
businesses and consumers.
Those merry-go-round transactions first came to the
public's attention through a 2013 New York Times article. We
dug into the facts behind the story and uncovered a troubling
set of practices that included six merry-go-round trades
involving more than 600,000 metric tons of aluminum.
To remove LME-warranted metal from an LME warehouse, the
metal's owner must cancel its warrants and pay any rent or
storage bills. Then the metal is placed in line for load-out.
That line is the ``queue'' which you will hear a lot about
today.
Until Goldman bought Metro, aluminum in the load-out line
was shipped from a warehouse in a matter of days or weeks. But
as you can see from that chart we have up there, Exhibit 1f,\1\
since Goldman's acquisition of Metro, the queue to exit the
Detroit warehouses has gotten longer and longer. In January
2010, it was about 40 days; by September of this year, it had
grown to an unprecedented 600 days. Why? Because of actions
taken by Metro, the Goldman-owned warehouse operator. And what
difference does it make? A big difference. The price consumers
must pay for aluminum is made up of the benchmark price set on
the LME's exchange, plus a regional premium based on regional
storage and logistics costs. The longer the queue, the higher
the storage costs, and the higher the storage costs, the higher
the premium consumers must pay. Statistical analysis shows an
extremely high correlation between the length of the queue and
the U.S. premium level.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1f, which appears in the Appendix on page 821.
---------------------------------------------------------------------------
LME rules require that warehouses each day load out a
minimum quantity of metal. That minimum was 1,500 metric tons a
day for large warehouses such as Metro's, until April 2012,
when it was increased to 3,000 metric tons. Goldman's
warehouses have treated the LME minimum as a maximum, shipping
no more than the minimum. In addition, Metro formed a single
exit line for all 28 of its Detroit-area warehouses combined,
and decreed that the daily minimum applied to that single exit
line.
Now, the merry-go-round deals increased the length of the
queue and clogged the exit line. In most of the merry-go-round
deals, the metal owner agreed to cancel warrants on a large
amount of aluminum and put that metal in the exit queue. When
the owner got to the front of the line, it loaded out its metal
onto trucks, but the metal did not leave the Metro system.
Instead, the trucks moved the aluminum to a nearby Metro
warehouse, and the metal owner eventually re-warranted the
metal. In exchange, Metro paid millions of dollars to the metal
owners--once when they canceled the warrants and again when
they re-warranted the metal in another Metro warehouse.
It is important to understand that the first of these
deals, reached with Deutsche Bank just 7 months after Goldman
bought Metro, came after Deutsche Bank simply asked for a
discount on rent for its aluminum. Nothing prevented Metro from
simply giving such a discount. Instead, the warehouse proposed
the convoluted merry-go-round, which effectively gave Deutsche
Bank the discount it wanted, but with the added benefit to
Metro and Goldman of adding 100,000 tons of aluminum to the
exit queue.
Metro used this same model in several subsequent deals. In
some deals, metal was loaded onto a truck and shipped a mere
200 yards to a different warehouse building. Most of the deals
involved shuffling virtually identical loads of aluminum among
multiple warehouses, which is why a forklift operator called it
a ``merry-go-round of metal.'' Because each deal involved
between 100,000 and 265,000 metric tons of aluminum, loaded out
at 1,500 and then 3,000 metric tons a day, the net effect was
that each deal added weeks or months to the queue.
The lengthening queue had a number of effects. First, it
boosted revenue at Goldman's warehouses--the more metal stored
in the warehouses, the more rent and fees.
The longer queue also affected aluminum prices. The ``all-
in'' price that consumers pay for aluminum has several
components, but the two major components are the LME Official
Price, set on LME's exchange, and a regional premium that
reflects local variations in storage and delivery costs. The
regional premium in the United States is known as the Midwest
Aluminum Premium. And as the chart shows, Exhibit 1f,\1\ as the
queue in Metro's Detroit-area warehouses increased, so did the
Midwest Premium. As the queue increases, the premium increases.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1f, which appears in the Appendix on page 821.
---------------------------------------------------------------------------
Most market participants believe that a higher Midwest
Premium means higher all-in prices, which means Goldman's
warehouses are using a tactic that earns the bank higher rents
at the expense of a wide range of businesses that use aluminum.
Those businesses include Austal, a company that builds combat
ships for our Navy and which told the Subcommittee that the
effects of rising Midwest Premiums have forced it to take
costly steps that damage not just the company, but cost U.S.
taxpayers.
Goldman argues that these market participants are
incorrect, and that the total price of aluminum was unchanged
by the merry-go-round deals and the longer queues. It argues
that as the Midwest Premium rises, the LME price falls. That is
the Goldman argument. The Midwest Premium rises, the LME price
falls, so that the all-in price remains unchanged. Again, that
is not what other market participants say. But even if that
were true, Goldman's warehouses are still engaged in
unacceptable manipulation. As the queue-inflated Midwest
Premium has risen, it has taken up an increasing share of the
all-in price for aluminum--from just 6 percent of the all-in
price in 2010 to over 20 percent this year. That increase means
that the LME price has fallen as a percentage of the all-in
price, making LME futures a less effective tool to hedge price
risk.
Now, in addition to assessing supply and demand, aluminum
users must try to hedge just how long a load-out queue
Goldman's warehouses can engineer. What's more, if Goldman's
theory is correct and the LME price goes down as the premium
goes up, Goldman has the ability to manipulate the LME price by
manipulating the Midwest Premium, and then to make trades
taking advantage of that manipulation. Goldman's ability to
influence any portion of the price for a key component of the
industrial economy is simply unacceptable.
While the LME has rules designed to prevent a situation
where a warehouse could share valuable confidential information
with traders, those rules are porous. Under LME rules, Metro
shares confidential information with more than 50 Goldman
employees, including top executives who manage Goldman's
commodities trading, while also sitting on Metro's Board of
Directors. The Metro Board, which has consisted exclusively of
Goldman employees, reviewed and approved all significant
business decisions at Metro, including the merry-go-round
deals. In other words, a warehouse strategy that materially
affected the aluminum market was approved by executives of a
bank uniquely positioned to trade profitably on the effects of
that strategy. Think about the opportunity for Goldman to
affect the premium and price at the same time it was trading in
that metal.
In fact, the information to which Goldman's top commodities
executives have access through Metro is so sensitive and
valuable that LME will not publish it. In a 2013 report, LME
said it does not publish detailed information on warehouse
stock and queues because ``the danger is that those merchants
and trading houses with the most well-staffed analytical
capabilities will take advantage of the availability of data to
derive a trading advantage.'' It is hard to think of a trading
house that better fits that description than Goldman Sachs.
There is little doubt that if we were talking about the
stock market, rather than commodities transactions, the use of
inside information that affects prices would be strictly
prohibited. But until passage of Dodd-Frank, there were no
legal prohibitions on using valuable non-public information to
trade commodities, and even now, regulators' authority to stop
such abuse is untested.
So, the potential for abuse is great, and the only
protections against abuse are company policies against sharing
information. Given the recent history of banks improperly
sharing information to manipulate electricity, LIBOR, and
foreign exchange rates, the reliance on voluntary policies at
companies that have an economic interest in the opposite
direction is not enough protection for consumers, to put it
mildly.
This concern is especially relevant given Goldman's rapid
increase in aluminum trading after it acquired Metro. After
buying Metro in 2010, Goldman's physical aluminum stockpile
grew from less than $100 million to, at one point, more than $3
billion, a 30-fold increase. This stockpile also allowed
Goldman itself to add to the queue at its Metro warehouses,
where in 2012, Goldman canceled warrants on about 300,000
metric tons of its own aluminum, adding months to the queue.
Goldman made a series of massive aluminum trades at the same
time its warehouses' dealings were pushing the Midwest Premium
higher, including trades in 2012 involving more than 1 million
metric tons of metal.
Goldman contends that it adheres to rules preventing the
sharing of useful information between its warehouses and its
traders. That contention is hard to square with the bank's
stated justification for its involvement in physical
commodities. In a 2011 presentation to Goldman's board, its
executives wrote that Goldman's commodities division would
achieve higher value ``if the business was able to grow
physical activities, unconstrained by regulation and integrated
with the financial activities.'' Goldman's goal, in the words
of its own executives, is to profit in its financial activities
using the information that it gains in the physical commodities
business.
All of these issues and concerns come back to the principle
of separating banking and commerce. Banks are not supposed to
be running commercial businesses like warehouses, natural gas
facilities, or power plants. Those activities open the door to
higher prices and greater uncertainty for businesses and
consumers, and to price manipulation and trading based on
information not available to other market participants. To
restore confidence in commodity markets as well as reduce risk
in the banking system, it is time to reduce bank involvement
with physical commodities and to prohibit the use of non-public
information in transactions involving commodities that the
banks themselves control.
Our Report offers a number of ways to address the issue,
and the Federal Reserve's possible rulemaking provides a needed
opportunity to address these problems. Today we will explore
banks' physical commodity activities and the dangers that
result. Tomorrow we will hear from additional experts and
regulators.
And now I turn to my partner in this bipartisan
investigation, and my partner in so many other efforts over the
years, Senator McCain.
OPENING STATEMENT OF SENATOR McCAIN
Senator McCain. I thank you, Mr. Chairman, and before I
begin, I want to say what an honor and privilege it has been to
serve alongside you in this Subcommittee. Your tireless efforts
and steadfast dedication to exposing misconduct and abuse by
financial institutions and government regulators have set a new
standard for thoughtful and thorough congressional
investigations.
Whether the topic was the 2008 financial crisis, Swiss
banking secrecy, or JPMorgan's ``London Whale'' debacle,
professionals in the industry and the public at large knew that
they could count on you to get to the bottom of it with
authoritative reports and hearings. Your tenacity in uncovering
wrongdoing sparked significant changes in the financial sector.
I also commend you on zealously and effectively pursuing
your investigations in a way that has furthered this
Subcommittee's long-standing tradition of bipartisanship. We
may have had our disagreements, but we did not let them get in
the way of finding common ground in most cases.
While your retirement may come as a relief to some of those
on Wall Street, your patience, thoughtfulness, and commitment
to bipartisanship will be deeply missed on this Subcommittee,
on the Armed Services Committee, and in the U.S. Senate.
Today's hearing explores the way in which major banks
produce, store, and sell physical commodities like aluminum,
natural gas, and uranium. It sheds light on the little-known
yet large role that banks play in the commodities markets and
the risks inherent in those activities. This lack of insight
into the banks' commodities operations raises concerns about,
among other things, potential market manipulation and excessive
risk that could, in extreme circumstances, lead to taxpayer
bailouts.
This investigation has shown how, through their commodities
activities, some of the country's largest financial
institutions have taken on arguably excessive levels of risk,
raised suspicions of market manipulation, and potentially
gained unfair trading advantages.
JPMorgan, for example, paid fines for energy price
manipulation relating to its dozens of power plants, I believe
$410 million. Morgan Stanley has entered the oil industry and
even supplies several airlines with jet fuel at airports across
the country. Goldman Sachs has uranium holdings and manages
coal mines in Colombia. In each of these operations, there are
dangers of toxic spills, deadly explosions, and other
disasters. These are not the risks we normally associate with
banks, whose primary role should be focused on more traditional
banking activities.
The American people are all too familiar with costly
accidents in these industries. For example, BP incurred around
$40 billion in damages resulting from the Deepwater Horizon oil
spill. Imaging if BP had been a bank. The losses and the
liability resulting from the spill would have led to the bank
failing and another round of taxpayer bailouts. Even if a bank
survived such a catastrophe, the resulting financial shock
might hurt ordinary investors and pension holders.
Similarly, inappropriate activities undertaken by financial
institutions in commodities markets could lead to unfair
trading advantages and conflicts of interest for the banks, and
artificially higher prices for consumers.
Mr. Chairman, I think you have just outlined that some of
the activities have already led to artificially higher prices
for consumers, including aluminum.
Little is known about these activities, and even less has
been done to combat some of the biggest concerns about risk and
manipulation. This warrants oversight by Congress and financial
regulators as well as potential changes to laws and
regulations, to curb the dangers to the economy and halt unfair
practices.
While Chairman Levin has recommended, and our witnesses may
offer, some potential solutions in our hearing today, I think
we should be mindful of unintended consequences. But these
concerns are serious, and, again, part of it goes back to our
failure to commit after the catastrophe of 2008 that no
institution would ever be too big to fail. I do not believe
that anyone in America believes that these three financial
institutions before us, that we have reduced them to the state
where they are not too big to fail.
I thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator McCain, for
your warm comments, for our long friendship and collaboration
on so many matters, for your defense of this country, and your
taking the gavel at the Armed Services Committee is surely
going to be a very important moment in the future of this
country and that committee. And your work and your staff's work
on this Subcommittee has been essential to whatever successes
we have had in terms of our investigations and recommendations.
So thank you very much.
We are going to have a number of votes today at 2 o'clock.
There could be up to five votes, and my plan is to recess the
hearing during those votes, which will also allow people time
to have lunch. That is not what we planned for, but that is
what the Senate schedule has brought us to. So it is not
certain but it is likely that we will adjourn for about 90
minutes--it could be 60 to 90 minutes--at around 1:45.
We will now call our first panel of witnesses for this
morning's hearing: Christopher Wibbelman, President and Chief
Executive Officer of Metro International Trade Services LLC,
Allen Park, Michigan; and Jacques Gabillon, Head of the Global
Commodities Principal Investment Group of Goldman Sachs & Co.,
London, England.
Gentlemen, I appreciate both of you being with us this
morning. We look forward to your testimony, and as you, I
think, are already aware of, all witnesses testifying before
this Subcommittee are required to be sworn, so I would ask you
now to raise your right hand as I administer the oath.
Do you swear that the testimony that you will provide to
this Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
Mr. Wibbelman. I do.
Mr. Gabillon. I do.
Senator Levin. Under our timing system today, at about 1
minute before a red light comes on you will see the lights
change from green to yellow. That will give you the opportunity
to conclude your remarks. And your written testimony will be
printed in the record in its entirety. We would appreciate your
limiting your oral testimony to 5 minutes. And, Mr. Wibbelman,
we will have you go first.
TESTIMONY OF CHRISTOPHER WIBBELMAN,\1\ PRESIDENT AND CHIEF
EXECUTIVE OFFICER, METRO INTERNATIONAL TRADE SERVICES LLC,
ALLEN PARK, MICHIGAN
Mr. Wibbelman. Thank you, Chairman Levin, Ranking Member
McCain, and Members of the Subcommittee. My name is Chris
Wibbelman, and I am the CEO of Metro International Trade
Services. I have been with Metro since it was founded in 1991
as a startup company in Michigan, and I have served as its CEO
since 2006.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Wibbelman appears in the Appendix
on page 139.
---------------------------------------------------------------------------
I was born and raised in Detroit. I attended Detroit public
schools and graduated from Michigan State University. I have
worked my entire life in the greater Detroit area, managed and
ran several businesses. I have also served as Manager of Small
Business Development for the Greater Detroit Chamber of
Commerce.
Metro operated LME warehouses since 1992 when we secured
approval for Detroit to serve as an eligible LME delivery
point. Much of Metro's growth occurred following the global
financial crisis when worldwide consumption of aluminum
declined and the demand for storage of metal increased.
Starting in 2008, Metro purchased or leased 5.1 million
square feet of warehouse space, much of which was unused
industrial buildings. The process of renovating the industrial
space and installing rail track and rail sidings created jobs
when many Detroit residents were out of work or being laid off.
The first thing to understand about the aluminum
warehousing business is that it is driven by broader economic
forces. Given the cyclical nature of this business, from 1994
to 2001, Metro had virtually no aluminum whatsoever in its
Detroit warehouses. During that period, we managed the business
efficiently and remained committed to Detroit. And when the
aluminum consumption dropped beginning in 2008, Metro was in a
position to respond rapidly to the needs of aluminum producers.
I believe that we were instrumental in allowing North
American smelters to keep producing aluminum during the period
of collapsing demand.
The LME rules govern the way in which all LME warehouses
are operated. These rules are established by the LME and not
the warehouse companies. One such rule is the amount of metal
that the LME warehouses must load out each day. When the new
LME rule increasing the load-out rate was suspended by a court
in the United Kingdom, Metro announced that it would comply
with the rule voluntarily, even though it was not required to
do so. More aluminum has been loaded out of Metro's Detroit
warehouses than from any other warehouse company in the United
States. In 2014 alone, we expect to load out approximately
600,000 metric tons of aluminum.
The Subcommittee's Report makes repeated references to
aluminum ``queues,'' and it is important to understand that all
of the aluminum stored in and out of aluminum warehouses, 80
percent of it is not subject to any queue. Consumers can
purchase aluminum from producers or any owner of aluminum that
is stored in or out of the LME system, and that metal is
available for immediate outbound shipment.
It is also important to understand two other aspects of the
queues.
First, they are the result of independent decisions of
owners of metal to realize the relative value of that metal
compared to other metal. In order to realize that value, the
owners must remove the metal from Metro's LME warehouse.
Second, metal owners pay rent for all metal in Metro's
warehouses, regardless of whether it is in a queue or not.
Metro's revenues are not dependent on the length of queues.
The Subcommittee's Report also refers to the July 2013 New
York Times article you mentioned, which described supposed
``merry-go-round transactions'' involving the movement of metal
off-warrant from one warehouse to another. As the article
itself acknowledged, there is no suggestion that the activities
violate any laws or regulations. Metro offered its customers
the opportunity to store metal off-warrant in a different Metro
warehouse. Such customers had various other options, including
storing their metal with competing companies, many of which
have warehouses near to Metro's.
Metro offered these off-warrant transactions to compete for
storage of their metal once it was loaded out and it was no
longer part of the LME system. But it was always up to the
owner, not Metro, to decide what to do with the metal.
The metal at issue in these relatively few transactions was
loaded by Metro at the owner's instructions onto a truck,
issued a bill of lading, and moved to another location at the
owner's direction. Once the owner made the choice, the LME
rules required that Metro follow the owner's instructions and
treat the metal as loaded out and reduce its LME inventory
stocks accordingly. The fact that the metal owner moves the
metal between Metro warehouses in the Detroit area is no
different under the LME rules than if it moves to an equally
close non-Metro warehouse.
I appreciate the opportunity to provide this information
about Metro's warehouse business, and I hope it will contribute
to the Subcommittee's understanding.
Senator Levin. Thank you very much, Mr. Wibbelman.
Mr. Gabillon.
TESTIMONY OF JACQUES GABILLON,\1\ HEAD, GLOBAL COMMODITIES
PRINCIPAL INVESTMENT GROUP, GOLDMAN SACHS & CO., LONDON,
ENGLAND
Mr. Gabillon. Chairman Levin, Ranking Member McCain, and
Members of the Subcommittee, my name is Jacques Gabillon. I
lead Goldman Sachs' Global Commodities Principal Investment
Group, or GCPI, and I also serve as chairman of the board of
directors of Metro.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Gabillon appears in the Appendix
on page 142.
---------------------------------------------------------------------------
In early 2010, GCPI believed that the Metro warehouse was a
sound investment because the global recession had reduced
worldwide demand for aluminum and would increase demand for
storage. It was a good investment.
At the time of the investment, customers had already
deposited over 800,000 tons of aluminum at Metro, and we
believed that the surplus condition would persist.
Consequently, Metro was well positioned to continue to realize
this demand for storage.
Metro's board of directors sets the general strategy and
conducts oversight in keeping with standards of good corporate
governance and the requirements of the Bank Holding Company
Act. The board has always included people from the firm's
control functions, including the Compliance Department.
As you know, Metro is subject to the rules of the LME,
including the minimum amount of metal required to be loaded out
of warehouses each day. Often the dynamics of this LME system
are mistaken for the broader aluminum market, which supplies
most consumer products.
As a starting point, the price negotiated between many
sellers and buyers of aluminum in the United States is commonly
referred to as the ``all-in price.'' The difference between
this all-in price and the price for an LME warrant is referred
to as the ``Midwest Physical Premium.'' But one thing is clear:
The all-in price has actually fallen substantially since 2008.
Consequently, any suggestion that end users are paying more for
aluminum because of a higher premium is simply not supported by
the facts.
Like every other market, the price of aluminum is
established through supply and demand, and those trends have
been unmistakable. There has been a consistent surplus of
aluminum since 2008, resulting in a large volume that has been
placed in storage. That is why there has never been a shortage
of aluminum.
In addition, there are large quantities of aluminum stored
outside the LME system. So together with non-queue aluminum,
there is approximately 9.6 million tons of aluminum to be sold
for immediate delivery to any user.
I would like to briefly address the issues of queues. To
begin with, the length of the queue to remove metal from
Metro's warehouse is not the result of any action by either
Goldman Sachs or Metro. General economic confidence and
availability of credit improved, making off-warrant storage a
more attractive alternative. This occurred not only in Detroit,
but also in another major city for metal warehousing,
Vlissingen in the Netherlands.
One more thing occurred at the time. The LME changed its
rule to double the minimum load-out requirement from 1,500 to
3,000 tons per day. The Subcommittee should know that when the
LME doubled the minimum load-out requirement, the result was
actually longer, not shorter, queues. And most importantly,
based on the reports we have provided to the Subcommittee,
these queues do not drive the all-in price that consumers pay.
On a related issue, we have provided a significant amount
of information to the Subcommittee on the issue of incentives.
Operators may offer an up-front payment on future rent
collections to customers who place metal on warrant in their
warehouses. In other instances, operators offer discounted rent
to customers who agreed to store their metal for specific
durations. These incentives are similar to those offered by
landlords, such as offering one month's free rent to attract a
tenant or reducing rent for a tenant who signs a long-term
lease.
Metro has offered both of these incentives, consistent with
the LME rules and industry practice. The inducements that have
been offered result from arm's-length negotiations between
Metro and a sophisticated customer.
Finally, I will briefly conclude with a description of the
information barriers that exist between Goldman Sachs and
Metro. The LME rules require that an information barrier be
established between a warehouse company and affiliated trading
entities. Goldman Sachs has such a barrier in place which not
only meets, but exceeds, the LME's requirements. We take this
issue very seriously.
For example, much of the material that Metro generates and
distributes to its board is not actionable for a trader and, in
any event, is dated and sanitized to remove the names of
counterparties. Regular reviews by Goldman Sachs personnel and
outside auditors have not found a single instance where
confidential Metro information went to the metals trading
personnel of Goldman Sachs.
Mr. Chairman and Senators, in the many hours we have spent
with the Subcommittee staff, we have described the market
fundamentals that dictate price and availability, and I look
forward to continuing that discussion today. Thank you.
Senator Levin. Thank you very much.
First, Mr. Wibbelman, you are the Chief Executive Officer
of Metro. Mr. Gabillon, you were for most of the period an
executive in Goldman's Global Commodities Principal Investment
Group, and you were chairman of Metro's board of directors. So
in the very first board meeting, after Goldman bought Metro in
2010, the board discussed the incentives that Metro would pay
to attract more aluminum to its warehouses in Detroit.
If you look at Exhibit 1b,\1\ that is a chart which was
sent to us by Goldman's legal counsel on the total amount of
freight incentives or allowances paid by Metro in each year
from 2010 to 2013. You will see that each year after Goldman
acquired Metro, Metro paid more and more cash incentives to
attract aluminum to its Detroit warehouses, going from about
$36 million to over $128 million. That does not count expanding
rent discounts and other incentives, so that is an increase of
about 350 percent over just a few years for freight allowances.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1b, which appears in the Appendix on page 817.
---------------------------------------------------------------------------
Are those figures accurate? Were those allowances and
subsidies increased as shown on that chart?
Mr. Gabillon. I do not recognize exactly the numbers.
Senator Levin. Are they approximately right?
Mr. Gabillon. But the trend is correct and is a reflection
of the evolution of the aluminum markets.
Senator Levin. Now, Mr. Wibbelman, you told the
Subcommittee that after Goldman acquired Metro, you generally
had to run all your major decisions by Metro's board or a board
subcommittee. That was made up totally of Goldman people. Did
you consult with Mr. Gabillon and the board before increasing
Metro's incentives?
Mr. Wibbelman. So, Senator, I had a level of authority for
incentives at various time periods, and that would be adjusted
by the board of directors. And then as circumstances changed,
that would be occasionally reviewed from time to time or it
would be--we would make a specific request on a specific case
basis, and it would be either approved by the Commercial
Subcommittee or it would----
Senator Levin. Of the board?
Mr. Wibbelman. Of the board, or it would not.
Senator Levin. So as to whether you consulted with Mr.
Gabillon and the board before increasing Metro's incentives,
the answer, I take it, is generally yes, although you had some
authority between those approvals. Is that correct?
Mr. Wibbelman. Yes.
Senator Levin. So basically it was a joint decision to go
ahead with this program and these incentives, is that correct?
Mr. Wibbelman. Well, Senator, if I might, you know, the
market itself at that point in time was, you know, incredibly
dynamic and unique, and so, you know, it was--at that point in
time, we were evaluating really a wave of surplus metal that
was making itself available to us. And Metro was trying to
respond operationally in order to be able to receive it all,
and that is----
Senator Levin. You were giving incentives to bring more
into your warehouse. Is that correct?
Mr. Wibbelman. Incentives have been a part of our business
for the 23 years----
Senator Levin. I understand, but the amount of the
incentives dramatically increased. Is that correct?
Mr. Wibbelman. Because the magnitude of the metal also
increased.
Senator Levin. Did the amount of the incentives
dramatically increase?
Mr. Wibbelman. They increased over the full 5-year period
of time.
Senator Levin. As shown on that chart?
Mr. Wibbelman. Yes.
Senator Levin. And that was a joint decision, was it,
between you and the board and the board subcommittee?
Mr. Wibbelman. Generally, yes.
Senator Levin. OK. Now, if you look at Exhibit 1d,\1\ this
is a list of Metro board members, and this was supplied to us
by Goldman's legal counsel. Are these all Goldman employees? Is
that correct?
---------------------------------------------------------------------------
\1\ See Exhibit No. 1d, which appears in the Appendix on page 819.
---------------------------------------------------------------------------
Mr. Wibbelman. Not currently anymore, no.
Senator Levin. They were?
Mr. Wibbelman. At the time of their service, yes.
Senator Levin. And, Mr. Gabillon, did Mr. Wibbelman talk to
you personally as well as to other board members about
increasing the amount of freight incentives that Metro would
pay to attract metal to its Detroit warehouses? Did you have
personal conversations with Mr. Wibbelman about that?
Mr. Gabillon. Yes, we had many conversations in the context
of the board, yes.
Senator Levin. About that subject?
Mr. Gabillon. Yes.
Senator Levin. And then the board members approved these
increased amounts generally. Is that correct?
Mr. Gabillon. I think there were many times where we did
not approve an increase.
Senator Levin. You disapproved an increase?
Mr. Gabillon. Yes, there were many times where we kept the
level of approval constant.
Senator Levin. OK. But when there were increased amounts,
the board generally approved them. Is that correct?
Mr. Gabillon. Yes, that is correct.
Senator Levin. Now, we are going to spend some time talking
about LME warrants, queues, and so I want to explain this as
clearly as I can. The LME is the world's largest metals
exchange, and when you buy a future contract on the LME, in a
fixed period of time you can settle the contract by paying
money and taking delivery of warrants, which are documents that
convey actually legal title to specific lots of metal that are
stored in an LME-approved warehouse. In aluminum, these lots of
metal are 25 metric tons or about 2,200 pounds. And when an
owner of the metal wants to take physical possession of the
metal, the owner has to cancel the warrants and get in the exit
line or queue to leave the warehouse.
But the LME warehouses only have to load out a specific
amount of metal every day. For the largest warehouses, it used
to be 1,500 metric tons. It was raised to 3,000 metric tons. So
for warehouses that store hundreds of thousands or millions of
tons, if an owner of a lot of aluminum cancels his warrants at
once, it can dramatically increase the queue, making everyone
else stay in the warehouse and continue paying rent longer.
But that is not the only thing. As we will learn more about
later, the length of that queue impacts the prices of metal and
related financial products. It is highly correlated to the
premium, and that premium, when added to the LME price, is the
so-called all-in price.
Mr. Wibbelman, beginning shortly after Goldman bought Metro
and over the next few years, Metro entered into what became six
deals that involved owners of metal being paid incentives by
Metro for waiting in the queue, moving metal from one Metro
warehouse to another, and re-warranting. And I am going to call
them ``merry-go-round deals.'' That is what a forklift operator
called them.
Mr. Wibbelman, you told the Subcommittee that Metro had
never done deals like that prior to being acquired by Goldman.
Is that correct?
Mr. Wibbelman. Yes, but I do not think it was anything to
do with Goldman as to why that was not the case, Senator.
Senator Levin. I understand. But before you were acquired
by Goldman, you never entered deals like that. Is that correct?
Mr. Wibbelman. Yes, but there was never a market dividend
like that either.
Senator Levin. OK. Now, before doing this new type of deal,
did you consult with Mr. Gabillon or others at Goldman?
Mr. Wibbelman. Yes.
Senator Levin. And did you consult with Goldman employees
on Metro's board before finalizing each of these deals?
Mr. Wibbelman. Yes.
Senator Levin. So it was a joint decision to go ahead.
Mr. Wibbelman. Yes, I think it----
Senator Levin. Is that fair to say?
Mr. Wibbelman. I would say that there was an alignment of
understanding about the deals. Probably some of those deals I
might have had the authority to execute without formal written
authority, and other ones I did not, but all of them were
thoroughly vetted.
Senator Levin. And jointly decided upon. Is that correct?
Mr. Wibbelman. Yes.
Senator Levin. OK. Now, this is what happened on 1 day,
December 27, 2013. Workers at eight of Metro's warehouses were
rapidly shuffling about 5.5 million pounds of aluminum between
Metro's warehouses. Workers at a warehouse in Detroit on East
McNichols Road were busy shipping out ten truckloads of
aluminum, which is more than 860,000 pounds, to a warehouse on
Lynch Road. The Lynch Road warehouse workers were busy shipping
17 truckloads of aluminum, totaling about 1.4 million pounds,
right back to East McNichols Road.
Now, if that were not enough, three other warehouses, on
Lafayette Street, Pennsylvania Road, and 22d Street, shipped
millions of pounds of aluminum to three other nearby warehouses
located at East Nine Mile Road, Ecorse Road, and West
Jefferson.
Now, when you look at these deals and look at the
specifics, this is what happened. Look at Exhibit 1c.\1\ This
was provided by Metro's legal counsel. It shows that as of
January of this year, over 600,000 metric tons of metal were
moved between Metro warehouses in Detroit. All of those 600,000
tons, if you look at Exhibit 1c, came from just those six deals
that you identified. Is that correct? First of all, look at
Exhibit 1c and do you agree--this was provided, again, by Metro
legal counsel--that all 600,000 of those tons came from just
those six deals that we have talked about. Is that correct?
---------------------------------------------------------------------------
\1\ See Exhibit No. 1c, which appears in the Appendix on page 818.
---------------------------------------------------------------------------
Mr. Wibbelman. Yes.
Senator Levin. Now, the merry-go-round deals required Metro
to organize and pay for thousands of truck shipments between
its own warehouses, pay millions of dollars in incentives to
its warehouse customers. We have details on the incentive
payments for just two of those six deals, but those invoices
alone show Metro owing two warehouse customers, Red Kite, which
is a hedge fund, and Glencore a total of about $37 million. And
Exhibit 22a\2\ is an invoice summary of just the most recent
two deals.
---------------------------------------------------------------------------
\2\ See Exhibit No. 22a, which appears in the Appendix on page
1002.
---------------------------------------------------------------------------
Can you tell us first, Mr. Wibbelman, how much Metro paid
for the first four deals? We know it was about $37 million in
subsidies and incentives for the two that I have mentioned, but
just for the first four, do you know what that total is?
Mr. Wibbelman. I do not know what that total is, Senator.
Senator Levin. The two deals alone that we are talking
about required 6,500 truckloads of aluminum to be shuttled
between Metro's Detroit warehouses. Do you know how many
thousands of trucks Metro had to arrange and pay for under the
previous four deals, Mr. Wibbelman?
Mr. Wibbelman. I do not know that, Senator.
Senator Levin. That is OK. These deals were so important
that they were taken to Metro's board of directors for
approval.
Now, they were not in a formalized contract. Is that
correct? These deals did not result in a formalized contract?
Mr. Wibbelman. Overwhelmingly, none of our deals takes
place on a formal contract.
Senator Levin. All right. There was an effort at a formal
contract, was there not, with Deutsche Bank?
Mr. Wibbelman. If a customer wants to have a contract, we
will look at it and talk about whether we need to have one or
not. But our deals are settled incrementally over time.
Senator Levin. That is fine.
Mr. Wibbelman. So we tend not to need them.
Senator Levin. And Deutsche Bank wanted one?
Mr. Wibbelman. They provided one.
Senator Levin. And signed it?
Mr. Wibbelman. And signed it.
Senator Levin. And you did not?
Mr. Wibbelman. I do not believe it was countersigned.
Senator Levin. And why?
Mr. Wibbelman. I think they just decided they did not need
it.
Senator Levin. Oh, they did not want it, Deutsche Bank?
Mr. Wibbelman. I do not have that recollection at this
time. It was not a material component of whether the deal took
place. We knew we would not have had to make any of our
payments if it had not been executed like it was supposed to.
Senator Levin. Now, we only have the details on the last
two of these deals, but, again, the six deals involved Metro
arranging and paying for thousands of trucks to move over
600,000 metric tons of aluminum from one warehouse to another.
In one case, the aluminum was moved from one warehouse to
another about 200 feet away.
Now, was the point of all these truckloads shifting metal
from one warehouse to another Metro warehouse to enable Metro
to claim it was meeting the LME daily minimum load-out rule
that said that a warehouse had to load out a minimum of 1,500
pounds, later 3,000 pounds a day, while at the same time
ensuring that virtually no metal actually left the Metro
system?
Mr. Wibbelman. Well, Senator, I mean, it starts with the--
--
Senator Levin. Was that the point of it, is my question.
Mr. Wibbelman. I am trying to answer. It starts with the
recognition of the customer that the metal that is available
within the Metro system is of relatively better value than any
other metal it can purchase. And, typically, for example, in
the first deal that you mentioned, the owner wanted to own
metal and finance it for a duration of time. And the way for
them to capture that was to own the metal, and once they owned
the metal, the way for them to protect their value was to put
it in the queue and plan to take it out.
Senator Levin. They could have continued to own the metal
and leave it in the warehouse. Is that correct?
Mr. Wibbelman. They could have, but it would have cost them
more, and so they chose not to do that.
Senator Levin. And you gave them a subsidy to go through
this rinky-dink merry-go-round system. They could have----
Mr. Wibbelman. Well, Senator, we do not----
Senator Levin. You could have given them a subsidy, a
discount, and leave it in the warehouse, could you not?
Mr. Wibbelman. Well, you can--Senator, we are a commercial
business, right?
Senator Levin. Is that right? You could have given them a
discount and left it in the warehouse.
Mr. Wibbelman. Yes.
Senator Levin. But you moved it to another warehouse,
sometimes 200 feet across, and the result of that was it stays
in your warehouse but it also lengthens the queue. Were you
aware of the fact that the queue would be lengthened when they
did what you arranged for them to do?
Mr. Wibbelman. We did not arrange for it, right? The
customer chose to do it----
Senator Levin. No, but the customer was also paid to do it.
Mr. Wibbelman. The customer was paid----
Senator Levin. By you.
Mr. Wibbelman. In the event that they moved it to another
warehouse and then chose to warrant it later. They did not have
to make that choice, and they did not.
Senator Levin. They were paid by you, were they not, they
were paid by you to keep that in your warehouse?
Mr. Wibbelman. That was a choice they made.
Senator Levin. Would they be penalized if they did not do
it under the contract?
Mr. Wibbelman. Well, it was a contract where they--what
they did is they, by freedom of contract, chose to agree on an
economic set of conditions.
Senator Levin. And under that contract, was there a penalty
if they did move to another warehouse other than yours? Was
there a penalty?
Mr. Wibbelman. Well, we presumed that we would get a
revenue stream in order to provide the incentives we provide,
and if they chose a different route, they were effectively
going to refund us back that amount.
Senator Levin. Mr. Wibbelman, I am asking you a very direct
question. You gave them an incentive to, first of all, de-
warrant, right? They would have to then go to the head of the
queue, and then you gave them an incentive in a contract, in an
agreement to go to another warehouse, sometimes a few hundred
feet away, and join another queue. Is that correct?
Mr. Wibbelman. No, because they had many options, Senator.
They had the option----
Senator Levin. Not under the contract they did not.
Mr. Wibbelman. Yes, they did. They had the option----
Senator Levin. They could break the contract.
Mr. Wibbelman. They can break the contract.
Senator Levin. OK. That is not much of an option for most
business people to break----
Mr. Wibbelman. That was the----
Senator Levin. Wait a minute. Let me finish. That is not
much of an option for most business people. You say they had
the freedom to break the contract. You entered a contract
which, if they lived up to it, required them to move, sometimes
a few hundred feet, their metal to another Metro warehouse. You
paid them to do that, and then there was a penalty if they did
not under that contract. They had the freedom to break the
contract. Most business people do not consider that a choice.
Mr. Wibbelman. Well, Senator, they set the contract up in
the beginning----
Senator Levin. Did you not? Were you not a party to that
contract?
Mr. Wibbelman. Of course. I am one part. The other party is
the counterparty.
Senator Levin. Of course.
Mr. Wibbelman. And so that was the agreement----
Senator Levin. But under the contract--let us be clear--you
insisted in that contract that they would pay a penalty if they
did not put their metal into another Metro warehouse. You paid
them a subsidy to do that, and there was a penalty if they did
not do that. Is that correct under that contract?
Mr. Wibbelman. That was correct, but it was also in
response to costs that we incurred or revenues that we did not
receive. So we were effectively trying to get a reimbursement
for things that we would otherwise have been able to receive or
expenditures were made.
Senator Levin. And you could have given them an incentive
to stay in the original warehouse, could you not? You could
have kept them there with a discount? Is that correct?
Mr. Wibbelman. Yes, we could----
Senator Levin. You were allowed to do that.
Mr. Wibbelman. We could have given them anything, but
commercially, as a business, that is not what we choose to do.
Senator Levin. No. But you chose instead to do this in a
way which, will you agree, lengthened the queue?
Mr. Wibbelman. So we----
Senator Levin. I am just asking you. Was the effect of this
to lengthen the queue?
Mr. Wibbelman. Senator, anyone that cancels a warrant in a
warehouse for that moment adds to the queue. But it could have
been any--remember, there are tons of other warehouses.
Senator Levin. I am just getting a direct answer from you,
if I can. The effect of this arrangement was that the queue was
lengthened. Is that correct? It is a simple, direct question.
And you are under oath. Was the effect of that to lengthen the
queue?
Mr. Wibbelman. If they chose to cancel their warrants-----
Senator Levin. Not if they chose. Did the contract
provide----
Mr. Wibbelman. Yes, but if they chose that, they had to
actually obtain warrants and cancel them, and that was
something that was their choice.
Senator Levin. This is warranted metal in your warehouse.
Mr. Wibbelman. Yes, but the warrants are freely floating
title documents.
Senator Levin. Of course.
Mr. Wibbelman. They have to go find one, right?
Senator Levin. I understand.
Mr. Wibbelman. And once they find it, they have to actually
cancel it.
Senator Levin. I want to get a straight answer from you, if
I can.
Mr. Wibbelman. I am trying to give you them.
Senator Levin. OK, but let me go through this. You entered
into a contract which required the counterparty, is that not
correct--if they lived up to the contract----
Mr. Wibbelman. Yes, if they chose to.
Senator Levin. If they chose to live up to a contract, do
not most people you deal with honorably live up to their
contract?
Mr. Wibbelman. But it was always their option.
Senator Levin. To cancel--to not live up to the contract?
Mr. Wibbelman. It was always if you do it, then you will
get the incentive.
Senator Levin. The contract you entered into required them
to immediately cancel their warrants. Is that correct?
Mr. Wibbelman. I do not recall that it was a requirements
contract. I recall it was an optional contract, an option.
Senator Levin. Well, we will get into the words of the
contract and which you did not want to put in writing, but we
do have one contract that is in writing. And I just want to
sum--just get to the bottom line. The contract which you
entered into required them, if they lived up to the contract--
--
Mr. Wibbelman. Which they did not have to do, right?
Senator Levin. Let me just finish this. If they live up to
the contract, they were required to immediately cancel the
warrants, move the metal to another warehouse, and the result
of that is to lengthen the queue. Is that accurate? If they
lived up to the contract.
Mr. Wibbelman. If they made all those choices, which they
did not have to make by the contract, in my recollection.
Senator Levin. If they lived up to the contract, is my
question.
Mr. Wibbelman. My recollection is that the contract was an
option contract where they had the option to do it.
Senator Levin. The option to enter the contract?
Mr. Wibbelman. They had the option--they never had to
cancel the metal in the first place.
Senator Levin. OK. Senator McCain.
Senator McCain. Remarkable. Mr. Wibbelman, it used to take
40 days for Metro to remove aluminum from its warehouses for
its clients. Now it takes over 600 days. How do you explain
that?
Mr. Wibbelman. Senator, that is a recognition of the
relative value of the metal that is in Metro's warehouses
compared to any other metal that exists in the LME system or
with any other private owner in the world, and that is--what
happens is those warrants are canceled when someone perceives
it as being a value, a relative value.
Senator McCain. That has to do with the time that it takes
to remove aluminum from a warehouse?
Mr. Wibbelman. Well, the LME system, Senator, is a seller's
choice contract. So, in other words, if someone sells metal,
they get to pick which warrant that they want to surrender in
satisfaction of that contract.
Senator McCain. Someone wants Metro to remove aluminum from
its warehouse, a client does. Now it takes over 600 days, and
it used to take 40 days. And you are saying that has to do with
the nature of the contract?
Mr. Wibbelman. No. Well, I am saying that it is a
reflection of the fact that the London Metal Exchange price
moves in relation to the relative value of the available
warrants that are freely floating in the market.
Senator, if I can explain----
Senator McCain. Mr. Gabillon, Metro's warehouses are
approved by the London Metal Exchange. Isn't it true that LME
raised concerns about the merry-go-round scheme in your
warehouse operations? Is it true that they raised concerns
about it?
Mr. Gabillon. First, Senator, if I may, we do not call them
``merry-go-round transactions'' for a very precise reason. We
refer to them as ``off-warrant transactions'' because that is
what Metro offers to its customers.
Senator McCain. I am just asking, is it true or not true,
yes or no, that LME raised concerns about your warehouse
operations?
Mr. Gabillon. They started an investigation on a very
specific point, yes.
Senator McCain. Mr. Gabillon, over 50 Goldman employees
received confidential information about Metro's warehousing
operations. So, therefore, they have access to commercially
valuable non-public information. And Goldman, as we know, has
other interests, including trading. What procedures does
Goldman have or do you have to ensure that its traders do not
have access to commercially sensitive information?
Mr. Gabillon. So we have a very precise system, and as I
said in my opening statement, we take that very seriously. So
if I can describe briefly, as you know, it is an LME
requirement to have an information barrier between a warehouse
company and affiliated trading companies. So right at the
acquisition time, we put in place a procedure that actually
goes beyond the LME requirements on a couple of levels, and
effectively restrict to a very small list, not the 50 people
you mentioned but I believe it is 8 people right now. We
receive some sanitized, aggregated information, which are
really the people in my team and some of my superiors that
represent the shareholders of Metro, because you will relate to
that. But Metro is owned 100 percent by Goldman Sachs, and it
is actually consolidated in the Goldman Sachs Group, so this
means that we need--we have a need for information.
So some of the people you referred to--and I believe the
number is well below 50 currently, constitute of people that
receive non-commercial information, primarily financial
information, and they sit in our Financial Control Department.
They will also sit in our Legal and Compliance Department.
There are also some people that actually sit in the E-Mail
Surveillance Group, and that's the information received.
Then we have this policy where all this information is
restricted to that very small group of people, and nothing goes
to the metal sales and trading people. We have a segregated
room, and we have email surveillance which is perfected by our
Compliance Department. And I would say in the last 5 years,
since acquisition, we never had a breach of that policy.
Senator McCain. How would you know that, Mr. Gabillon?
Don't Goldman employees oversee the operations of your
warehousing business? How would you know whether they used that
information or not?
Mr. Gabillon. I am not sure what you meant by Goldman Sachs
people oversees the----
Senator McCain. Goldman employees have access to sensitive
information about your operations, right? Because they own it,
and I think that is legitimate. What confidence do we have that
they do not share it with the other aspects of Goldman's
operations, which they could use to their advantage?
Mr. Gabillon. We have two levels. We have the system that I
described, and nothing has ever come up, so we have email
surveillance which has confirmed----
Senator McCain. So nothing has ever come up is the answer
to the fact that they have access to sensitive information
which could give them an advantage in their other operations.
So nothing has ever come up so it is OK?
Mr. Gabillon. No, I would say two things. One, they do
not--metal and sales trading people do not have access to any
of the Metro information. Even myself as chairman of the board,
the data I get from the Metro people for the perfecting of
the--as a shareholder----
Senator McCain. Is there a prohibition from them sharing
operation----
Mr. Gabillon. Yes, there is.
Senator McCain. There is?
Mr. Gabillon. There is under our policies, yes.
Senator McCain. And how do we know that that is enforced?
Mr. Gabillon. OK. So the second thing I was going to say, I
believe 2\1/2\ years ago the LME introduced a further
requirement on the information barriers which would require
Metro to have a third-party certification of the information
barrier policy. This audit has been performed twice by PwC, and
twice Metro has passed successfully, the fact that no
information, no confidential information went to metal trading
people at Goldman Sachs. So that is a third-party certification
which might give you additional comfort.
Senator McCain. Well, I am glad you have that confidence.
Unfortunately, we have seen time after time instances where
that is not necessarily true, and to me it sets up a
relationship which could over time lead to manipulation, and
because you have had no complaint does not mean necessarily
that that is the case.
Mr. Chairman, I have no more questions.
Senator Levin. Thank you.
Senator Portman, are you ready? I can go, or you, either
way.
Senator Portman. Mr. Chairman, I will go ahead if that is
OK.
Senator Levin. Sure. Senator Portman.
OPENING STATEMENT OF SENATOR PORTMAN
Senator Portman. And I apologize. I was on the floor
talking about one of Senator McCain's and your favorite
topics--in fact, I mentioned you--which is the issue in Ukraine
and what is going on with Russia. But I am happy to be here,
and I appreciate your holding the hearing, which gives us an
opportunity to explore the role that banks play in the
commodities markets.
Since Gramm-Leach-Bliley was enacted, banks have had this
legal authority to engage in physical commodity activities, and
I know that many end users of commodities think that the banks'
involvement in this area has been beneficial. I know
municipalities in my State of Ohio have told me that. The
natural gas market is an example for them where they think it
has been helpful.
Nevertheless, I agree this is a responsible use of our
oversight responsibilities to revisit that decision by Gramm-
Leach-Bliley periodically and to ensure that banks are using
that authority in responsible ways that do not threaten the
security of our financial system.
The focus of this panel is on how one particular bank,
Goldman Sachs, has used its authority under Gramm-Leach-Bliley
to participate in the market for a particular commodity, so
this is, as I understand it, focused on one particular issue,
and that is aluminum. Specifically, Goldman used its authority
to purchase a company called Metro that warehouses aluminum. I
understand the aluminum market is characterized by two types of
warehouses: One are warehouses governed by the rules
established by the London Metals Exchange, known as the LME
warehouses, and then those not governed by LME rules, known as
the non-LME. Metro's LME warehouses are the focus, as I
understand it, of this Subcommittee's inquiry today, and I also
understand that aluminum owners have three basic options for
what they do with their metal. They can sell it to end users.
They can store it for sale later. If they choose to store it,
they can do so in LME warehouses or in non-LME warehouses.
So my questions, I guess, are more about how does this all
work? If you could just explain to me--and I know some of this
discussion has already occurred, although we had somebody
monitoring the hearing earlier who said that some of these
issues have not come out yet, so let me ask some specific
questions.
Describe for us how the aluminum warehousing system really
works. Why do aluminum owners warehouse their metal at all? How
do they decide whether to use an LME warehouse or a non-LME
warehouse?
And let me go ahead and give you the second question that I
have, which is: Since 2008 it seems that aluminum owners have
increasingly chosen to warehouse their metal instead of selling
all of it under the physical market. This has resulted in
rising warehouse inventories, particularly at LME warehouses.
Can you explain why? Why are these warehouse inventories,
particularly LME inventories, increasing over the last several
years? In some cases, these inventories have risen
dramatically.
So how do aluminum owners decide where they are going to
put their metals, LME or non-LME? And why, since 2008, have we
seen the increasing inventories?
Mr. Wibbelman. Well, Senator, the London Metal Exchange
operates as a futures market, and it is a market unto itself.
It can be interacted with by the consumers if they choose to do
that, but it has provided itself a market by which producers
could continue to produce metal during periods when the demand
was collapsing.
So following the global financial crisis, for example,
since that point in time, Metro has received into Detroit 3.6
million metric tons of metal, and that really acts as a
strategic stockpile and a buffer stock, which really gives the
consumers a chance to have some alternative sources of metal.
Now, they have not entered the warehouse to take metal out
directly very often, but what has happened is Metro has been
shipping metal out in great quantity--600,000 tons a year for
the last several years--and that metal goes to the particular
owners. And those owners have a choice. They can put it back
onto the LME. They can put it back--they can sell it to
consumption, or they can store it off-warrant in off-warrant
storage areas.
And so what the LME system has done is essentially allow us
to create a strategic stockpile within North America, a large
one. And so that is why the argument about pricing. I mean,
Metro's activities have done really, I think, nothing but
amplify the competitive options that people have had, when you
are talking about 3.6 million metric tons that really might
never have been produced in the first place. And really it was
only when the LME system rules were under some revision that
smelters started to really amplify their shutdowns, for
example, in your State.
And so really the LME system has been quite vital for
producers to be able to have a predictable customer when no
customer exists in the physical consumption world.
Senator Portman. Mr. Gabillon, any additions to that?
Mr. Gabillon. Yes, maybe I will just add one thing, because
you asked a question about whether people decide to store on
the LME or not on the LME.
Senator Portman. Right.
Mr. Gabillon. I think to put things in context--and I think
it is relevant to the earlier debate that took place on those
off-warrant transactions. In the LME, you are under rules set
by the LME, but you have a lot of benefits that are attached to
it because you have what we call liquidity, which is, each
metal is described as a warrant, and there is a trading place
where you can buy and sell futures contracts that will deliver
on these warrants.
So if you want to be, for instance, a financier and you
want to finance your metal, you will find that if you own metal
under the LME, meaning stored in an LME-approved warehouse's
warrant, banks will give you a lot of financing, you will have
a lot of liquidity, because if your collateral needs to be
foreclosed, it will be very easy for the bank to foreclose on
it and then sell it into the market. And so that is under the
contract of the LME.
Of course, the downside of that, the LME has to have rules,
so, for instance, the minimum load-out rules and when you can
take it, and you might have to wait.
Senator Portman. But customers are willing to have those
restrictions in order to get the benefits, including more
liquidity?
Mr. Gabillon. Yes. And when we say ``customer,'' I think we
should try to be a bit more precise. The other thing I would
say of this LME warehousing system, it is not a supply storage
system. It is an LME warehouse system that has been built and
established to support the LME as a marketplace. So not a lot
of people would use that. Producers would use that as a market
of last resort when it happened in 2008 because suddenly there
was a collapse of demand, and the only people that could
actually buy this aluminium and finance it, to your point, was
on the LME. But that is easy to deliver onto. If you buy onto
the LME, for instance, it is actually the seller that decides
which ones they are going to deliver. So they could be in
Malaysia, they could be in Rotterdam, or they could be in
Detroit. You do not know in advance. So people generally have
not used the LME to provide.
Then if you are storing off-warrant, very quickly, which is
part of what our customers sought to do in the past, you are
taking much more risk because you are on your own, if you like.
You are storing metal in a warehouse somewhere. There are no
rules, right? It is a bit more difficult to get financing. You
need to organize the logistics.
Senator Portman. And more exposure.
Mr. Gabillon. And more exposure because most of the people
are storing aluminum, and that is something we have not gone
through yet. It is a bit more complicated, but when people own
the commodity, most of the time they would have hedged it. If
you have done all of that on the LME, again, your risk is very
reduced because if something happened, you can just wait and
deliver your LME warrant. If you are doing that in a field,
though, in a warehouse which is far from an LME delivery point,
you run a lot of risk between the two, and it is more
complicated, and that is why banks are reluctant. So people
always have to decide between those two, and right after the
financial crisis, there was not a lot of confidence, funding
was difficult, so that is why all this material went onto the
LME. And now as the situation has improved, that is why the LME
metal is trying to get out. Sorry for the long answer.
Senator Portman. As the economy began to pick up--one of
the questions I have, just hearing you all--what percent of the
market does this particular warehouse and this company
represent? The Goldman investment is in Metro, I take it. Do
you have other warehouses? You are the Goldman guy, right?
Mr. Gabillon. We own 100 percent of Metro. That is it. It
is a bit difficult to answer the question about market share
because it does vary over time. So as I said, at the beginning
of the financial crisis, all this metal went onto the LME, and
not a lot of metal was stored outside. If you look at it
today----
Senator Portman. What percent of aluminum is in this
warehouse today, the Metro warehouse?
Mr. Gabillon. Today it is about a million.
Mr. Wibbelman. About a million.
Mr. Gabillon. A million tons, and the annual market for
aluminum is about 50 million tons, and probably observers of
this market would tell you you probably have something like 12
million tons being stored on the planet right now. It is
difficult--we know about the LME because it is publicized, but
what is outside, we do not have the data.
Senator Portman. Are you saying 2 percent? Are you saying
50 and 1?
Mr. Gabillon. Two percent of production; 2 percent of
annual production is stored right now in Metro.
Senator Portman. OK. And what percent of the aluminum that
is stored is in your warehouses?
Mr. Gabillon. Then it would be 1 versus 12, so 8 percent.
Senator Portman. One of the things that the Subcommittee
staff Report indicates is that the LME warehousing facilities
at Metro affected price movements for aluminum in the United
States. It sounds like it is about 8 percent of the stored
aluminum. In your opinion, do LME warehousing practices have a
meaningful effect on the physical price of aluminum? If not,
what other factors influence that price?
Mr. Wibbelman. Senator, I would say that there are a lot of
actors in the marketplace, and so you have what producers
choose to do, if they continue to produce metal or not. You
have got financiers. We have been operating in a zero interest
rate environment lately, and so the people who are owning metal
are often owning it because the returns on--the safe returns on
owning metal and deploying their capital into metal create a
return of between 5 and 8 percent for many of these
institutions and trades. That is why a lot of these
institutions have wanted to own metal and were willing to buy
metal in order to do it. It is because they are looking at the
difference between a 0-or a 1-percent return versus a 5-or 8-
percent return during this whole 5-year period at various
times.
Senator Portman. So how do you respond to the concern that
the way you have stored the product at Metro affects pricing?
What is your response to that specific concern?
Mr. Gabillon. Well, Senator, I think as we discussed, there
are two parts in what we call the all-in price, which is the
price paid by customers. We have the LME price, which it is
called the LME price because it is the price on the LME, so it
is affected by LME rules, clearly. And then you have the
physical premium. So as the physical premium has gone up, the
LME price has actually gone down. And if you may, we have a
graph which we think is pretty relevant, if we could show it to
you.
Senator Portman. My time is up, so it is up to the
Chairman.
Senator Levin. Sure, if you want to.
Senator Portman. Yes, let us see the chart if you have one.
Mr. Gabillon. I will start to describe it, but you are
going to have it in one second.
Senator Portman. And while we are getting the chart, what
is the comparison to what goes on, say, in the Asian market,
the Japanese market, for instance, where there is a significant
amount of aluminum used, or the European market?
Mr. Gabillon. Well, I think if you look globally, you will
see it is not perfect in timing. But the markets tend to be
reacting at the same time, so if you wanted to look at those
equivalents of the physical premium in the United States and in
Europe and in Asia, you would say that they have all risen at
the same time. And part of the reason is also because the LME
price--we have talked a lot about the United States here, but
the LME price is a global price, because as I said, when you
deliver aluminum on the LME, you decide where you can deliver
it. So people are always calculating which metal to deliver
when, and the LME price, if you think about the LME price
today, it probably reflects much more the situation in
Vlissingen in the Netherlands than it did. But at another point
in time it would be different, so you have a constant
evolution.
If you look at this chart we have provided,\1\ just to put
it in context, it is between the beginning of 2007 to very
recently. The light blue curve is what we call the aluminum
all-in price, and you could see that it was quite elevated
before the financial crisis. Then it went down a lot. And then
it has been moving--we have a kind of trend line. It has been
moving down over the last of those years. And then we have
represented as one example of what has been going on the LME,
what we call the aluminum queue calculated in this, which
reflects something which is well known to observers, that those
queues have risen. Actually, they actually started to fall off
quite a lot this year, and you can see when everything is said
and done, you can see that actually there is no correlation
between the increase of the queue and the all-in price that is
paid by customers in the United States.
---------------------------------------------------------------------------
\1\ See chart provided by Mr. Gabillon, which appears in the
Appendix on page 147.
---------------------------------------------------------------------------
So we know it is complicated. There are many factors. At
times it varies, the dynamic varies. A lot of the people that
actually observe those markets, including us, sometimes get it
very wrong. But when everything is said and done, you can see
that there is no correlation. So we do not believe that the LME
rules impact the all-in price for customers.
Senator Portman. And of all those factors--and you say it
is complicated--you would say that the economy would be the No.
1 factor, in other words, the demand in the economy?
Mr. Gabillon. On the all-in price, definitely. If you see
again this graph, you can see that the all-in price went down
pretty much a lot until the end of last year. And actually, it
is only this year, with the combination of increased demand, in
particular in the United States, and also a lot of smelters
closures in the United States and in Europe in response to
those prices, that the situation has started to shift, and now
the aluminum all-in price is starting to rise at a time where
the queues are very limited.
Actually, if you look at it specifically in 2014, you would
see that at the beginning of the year, even if you think about
the physical premium itself, it started the year at 250,
finished the year at--currently we are at 500. For instance,
the queue in Detroit has actually been reduced a lot during the
same period. So that is why I am trying to say when it is
complicated, at times the correlations change. But overall we
think this graph summarizes the situation.
Senator Portman. If the EU economy were growing right now
and the U.S. economy having picked up some steam recently, you
would see this light blue line going back to here it was
probably in early 2008?
Mr. Gabillon. I mean, it is always difficult to speculate,
but that is not impossible.
I think the other thing which is starting to drive that
price is as smelters have closed here, the North American
sector needs to import aluminum, in particular, to the United
States, and, therefore, they need to import it from abroad, and
that has higher transportation costs and most of the production
increase is in China these days.
Senator Portman. OK. I have additional questions, Mr.
Chairman, but I do not want to take your time.
Senator Levin. Thank you.
Just while we are on that point, I think most experts in
the field will say there is a relationship, by the way, between
queue length and the price that people pay for aluminum. But we
are going to--and that is an important argument, but to me, an
equally important argument is whether there is a relationship
between queue length and what you call and everyone else calls
the ``premium.'' Would you acknowledge there is a
relationship--and this is something Senator Portman was getting
to, I think. Is there a relationship, a direct correlation, in
fact, a very high correlation between queue length and premium?
Just, yes, is there a high correlation?
Mr. Wibbelman. Senator, what I would say is that when the
premium goes up, the value of the available metal within
Metro's warehouses becomes more attractive, and so then people
look for it and try to cancel warrants, and then, therefore, it
becomes a longer queue. So I think it is just a question of
cart before the horse.
Senator Levin. No, my question is: Is there a direct, high
correlation between queue length and premium?
Mr. Gabillon. Senator, I would say if you look at 2014, I
would say no.
Senator Levin. In general, is there a high correlation, yes
or no?
Mr. Gabillon. First, correlation does not mean causality.
Senator Levin. I did not say it meant causality. I did not
ask you causality. I asked you correlation.
Mr. Gabillon. If you ask me as a statistician, including
the data up to today, I would say the correlation is not great,
no.
Senator Levin. OK. Then that is a major argument here. If
you can say there is no correlation between premium and the
length of the queue, then you are in a very different
mathematical world than most of the mathematicians that look at
this. OK?
By the way, on your chart, when there was a big jump in the
queue length, what happened there? Weren't there a whole lot of
cancellations right there?
Mr. Gabillon. So there were----
Senator Levin. Can you give me a yes or a no to that
question?
Mr. Gabillon. Yes, cancellation drives queue, so yes, there
were a lot of cancellations.
Senator Levin. That is, as far as I am concerned, the most
important six words I have heard yet this morning.
Cancellations drive the queue, and we all ought to remember
that. OK? And then if there is a correlation between the queue
and the premium, which most statisticians will say there is,
then you have the important connection between the premium and
the queue. And if the queue is driven by cancellations and if
your contracts require cancellations--which they do if they are
living up to--at that point you have your contracts requiring
cancellations. In order to get discounts, you have to cancel
the warrants, which in turn drives the queue, which in turn is
correlated to the premium. And the premium is, by your
argument, just part of the all-in price. You say it does not
affect the all-in price. Most of the users will say it sure
does. But that is an argument that we will take up with every
panel as to whether or not the premium, if it goes up, leads to
higher all-in prices. You folks differ with most users on that
issue, but in terms of the premium--the premium is clearly an
important part of the all-in price, and your actions are
directly correlated to the premium, because you are driving the
queue, as you just pointed out, and the queue has a direct
correlation to the premium.
Now, that is not just the price of aluminum we are talking
about, folks. This is also the transactions in aluminum which
Goldman are involved in, because the premium--there are
transactions based on premium. And if you are right that if the
premium goes up, the other part of the price will go down--that
is what your argument is--you are saying then that the LME
price will go down if the premium goes up. There are huge
amounts of aluminum-related transactions that are based on the
LME price.
So if your argument is right and, again, most users
disagree with your argument, and I think most experts would
disagree with your argument, and we are going to hear from some
of those on the next panel. But if your argument is right, two
things then are affected: First, the premium, if it goes up,
there are financial transactions based on that premium; second,
your argument, the premium goes up, LME price goes down because
there is no effect on the all-in price. At that point the
effect on the LME price by the increase in the premium is part
of your argument. You are saying premium is up, LME price has
to go down, because the all-in price is the same. That is your
argument. At that point, now driving the queue, which is
obviously driven by cancellations, and the queue correlation to
the premium is directly affected to the LME price, by your
argument.
Again, most people do not agree with your argument. Most
people that use aluminum believe that when you increase the
premium, which is what the queue does--forget causation, it is
correlated, the length of the queue to the premium is
correlated, that is what most mathematicians will say in a very
high way, you are having a very significant impact on LME price
and--and this is significant for Goldman, because this is what
I believe it is mainly about for Goldman, are the financial
transactions, because their impact on the queue by what they do
with cancellations--and that is what these contracts are about.
These contracts are about you must cancel. That is in the
contract. I know, they do not have to live up to the contract.
I understand that. They can violate the contract. But most
people do not enter into contracts to violate them. And so if
they live up to the contract, under the words of the contract
you must immediately cancel, which means the queue goes up,
cancellations drive the queue, you just said it. And the
relationship, the correlation between the length of the queue
at that point and the premium is a direct correlation. And at
that point, under your own argument, it seems to me you lose a
very significant other argument, and that is the relationship
here between premium and the LME price.
So I do not know if Senator Portman wants to go on. I have
a lot of additional questions, but the issue, Senator, which we
have just been talking about is the relationship between the
premium and the queue, and there is a high correlation. This is
the all-in price. They are arguing here that the all-in price
is not driven by queue length, because their argument is that
if the queue length goes up, the LME price--excuse me, if the
premium goes up, the LME price goes down, because the all-in
price stays the same. But it is the premium issue which is the
issue here as well as the effect of the queue on the all-in
price. But there is not much doubt in most statisticians' minds
and beliefs that there is a direct, high correlation between
the length of the queue and the premium.
I know their argument, and I have heard it. Most of the
people that we are going to hear from do not agree with the
argument that the length of the queue does not have any effect
on the all-in price, on the price of aluminum. But even if they
are right--and most people disagree with it--where they are
clearly wrong by almost any statistical analysis is the fact
that there is a high correlation between the premium and the
length of the queue. And once that is true, if, as they argue,
the all-in price is made up of two components--one the premium,
the other one the LME price--then the LME price is affected by
the premium going up or down, and at that point the LME price
is very significant in terms of financial transactions.
So this chart is very much disagreed with, again, by most
users, including the auto industry, which is using aluminum,
which is a big, big problem with the way in which aluminum
prices are set.
Senator Portman. You are part of this, too, so I will get
back to you. But they care a lot about the all-in price.
Senator Levin. They do.
Senator Portman. I am admitting I am no expert in the
aluminum market, but why is the premium so important as
compared to the price? And is this a matter of--you say
correlation. Does that mean causation? And are there other
things that could explain that correlation?
Senator Levin. Well, when you look at their chart, that big
line jump right there, is when there was a whole bunch of
cancellations of warrants. The queue went up, including the
ones we are talking about today. Many of them, right at that
big jump right there. And this is the queue length. And so,
again, the high correlation becomes critical because under
their contracts, for instance, that Deutsche Bank had to
immediately cancel warrants--under all their contracts. If we
are talking about these six contracts, all the warrants had to
be immediately canceled. That immediately caused the queue to
increase. You can see it with that huge jump right there. And
so the queue increases, and then the question is: Is there a
correlation between the length of the queue and the premium?
And there is a high correlation at that point. And the premium
is a big, growing part of the all-in price, by the way. It used
to be 5 percent of the all-in price. A few years ago, the
premium was 5 percent of the all-in price. It is now over 20
percent of the all-in price.
Senator Portman. Let me just ask you gentlemen about that.
The question I just asked a second ago is does correlation mean
causation? And what else would you think, assuming you agree
with the correlation, would be the causation? Is it the LME
rules? What is your sense of that?
Mr. Gabillon. So if I may, first, to come back to our
graph, that is not the theory, with just the observation of
this, I think everybody can conclude from that graph.
If we go back to the precise point of premium versus
cancellation--and, again, I appreciate it is complicated--there
is effectively--that is a factor. The queue is a factor in the
premium, and there is a simple fact, which is if you receive a
warrant on the LME and there is a long queue in front of you,
the owner of that warrant is going to have to pay the storage
fee for that period of time. So as that period goes, the LME
price will go down. That is the various effect of the premium.
Now, when we say queue--and this is where it gets a bit
more complicated--it depends which queue you are talking about.
So there is a period of time where maybe for a few days--the
queue in Detroit was the longest in the LME system, and then
that might have a bigger impact. But there was a period when,
if you look at it today, the queue on aluminum is not the
longest in Detroit. It is actually in Vlissingen. And this is a
global market. This is a global contract. In the LME you do not
have a contract in United States, a contract in Europe, a
contract in Asia. You have one global contract, and everything
is priced out. So right now the queue in Vlissingen has
probably a bigger impact than any other queues in the world. So
that works like this. At another period it might be different,
and that is why the correlation can vary from time to time.
And, yes, I mean with correlation, we can have people fighting
all the time. But there are periods where it is different, and
so the correlation exists at that time. And sometimes, as Mr.
Wibbelman said, it is the other way around. When premium--when
you look back at why cancellations started to happen, it is
because the premium was starting to go up. That was a signal to
the market, which is take that metal which is on-warrant,
cancel it, and bring it outside. So sometimes it works both
ways. That is why the correlation-causality is more complicated
than that. And this market is complicated, and people disagree
all the time. That is what makes markets.
I will give you one anecdote how complicated it is, and
Senator Levin referred to it when he showed us the big increase
in cancellations in Detroit. By the way, if you had the chart
of other parts of the LME system, you would see there was an
even bigger cancellation a few weeks before that event, and
that event happened when the LME, after doing an independent
report on queues, reached the conclusion, had a consultation,
and implemented the rule to double the load-out from large
warehouses like ours, with a view to reduce queues. The impact
on the market was that queue did not shorten, but queues became
longer as a result of that.
So that is an example of how even when you have the best
brains that have studied this market, you look at it and try to
understand what drives what and when, it is not that simple.
So I appreciate that, it is a very complicated issue of
correlation between premium and things, but I think it is more
complicated than that.
Senator Portman. By the way, the LME rules under which
Metro operates, are these rules that if you were to sell the
warehouse, which I understand you are thinking of doing, that
the new owners would also operate under?
Mr. Gabillon. That is correct.
Senator Portman. And who might the new owners be if you
sold the warehouse?
Mr. Gabillon. We are running a sales process right now, and
we have a variety of interest from companies in Europe, Russia,
and China. There is a variety of them right now.
Senator Portman. You think it would be a foreign owner? I
do not mean to probe here, but I will.
Mr. Gabillon. I think it is possible, yes.
Mr. Wibbelman. Even if it is not a foreign owner, it is
safe to say that the center of gravity of the business
generally is going to move from the United States to Europe or
to Asia, and essentially it is because the competitive
environment that Metro operates in. I mean, all of the other
warehouse company owners are essentially unregulated traders
that operate in those areas, and so they are able to do things
to acquire metal for their own warehouse companies, which will
essentially create strategic stockpiles elsewhere or within
those companies.
Senator Portman. So if it is not owned by a bank or
Goldman, it is likely to be owned by a trading company. And let
me just be clear: Is that trading company going to be living
under the same LME rules or not?
Mr. Wibbelman. It will not have all the banking
restrictions if it is not a bank, right? So it will not
necessarily have that type of restriction. Many of the
companies that own LME warehouse companies, the parent
companies, are trading conglomerates in some cases, and they
essentially, source metal for their own warehouse company, and
the profit will go up vertically into the same ownership
structure. I mean, Metro has been run from a profit center
basis, completely separately from Goldman. In other words, we
act maybe as counterparties occasionally, but not as a unified,
vertical structure.
Senator Portman. Thank you, Mr. Chairman. I have,
unfortunately, another appointment I cannot miss, and I
appreciate your testimony, gentlemen, and thank you, Mr.
Chairman, for letting me come and indulging me with the time.
Senator Levin. Thank you very much, Senator Portman.
Let us now start with the Deutsche Bank contract under
which they were required to cancel their warrants, the first
one. Now, that deal was in September 2010, just a few months
after Goldman acquired Metro, and it involved Deutsche Bank and
100,000 metric tons of aluminum. Here is what Deutsche Bank
told us: That in September of----
Senator Baldwin.
OPENING STATEMENT OF SENATOR BALDWIN
Senator Baldwin. Thank you, Chairman Levin. I actually
wanted to start by thanking you for your leadership of this
Subcommittee. I remember our first meeting together as I became
a new Senator and you talking about the importance and the
power of the gavel of this particular Subcommittee, and you
have wielded it so much in the interest of the American people,
and I deeply, deeply appreciate your work and leadership on
this Subcommittee.
I also want to thank you for holding today's hearing. I am
greatly concerned about the role that financial institutions
are playing in physical commodities markets, and particularly
aluminum, because I have heard about this issue from
manufacturers all across my home State of Wisconsin, from
breweries that use aluminum in their cans to Mason jar
manufacturers to heavy trucks, and if you are making a product
with aluminum in it, you know this issue very well.
The fundamental basis for any well-functioning commodity
futures market is that futures and cash converge, and I think
we have seen a massive disconnect in the aluminum market, and
today's Report identifies the reason.
Mr. Chairman, because I know you have probed during this
first panel into the relationship between the queue and the
premium, my real interest is asking some questions of the
second panel. I know it is going to be a little while before
they come. I wanted to come here today to note my concerns. I
hope to be back to ask my questions of the second panel. If
that is not possible, I am going to leave my questions with you
for the record, but I do not have any questions right now of
this panel.
I thank the Chairman for your indulgence in allowing me to
thank you and state my interests in this issue.
Senator Levin. We are always happy to indulge colleagues
who want to thank me. Believe me, it is----
[Laughter.]
Senator Levin. Thank you, Senator Baldwin, for your great
involvement in so many issues involving consumers, as well as
this one, and for your comments about me. I very much
appreciate them.
Let us get to the Deutsche Bank deal again. This was
September 2010. It was just a few months after Goldman acquired
Metro. It involved 100,000 metric tons of aluminum. Deutsche
Bank told us that in September 2010 it entered into
negotiations with Metro seeking cheaper rent for the metal that
it was storing at Metro warehouses in Detroit.
The LME told the Subcommittee that no LME rule prevented
Metro from giving Deutsche Bank a rent discount for LME
storage. So Metro could just give, if they had decided to,
Deutsche Bank the discounted rent while still on-warrant in the
first warehouse. Is that correct? You had the power to do that?
Mr. Wibbelman. We could do that, yes.
Senator Levin. And Metro has given rent discounts for LME-
warranted metal in the past. Is that correct?
Mr. Wibbelman. Yes.
Senator Levin. Metro did not do that here. Metro instead
proposed that Deutsche Bank cancel warrants on its 100,000
metric tons of aluminum ``as soon as possible.'' Cancel
warrants as soon as possible, and then wait in the queue; when
it got to the head of the queue, send its metal from one set of
Metro warehouses to another. After a brief period, Deutsche
Bank would then re-warrant the metal at the new warehouses.
Again, Mr. Wibbelman, why not just let Deutsche Bank stay
in the first warehouse and give it a cheaper rent?
Mr. Wibbelman. Well, I mean, we are a commercial business,
and we evaluate every commercial opportunity independently,
according to what is in the best interests of our commercial
position. In that case, I can tell you that Deutsche Bank had
the optionality to move the metal out or not move the metal
out. And, in fact, they did not move a great deal of the metal
out. They left it in the warehouse and re-warranted it in place
because it was commercially more viable for them to do that.
Senator Levin. How many tens of thousands of tons did they
move to a different Metro warehouse?
Mr. Wibbelman. My recollection was of the 100,000 tons,
they moved 70,000 metric tons, and they did not move 30,000
metric tons, and they re-warranted all the stock in--whether
having left the warehouse or not having left the warehouse.
Senator Levin. Exactly. It was important to you, however,
that they move to another warehouse. Is that correct?
Mr. Wibbelman. Well, they wanted the optionality----
Senator Levin. Was it important to you that you required
them to cancel the warrants as part of this deal?
Mr. Wibbelman. Senator, the issue for them----
Senator Levin. I am just asking you if it was important to
you.
Mr. Wibbelman. I am trying to explain that the issue is
that if they do not put the metal in the queue, Metro having at
that point, for example--I am just guessing--a million tons of
metal in storage, then someone else could cancel metal, and
that they could then jump ahead of them and make their metal
less valuable. So the LME rules actually----
Senator Levin. I am just asking a simple question. Was it
important to you? And is that why it was in the contract that
they cancel the warrants?
Mr. Wibbelman. Metro was going to make the same amount of--
--
Senator Levin. So it was not important to you?
Mr. Wibbelman. So it was--we gave them an option to do it.
Senator Levin. I am just asking you whether or not, if they
live up to the contract, did they have to cancel warrants? That
is all. It is a pretty simple question.
Mr. Wibbelman. Yes, I would say that the--what we were
doing was we were providing them options for once the metal
left the warehouse, if that is what they chose to do, and that
was the basis of the contract.
Senator Levin. I take it you are not going to answer the
question as to whether or not it was important to you that they
cancel the warrants.
Mr. Gabillon. Maybe I can try----
Senator Levin. No.
Mr. Wibbelman. I am trying to answer the question, Senator.
I am sorry. I think it was probably not important to me
personally whether it happened----
Senator Levin. Not personally. I am talking about the
company. You paid them to move 70,000 tons, did you not? You
gave them a discount. Is that correct?
Mr. Wibbelman. We gave them some discounts if they moved
it.
Senator Levin. Right.
Mr. Wibbelman. But it was their choice.
Senator Levin. It was not their choice whether to cancel or
not?
Mr. Wibbelman. Yes, it was. They owned the metal.
Senator Levin. No, but wait a minute. If they lived up to
the contract, they had to cancel. Once they sign a contract, is
it not true that, to live up to that contract, they had to
cancel the warrants? Yes or no.
Mr. Wibbelman. It was not a requirements contract, it did
not require them to cancel metal. If they wanted to achieve
the--if they wanted to put it back on warrant from a different
warehouse, then they would----
Senator Levin. Take a look at Exhibit 23,\1\ would you,
please? Page 5, Section 3.1: ``. . . the Parties agree that
[Deutsche Bank] will request the maximum number of Slots and
place the Goods or part of the Goods off-warrant as soon as
possible thereafter . . .'' That means cancel the warrants,
doesn't it? Does that mean cancel the warrants?
---------------------------------------------------------------------------
\1\ See Exhibit No. 23, which appears in the Appendix on page 1011.
---------------------------------------------------------------------------
Mr. Wibbelman. Cancellation would be required for that,
yes.
Senator Levin. OK. The parties agree that they would ``as
soon as possible thereafter,'' obviously ``dependent on
existing demand for slots.'' But, nonetheless, as soon as
possible. And then they canceled, and look what happened to the
queue. See that big jump in the queue? That is what happened
when they canceled the warrants. Do you think there is a
correlation there between canceling warrants and the length of
the queue?
Mr. Wibbelman. Oh, if they cancel, there is definitely--the
queue would lengthen until the metal ships out, until some of
the metal shipped out. That is right.
Senator Levin. OK. So I am glad we finally got to that
point, that there is a correlation between canceling the
queue--canceling the warrants and queue length. That is
progress.
Let us keep going then with Deutsche Bank. The contract was
signed by Deutsche Bank, not by Metro. Did it reflect the
agreement that was reached between you?
Mr. Wibbelman. I mean, it was--my recollection is this was
written by Deutsche Bank. It was signed and sent over by them,
and that it was never executed, and----
Senator Levin. You mean never signed by you?
Mr. Wibbelman. Yes.
Senator Levin. You do not mean executed.
Mr. Wibbelman. Well, it was never signed by me or executed
by us, yes.
Senator Levin. It was not executed. Didn't you live up to
this contract?
Mr. Wibbelman. Well, I do not--sir, I cannot tell you that
these terms were----
Senator Levin. Did you live up to a contract with Deutsche
Bank which was like this contract?
Mr. Wibbelman. No question, generally speaking, this type
of thing took place, yes.
Senator Levin. Not this type. This thing took place.
Mr. Wibbelman. So the reason, sir, why we do not have
contracts is because how Metro's business operates is it is
basically a timeline.
Senator Levin. OK. Let me go back. That is not my question.
Basically this contract was executed. Is that correct? This
agreement was executed?
Mr. Wibbelman. I can tell you that the amount of tons that
were contemplated when this contract was sent across ultimately
did get canceled, and some of it did ship out.
Senator Levin. OK. And did you live up to the section that
said that Deutsche Bank would have to pay $65 per metric ton if
it sold the metal instead of moving it to another Metro
warehouse and re-warranting? Was that part of the deal?
Mr. Wibbelman. They did not ultimately sell any of the
metal.
Senator Levin. No, I know. But would they have had to--was
there a penalty here? Come on, let us just get to it. The
section says Deutsche Bank would have to pay--this is Section
3.8--$65 per ton if it sold the metal instead of moving it to
another Metro warehouse. Am I reading it right? Was that part
of the deal?
Mr. Wibbelman. So generally we do have break fees to our
agreements, yes. If they agree to do----
Senator Levin. I am not talking about generally. Was that
part of the deal with Deutsche Bank?
Mr. Wibbelman. I cannot recall specifically, Senator, I am
sorry to tell you, but I would not doubt that it was not part
of the deal. I just cannot tell you for certain that it was.
Senator Levin. OK. You have no recollection as to whether
that was part of the deal or not?
Mr. Wibbelman. I do not know, Senator, if it was actually
ultimately invoiced and paid out that way.
Senator Levin. I am not talking about ultimately invoiced.
I am talking about the deal.
Mr. Wibbelman. It was perhaps a term contemplated by this
agreement. Again, I do not know if it was followed through
upon.
Senator Levin. That would be a $6.5 million penalty for
100,000 tons of aluminum.
Now, if Deutsche Bank broke the agreement to send the metal
to a Metro warehouse, then Deutsche Bank would have to pay $65
a ton. That is not free metal to me, by the way. You may want
to talk about as free metal, then you may want to talk about
choice. But when you enter into a contract, a business
contract, you have given up choice. You can break the contract.
That is always a choice. You could run a red light. You have
got a choice. You made a deal. I do not know why you want to
suggest you did not make a deal. You are in business. You made
a deal.
Mr. Wibbelman. Absolutely. Yes, we did.
Senator Levin. And part of that deal with that they would
cancel warrants as soon as possible, and as you point out,
finally, there is a direct relationship between canceling
warrants and queue length. And most statisticians will tell
you--and they will in the next panel--there is a direct
correlation between the length of the queue and the premium.
That may not always be true, by the way. Maybe that is not true
every day or every year, but it is generally true. There is a
correlation between queue length and premium. Why? Because the
longer the queue length, the more rent that is going to be
paid, and that is part of the premium, is how much rent do you
have to pay on top of what the LME price is. That is what the
premium is all about. It is cost of storage.
So Deutsche Bank did not pay any penalty here because,
after canceling warrants for all 100,000 tons, Deutsche Bank
ended up keeping 30,000 warrants, as you pointed out, in the
original warehouse and re-warranting it, and they sent about
70,000 tons into other Metro warehouses, and they re-warranted
it.
Now, let us talk about correlation. The contract, or the
``deal''--let me put it in your words--was dated September 15,
2010. Is that correct?
Mr. Wibbelman. Yes.
Senator Levin. Thanks. And then on September 20, 2010,
Deutsche Bank canceled warrants for 100,000 metric tons
pursuant to the deal.
Now, would you say that you had some influence over the
cancellation by entering into a deal which required them to
cancel if they lived up to the deal?
Mr. Wibbelman. Well, I think there were incentives that
they were trying to capture, but those incentives were not all
Metro. Some of those incentives were what the market was
offering in terms of its ability to capture a higher interest
rate on the capital it deployed, plus whenever Deutsche Bank
would enter into a transaction like that, they would gain the
optionality. They would have this metal, and then if the market
moved in any direction or another, they would be able to take
advantage of that movement. And so, for example, when the
market must have moved in some way where they decided not to
ship, for example, the 30,000 tons and to put it back on-
warrant within its existing location, they probably did that in
exchange of some market movement, I am guessing.
Senator Levin. Did that contract have an effect on
cancellations?
Mr. Wibbelman. Certainly I would say that their choice to
take advantage----
Senator Levin. No. Did the agreement----
Mr. Wibbelman. We were providing a solution----
Senator Levin. I am talking about did the agreement itself
provide for cancellations. Did the deal say if they lived up to
it. I know they did not have to.
Mr. Wibbelman. We are part of the market. We are part of
the LME's market, and I believe that this contract was--allowed
Deutsche Bank to have solutions to its--to the problems that
come with its----
Senator Levin. I am sure that is why Deutsche Bank signed
the contract, because they were given some money to keep the
warehouse there and they were penalized if they did not keep
the metal in the warehouse. OK.
Now let me go back to my question. Did the agreement have a
provision that related to cancellations? I will read it to you
again if you want.
Mr. Wibbelman. Any----
Senator Levin. Not any, this one. The deal that you made
with Deutsche Bank?
Mr. Wibbelman. It is a condition precedent for them to
cancel the warrants should they want to have the option of the
incentives we were offering. That is right.
Senator Levin. Did it have a provision relative to
cancellations?
Mr. Wibbelman. It talked about----
Senator Levin. Not talked. Come on. They do not talk.
Contracts, written things, do not talk. You talk.
Mr. Wibbelman. OK. Again, Senator----
Senator Levin. I am trying to get you to just acknowledge
what is obvious. This contract had a provision saying that if
they lived up to the contract and if they exercised the options
and all the rest, that they would cancel as soon as possible.
Mr. Wibbelman. That is right, as long as it is with the
``if.''
Senator Levin. Of course. You never have to live up to a
contract. You can pay a penalty. Or you cannot live up to it--
you can create a reputation for yourself that you do not live
up to contracts. You do not have to obey a red light. You could
go through a red light.
Now, did you enter into a deal with them?
Mr. Wibbelman. Certainly there was a deal that took place.
Senator Levin. And did that deal, if lived up to, relate to
cancellations?
Mr. Wibbelman. If they did cancel the metal, then, yes----
Senator Levin. No. Did it say they would cancel as soon as
possible?
Mr. Wibbelman. Sir, I am trying to tell you that was the
contract that they wrote, that we----
Senator Levin. I do not care who wrote it. Did you agree to
it? You did not sign it. Did you agree to a deal?
Mr. Wibbelman. We had a deal. There is no question about
that.
Senator Levin. Well, you had a deal. You did not agree to
the deal?
Mr. Wibbelman. Yes, our deal was conditional. If they chose
to----
Senator Levin. No. Did you have a deal?
Mr. Wibbelman. Yes, we had a deal.
Senator Levin. Did you agree to the deal?
Mr. Wibbelman. Yes, we did.
Senator Levin. Did the deal have a provision that, if lived
up to, would require cancellations as soon as possible?
Mr. Wibbelman. The deal was that if they cancel, then we
will make these payments. But it was their choice to cancel or
not cancel. We were not going to sue them if they did not. It
was a regular----
Senator Levin. Did it say they would cancel as soon as
possible if they lived up to it and exercised it? Did it have
that provision? Are the words that I am looking at, am I
reading them accurately?
Mr. Wibbelman. Senator, I am just trying to tell you that
the actual written document does not have as much weight as you
are imagining and in the way the actual transaction took place.
Senator Levin. Was it in your interest that they cancel?
Mr. Wibbelman. I mean, they had to cancel in order to get
our incentives. That is certainly true.
Senator Levin. Was it also in your interest that they keep
the metal in your warehouse and that they cancel?
Mr. Wibbelman. Well, in our interest, Senator, would be if
nobody shipped metal out of the warehouse.
Senator Levin. Did they cancel?
Mr. Wibbelman. They did cancel.
Senator Levin. Was it in your interest that they cancel?
Mr. Wibbelman. No, I do not think it was.
Senator Levin. So you entered into a deal that said they
would cancel as soon as possible, but that was not in your
interest?
Mr. Wibbelman. Well, remember that the relative bargaining
power, the owner can cancel with or without our involvement,
right? So we are trying to give them solutions that involve us
if they move us, right? And so that is what we were doing. We
were trying to provide solutions to them in the event that they
canceled and moved the metal.
Senator Levin. You are just telling us under oath that you
did not care whether they canceled or not.
Mr. Wibbelman. I cannot tell you that it was--I do not know
if they have----
Senator Levin. I am asking you. You are telling us under
oath you did not care if they canceled or not.
Mr. Wibbelman. Well, I would have to say, Senator, that I
do not recall then because I cannot tell you with certainty
that I cared. I can tell you that the intent of the deal was
that we are providing them with options to move--in the event
that they moved it.
Senator Levin. So the Deutsche Bank deal was approved by
Metro's board of directors, all Goldman employees, that
explicitly called for Deutsche Bank to cancel warrants for
100,000 tons of aluminum ``as soon as possible.'' That is the
agreement.
Then right afterwards, on September 20, Deutsche Bank
canceled warrants for 100,000 tons of aluminum. So now let us
look at the queue. There is the chart on the queue. This is
what happened when they cancel, that dramatic spike upward in
the length of the queue, jumped from about 25 days to 120 days.
That is when Deutsche Bank canceled. A hundred days more now
the queue is, and the queue is correlated to the premium, and
the premium is an important part of the price, and unhappily, a
growing part of the price for aluminum buyers. You at least I
think have acknowledged now that that spike was a result of
cancellation. I think you gave us that much acknowledgment. Is
that correct?
Mr. Wibbelman. Yes.
Senator Levin. OK. And just for the record, that chart is
Exhibit 1k.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 1k, which appears in the Appendix on page 826.
---------------------------------------------------------------------------
Let us look at another deal now, the fourth Red Kite deal.
Metro told the LME, London Metal Exchange, that the deal was
approved by a subcommittee of Metro's board on November 1. Was
that an accurate statement by LME, that the fourth Red Kite
deal was approved by a subcommittee of your board, which is all
Goldman employees?
Mr. Wibbelman. That could be true. I do not have a
recollection exactly, but it would be----
Senator Levin. OK.
Mr. Wibbelman. I would not say it is untrue.
Senator Levin. Take a look at Exhibit 25,\2\ if you would.
This is an email, I guess, from Gabriella Vagnini. Is that
correct?
---------------------------------------------------------------------------
\2\ See Exhibit No. 25, which appears in the Appendix on page 1026.
---------------------------------------------------------------------------
Mr. Wibbelman. Yes.
Senator Levin. She works for Metro?
Mr. Wibbelman. Worked for Metro.
Senator Levin. Worked for Metro at the time?
Mr. Wibbelman. Yes.
Senator Levin. And this was to someone named Barry Feldman,
who was at Red Kite. Is that correct?
Mr. Wibbelman. Yes.
Senator Levin. And they are a hedge fund in London?
Mr. Wibbelman. Yes.
Senator Levin. And it says, ``Dear Barry, I hope this email
finds you well. Please note, Metro's issued deal number''--
there is a deal number here. There is an agreement. Do you see
the word ``agreement'' there or ``deal''? Do you see those two
words?
Mr. Wibbelman. Yes.
Senator Levin. And then they lay out the deal between you
and Red Kite. And if you look down at the bottom of that
Exhibit 25, it says $36 per metric ton will be paid within 2
weeks of cancellation. That is a freight allowance, right?
Mr. Wibbelman. Yes.
Senator Levin. And that is like a subsidy that you are
going to pay them if they do what this deal provides for. Is
that correct?
Mr. Wibbelman. Yes.
Senator Levin. OK. And Metro is going to truck this
material to an off-warrant Metro storage facility in Detroit.
Is that correct?
Mr. Wibbelman. Yes.
Senator Levin. And then at the top of the next page, it
says Metro will incur the shipping costs. Metro, you guys are
going to pay the shipping cost to the other warehouse, right?
Mr. Wibbelman. Yes.
Senator Levin. And then it says Red Kite cancels 150,000
metric ton of aluminum in Detroit immediately. That was part of
the deal?
Mr. Wibbelman. Should they take up on it, yes.
Senator Levin. I am saying it was part of the deal. I asked
you before, part of the deal was you are going to incur
shipping costs. That is if you accepted the deal, right?
Mr. Wibbelman. Yes. But what I am trying to explain is that
there are deals that are conditional. A condition to us paying
all this stuff is that they do that.
Senator Levin. Right, exactly. Red Kite cancels 150,000
metric tons of aluminum immediately.
Mr. Wibbelman. Yes, because timing is important in these
transactions.
Senator Levin. Yes. You wanted immediate cancellation of
the warrants, right?
Mr. Wibbelman. Just in order for this economics to apply.
Senator Levin. Right. That is what you wanted. That was
part of the deal that you agreed to, right?
Mr. Wibbelman. Yes.
Senator Levin. And Red Kite fulfills the requirements to
get into the queue.
Mr. Wibbelman. Yes.
Senator Levin. There is a requirement to get into the
queue.
Mr. Wibbelman. Yes, only if they want to cancel and only if
they want to ship it out.
Senator Levin. And you are going to incur shipping costs
only if they ship it out, right.
Mr. Wibbelman. That is right, yes.
Senator Levin. So it is like every other part of this deal.
Mr. Wibbelman. That is right. That is how they all work.
Senator Levin. Yes, exactly. You have obligations,
responsibilities, commitments. You are going to pay what you
call a freight allowance, a subsidy. You will pay it if they do
these things, and you are going to truck the material. If they
follow through, you got to follow through. Metro will take care
of the shipping costs. And they will cancel. Is it not part of
all one deal here?
Mr. Wibbelman. Well, it is, Senator, but they have--things
happen, like just with the----
Senator Levin. I know things--I am just saying----
Mr. Wibbelman. With the Deutsche Bank transaction----
Senator Levin. Is it part of one deal or isn't it?
Mr. Wibbelman. It is. But it is not to say that that is the
only path by which this can be fulfilled.
Senator Levin. No, they cannot----
Mr. Wibbelman. Right.
Senator Levin [continuing]. Pursue the deal.
Mr. Wibbelman. And just like with the Deutsche Bank----
Senator Levin. And you do not have to pursue the deal
either, do you?
Mr. Wibbelman. No. But with the Deutsche Bank transaction,
for example, they decided not to ship the last amount. That did
not happen.
Senator Levin. The 30,000----
Mr. Wibbelman. Right.
Senator Levin. I understand. They did not ship 30,000. They
kept it in your warehouse. I got it.
Did Red Kite, in fact, cancel 150,000 metric ton of
aluminum immediately or promptly? Did they do that?
Mr. Wibbelman. I expect they did.
Senator Levin. No, not expect. You know whether they did or
not, don't you?
Mr. Wibbelman. Senator, there is a long timeline of this
business activity. I do not have the particular recall of one
deal at one moment in time, but I do not----
Senator Levin. Just another 150,000 metric tons of aluminum
on trucks, hundreds of trucks going back and forth. You do not
have any memory of the Red Kite at all?
Mr. Wibbelman. Oh, I have a memory of it.
Senator Levin. Well, let me refresh your recollection. Take
a look at the deal, will you? Exhibit 25. You agreed it is all
one deal?
Mr. Wibbelman. What page are you on, sir?
Senator Levin. Page 2. Since you do not have any
recollection as to what the deal was here with Red Kite, top of
page 2, ``Red Kite cancels 150,000 [metric tons] of aluminum .
. . immediately.'' Does that help your recollection?
Mr. Wibbelman. Sir, can you give me a page number?
Senator Levin. Sure. Page 2 of Exhibit 25.
Mr. Wibbelman. This page? OK.
Senator Levin. Does that refresh your recollection, ``Red
Kite cancels 150,000 [metric tons] of aluminum in Detroit
immediately''?
Mr. Wibbelman. Well, yes, I know that was part of the deal
if they did it. The only question I am having is, I just do not
recall that they did it. But I assume that they did.
Senator Levin. OK. And then it says, ``Red Kite fulfills
the requirements to get into the queue.'' Does that refresh
your recollection, that there is a requirement to get into the
queue?
Mr. Wibbelman. Well, what that refers to, sir, is that----
Senator Levin. Not refers to. Does that refresh
recollection that there was a requirement that they get in the
queue?
Mr. Wibbelman. That is not what this says, sir. What this
is saying is that there are requirements to getting into the
queue besides just canceling metal. They have to give us
shipping instructions. They have to provide us with----
Senator Levin. It is all there.
Mr. Wibbelman [continuing]. The rental payment, right.
Senator Levin. With instructions. Yes, it says, ``Red Kite
fulfills the requirements to get into the queue . . .''
Mr. Wibbelman. Right.
Senator Levin [continuing]. ``. . . with shipping
instructions for maximum appointments asap.''
Mr. Wibbelman. I am trying to make the distinction----
Senator Levin. What does ``asap'' mean?
Mr. Wibbelman. As soon as possible.
Senator Levin. Get into the queue as soon as possible. I
agree, with shipping instructions for maximum appointments.
Mr. Wibbelman. The distinction I was trying to make,
Senator, is it was not a requirement that they fulfill to get
into the queue. It was that they had to fulfill requirements
that Metro generally has in order to get into the queue, right?
In other words, we had a series of steps which all of these
businesses have to fulfill in order to get into the queue at
all.
Senator Levin. Were they required to get into the queue?
Mr. Wibbelman. No, they were not required to get into the
queue. They were required to do it if they wanted to take
advantage of the economics of this deal, though.
Senator Levin. In other words, if they wanted to live up to
the deal, they had to get into the queue? Yes or no.
Mr. Wibbelman. OK. If they wanted to--they could have
canceled the deal and not done it.
Senator Levin. If they wanted to live up to the deal, they
had to get into----
Mr. Wibbelman. It was not a requirements deal, sir.
Senator Levin. I am just asking a very direct question. If
they were going to live up to this deal, did they have to get
into the queue?
Mr. Wibbelman. If they wanted the benefit of our economics
in this deal, then they had to do that, yes.
Senator Levin. I do not know how that is any different than
what I am saying. If they were going to live up to the deal and
get the benefits that they saw in the deal, they had to get
into the queue.
Mr. Wibbelman. Yes. I am just saying it is an option for
them. They had the choice. You are saying it is a requirement.
Senator Levin. I am going to keep asking it until you give
me an answer.
Mr. Wibbelman. I have given one.
Senator Levin. In order to have the economic advantages
that they saw in this deal, and if they were going to live up
to the deal, they had to get into the queue.
Mr. Wibbelman. That is right.
Senator Levin. It took an hour to get there.
Mr. Wibbelman. You asked it differently.
Senator Levin. No, not really, because you knew very well
that people enter deals with the intent to live up to them, and
they enter deals because there is an economic benefit to them.
You know that. You are a business person, a very active
business----
Mr. Wibbelman. In this case, it was an option deal, right?
They had the option to take advantage of this or they did not.
Senator Levin. To enter the deal or not, to live up to the
deal or not. It is always an option. Break the deal or not. You
are free in that sense. We are all free to break deals. Not if
you want to stay in business for very long.
Now, I think you have already answered this question. You
paid them $27 million, I believe, is that correct, as part of
this deal? We can go through the invoice.
Mr. Wibbelman. Could have been.
Senator Levin. Does that sound about right?
Mr. Wibbelman. Could have been. We think of things in
dollars per metric ton. We do not tend to look at totals too
much.
Senator Levin. Do you want to go through these with me?
Because I can take the time and do it.
Mr. Wibbelman. No, I will stipulate to your facts.
Senator Levin. OK.
Mr. Wibbelman. I am just telling you how it works.
Senator Levin. That is fine. Now, would you agree with me--
I think you already have, but I better ask it to be sure--that
for 100,000 tons of metal where warrants are canceled for that
amount, that at a load-out rate of 3,000 tons a day, that the
queue would increase from that cancellation? I think you have
already agreed to that.
Mr. Wibbelman. Or from any cancellation, yes.
Senator Levin. Including that one?
Mr. Wibbelman. Yes.
Senator Levin. Now, Goldman canceled warrants, its own
warrants, for over 300,000 metric tons of aluminum in 2012. Do
you remember that?
Mr. Wibbelman. I know Goldman has canceled warrants, yes.
Senator Levin. OK. Assume that for the purpose of
discussion that they canceled warrants for over 300,000 metric
tons of aluminum in 2012. You do not dispute that?
Mr. Wibbelman. No.
Senator Levin. So with those cancellations by Goldman, did
Goldman through that action lengthen the queue?
Mr. Wibbelman. Yes, if they did cancel them, they would
have lengthened the queue. Any cancellation lengthens the
queue.
Senator Levin. I believe in your written testimony today
that you said that, ``The length of the queue to remove metal
from Metro's Detroit warehouse is not the result of action by
either Goldman Sachs or Metro.'' Now, that statement would not
be true relative to the 300,000 warrants of their own that
Goldman canceled. Would you agree that your written statement,
at least that part of it, is not accurate?
Mr. Wibbelman. What I am trying to say there is that----
Senator Levin. No, not trying to say. Would you agree that
as a matter of fact that when Goldman canceled 300,000
warrants, that it did as a matter of fact increase the length
of the queue?
Mr. Wibbelman. Any cancellation increases----
Senator Levin. My question wasn't any cancellation. You are
answering any cancellation. My question is Goldman's
cancellation.
Mr. Wibbelman. Yes.
Senator Levin. When Goldman canceled warrants for over
300,000 metric tons of aluminum in 2012, did that cancellation
directly lead to the lengthening of the queue?
Mr. Wibbelman. They occupied spots in the queue and,
therefore, yes, Senator, it lengthened the queue.
Senator Levin. So, therefore, you would want to modify your
statement, which you are free to do, and I am not your lawyer,
but I would suggest you would be wise to do, that your written
testimony says that, ``The length of the queue to remove metal
from Metro's Detroit warehouse is not the result of action by
either Goldman Sachs or Metro.'' In that case, at least, I
believe you would want to acknowledge that when Goldman
canceled the warrants on 300,000 metric tons that it owned,
that that did have a direct effect on the queue?
Mr. Wibbelman. Yes.
Senator Levin. OK. Now, next question. At least one person
who worked for you was concerned by this type of deal which we
have been talking about. If you would take a look at Exhibit
28,\1\ this is an email sent by Mark Askew, who is co-head of
sales at Metro, a long-time warehouse executive. I believe he
worked for you, for several years. Is that true so far? Do you
know who Mark Askew is?
---------------------------------------------------------------------------
\1\ See Exhibit No. 28, which appears in the Appendix on page 1052.
---------------------------------------------------------------------------
Mr. Wibbelman. Yes. Your characterization is accurate.
Senator Levin. OK. In this email, Mr. Askew relays a rumor
that another trading company had heard about the 100,000-ton
cancellation and that ``we were blocking others.'' Do you know
what Mr. Askew meant when he said ``we were blocking others''
by that cancellation? I think that is the Deutsche Bank
cancellation.
Mr. Wibbelman. Well, sir, at the time it was a rumor by
another trader at another conference, so I did not think I paid
much attention to it at the time.
Senator Levin. All right. So you do not remember seeing it?
Mr. Wibbelman. Well, I do not say that I did not see it. I
am just saying that I do not recall having seen it at the time.
Senator Levin. Do you know what he referred to when he was
saying ``we were blocking others''?
Mr. Wibbelman. Well, I think, as you pointed out, that he
was saying that if there is a cancellation, it would occupy
spaces in the queue.
Senator Levin. Does that mean he would be blocking others
from leaving the queue? Is that what you understand he meant?
Mr. Wibbelman. No. I mean, the LME system----
Senator Levin. The answer is no, that is not what you think
he would mean by that?
Mr. Wibbelman. I was trying to explain that the LME system
is effectively a jump ball, whoever gets there first. So it is
a system where people cancel metal, and the first actor in the
system is the one that is able to get in the queue.
Senator Levin. In that same email, Exhibit 28, he uses the
term ``Q management.'' What does that mean?
Mr. Wibbelman. Well, I think that at the time we were
marketing our off-warrant services to our own customers,
effectively people already in the warehouse. And so what we
were doing was offering them options on what they would do when
the metal left the Metro system. And so part of those options
were that it could be re-warranted. And, remember, at this same
time, we had a lot of metal that was going to our other off-
warrant competitors. It was leaving Metro and going--again,
another thousand feet or whatever to Metro competitors who were
LME warehouses. And so we were just competing for that same
business.
Senator Levin. The Deutsche Bank deal was, as we have said,
the first of six of these merry-go-round deals, and the next
four were with Red Kite. As we indicated, that is the hedge
fund in London. It took place in 2012. They involved a total of
over 400,000 metric tons. And in each deal, they agreed to
cancel warrants, wait in the queue, get to the head of the
queue, transfer the metal from one set of Metro warehouses to
another, and then re-warrant the deal.
Each time, if Red Kite did anything other than send the
aluminum to another Metro warehouse, it had to pay a
substantial penalty. And in January, February, and March 2012,
Metro entered into three separate merry-go-round deals with Red
Kite. In these deals, Red Kite was paid to cancel its warrants,
join the queue, pay again to re-warrant the aluminum in other
Metro warehouses.
Mr. Wibbelman, before entering these deals, did you consult
with Mr. Gabillon and the Metro board of directors or a board
subcommittee?
Mr. Wibbelman. Yes.
Senator Levin. Would you say then it is fair to say that
each of these deals was a joint Goldman-Metro decision?
Mr. Wibbelman. Some of the deals were specifically
authorized by the subcommittee, and others of the deals were
sort of vetted and understood. But generally we were aligned on
the transactions.
Senator Levin. So is it fair to say these basically
followed a joint Goldman-Metro decision?
Mr. Wibbelman. Yes.
Senator Levin. OK. Now, the fourth and the last Metro deal
with Red Kite was on November 5. It called for Red Kite to
start canceling warrants ``immediately.'' Red Kite started
canceling warrants 2 days later, on November 7, and the deal
ultimately included over 180,000 metric tons of aluminum. The
invoice, Exhibit 22a,\1\ showed Metro owed Red Kite $26 million
in payments due under this deal.
---------------------------------------------------------------------------
\1\ See Exhibit No. 22a, which appears in the Appendix on page
1002.
---------------------------------------------------------------------------
Now, Exhibit 25,\2\ if you will take a look at it, Mr.
Wibbelman, reflects the terms of the last Red Kite deal. It is
an email from Metro to Red Kite on November 5. And if you will
go to the top of page 2, where it says, ``Red Kite will cancel
150,000 [metric tons] of aluminum . . . immediately.'' And we
have gone through that word ``immediately,'' and Red Kite will
cancel, and I think it is pretty obvious you cared if they were
going to comply, and you finally agreed that if they were going
to comply with the deal, it was important that they comply with
the whole deal, and that was that they cancel 150,000 metric
tons of aluminum immediately. And then they will fulfill the
requirements as part of this deal ``to get into the queue with
shipping instructions for maximum appointments asap''--as soon
as possible.
---------------------------------------------------------------------------
\2\ See Exhibit No. 25, which appears in the Appendix on page 1026.
---------------------------------------------------------------------------
Now, if you go back to page 1 of that deal, Metro agreed to
pay Red Kite $36 per metric ton within 2 weeks of cancellation,
cancellation of the warrants. Metro agreed to pay and
ultimately did pay, and you have, I think, agreed to that so
far. Right?
Mr. Wibbelman. Yes.
Senator Levin. And Red Kite got in line to leave. Is that
correct?
Mr. Wibbelman. Yes, to my recollection.
Senator Levin. And then when Red Kite canceled, you now, I
think, have agreed finally that that will lengthen the queue.
Mr. Wibbelman. Yes.
Senator Levin. Mr. Wibbelman, at the end of the fourth Red
Kite deal in December 2012, the queue to leave the Metro
warehouses in Detroit was about 500 days long.
Mr. Wibbelman. Yes.
Senator Levin. Did Red Kite's cancellation of warrants on
400,000 metric tons of aluminum over the course of the year
contribute to the length of the queue? I know there were lots
of cancellations, but did their cancellations contribute to the
length of the queue?
Mr. Wibbelman. Any cancellation----
Senator Levin. Including those.
Mr. Wibbelman. Including those, yes.
Senator Levin. Mr. Wibbelman, the LME told us that queues
were never terribly long nor persistent prior to Metro's
acquisition by Goldman. Was that accurate, what the LME told
us?
Mr. Wibbelman. Yes.
Senator Levin. And then shortly after Goldman acquired
Metro, the queue grew from under a month to nearly 2 years.
Metro has the power, I believe, to load out more metal and
bring down the queue. Is that correct? You could do that if you
wanted to? The 3,000 tons is a minimum, not a maximum, right?
Mr. Wibbelman. Right. We did adjust from 1,500 to 3,000, so
we presumably could adjust further upward if the LME changed
the rules, yes.
Senator Levin. Well, you could do that without LME changing
the rules.
Mr. Wibbelman. Yes. But our business model is based on the
LME rules and our conforming to them.
Senator Levin. Yes, but you could do that. You are not
violating the rules by loading out more than 3,000 tons, are
you?
Mr. Wibbelman. No, but Ford could sell cars for $2,000
also. They do not do it.
Senator Levin. I am not suggesting that--and I do not know
what Ford's pricing is. What you said may be true, it may be
not true. I am sure they subsidize some cars and make profit on
other cars. But that is a different issue. The point here is
you could load out more than 3,000 tons if you want to, right?
Mr. Wibbelman. If we adjusted the business, yes, we could.
Senator Levin. And the queue then is significantly in your
control, the length of the queue.
Mr. Wibbelman. We have----
Senator Levin. You say you have no control over the queue.
You enter contracts which require people to increase the queue.
If they live up to the contract----
Mr. Wibbelman. But there are many other participants in the
contract that--and in the queue with whom we did not have any
such contracts.
Senator Levin. I understand. I am just talking about the
contracts that you did have, probably hundreds of thousands of
tons.
Mr. Wibbelman. But there are also many other pricing
components in the whole marketplace, other warehouses around
that have as much as 4.5 million tons of metal that is
available without going through the queue.
Senator Levin. Exactly right.
Mr. Wibbelman. So we are not the only actor.
Senator Levin. Oh, I know. That is exactly the point,
without going through a queue, a queue that is very important
to Goldman. Instead we have these incredible merry-go-round
deals that I do not know--they never existed before Goldman. Do
you know of any other warehouse that goes through those kind of
deals, they move from one warehouse to another, a few hundred
feet sometimes, pay people to cancel warrants, and then they
penalize them if they do not do that, if they live up to the
deal, and then they pay them again to re-warrant at another
warehouse? Do you know of any other company that does that?
Mr. Wibbelman. Well, Senator, I do not have visibility into
what all of my competitors do, but all of the warehouses in the
LME system are quite close together, generally. Detroit is
really an exception where we have 1,600 square miles of
eligible space in the tri-county area. So a lot of these areas
are in tiny little ports.
Senator Levin. Mr. Gabillon, in addition to sitting on the
Metro board, you have a full-time job, I believe, as an
executive at Goldman Sachs. Is that correct?
Mr. Gabillon. That is correct.
Senator Levin. And right now you are head of the Global
Commodities Principal Investments Group at Goldman?
Mr. Gabillon. That is correct.
Senator Levin. And in 2010 you led the analysis to acquire
Metro. Is that correct?
Mr. Gabillon. That is correct.
Senator Levin. And at the time Goldman acquired Metro,
according to Goldman's records, Goldman owned no physical
aluminum and in the months leading up to it had less than
50,000 metric tons of aluminum. And after acquiring Metro,
Goldman's physical aluminum trading spiked to over 1.5 million
metric tons in December 2012. Is that true, sound true?
Mr. Gabillon. I do not know the specific numbers, but that
sounds the right direction.
Senator Levin. Sound about right?
Mr. Gabillon. I do not know the exact numbers, but the
direction of travel, yes.
Senator Levin. Well, would you say it sounds about right? I
know the directions are right, but the direction would be right
if they moved from 50,000 to 100,000. I am saying here the
direction, according to Metro, Goldman's physical aluminum
trading spiked to over 1.5 million metric tons from zero or at
the most 50,000 metric tons before it bought Metro, and my
question is: Does that sound about right?
Mr. Gabillon. That sounds about right, except I do not know
the numbers, but I believe the metal trading group made some
hires in 2010 and 2011 that probably resulted into this
increased business activity, yes.
Senator Levin. OK. Now, you told the Subcommittee that
about the time that Metro was acquired by Goldman that Goldman
hired two aluminum traders that you had referred to them, and
these were traders that you knew from your years in the
business with whom--I am sorry. This is to Mr. Wibbelman.
Mr. Wibbelman. That was my testimony.
Senator Levin. I misspoke. This is to Mr. Wibbelman. That
at the time Metro was acquired by Goldman--and let me repeat it
because I was addressing the wrong witness. I apologize.
Mr. Wibbelman, you told the Subcommittee that about the
time Metro was acquired by Goldman that Goldman hired two
aluminum traders that you had referred to them, traders that
you knew from your years in this business and with whom you had
good relationships. Is that true?
Mr. Wibbelman. Yes, Senator.
Senator Levin. OK. I want to talk about these information
barriers that is your policy. LME-approved warehouses acquire
the following kind of information: Warehouse metal stocks,
information about the size of those stocks, the current and
future metal shipments, LME warrant cancellations, warehouse
queue length information that is not available generally to
market participants.
Now, the LME has recognized that traders privy to this kind
of warehouse information before it becomes available to the
broader market could use that non-public information to benefit
their trading strategies, which would gain an unfair advantage
over the rest of the market and over their counterparties.
Now, as I said before, this type of information about
warehouse queues is so sensitive and valuable that the LME will
not publish it. And in a 2013 report, the LME said it does not
publish detailed information on warehouse stock in queues
because ``the danger is that those merchants and trading houses
with the most well-staffed analytical capabilities will take
advantage of the availability of data to derive a trading
advantage.''
To prevent confidential information from the warehouse from
improperly flowing to traders, the LME requires warehouses to
create information barriers. Metro has a policy implementing
that requirement, and I happen to agree with what I believe
Senator McCain was driving at before about the potential value
of that information and how that value is very readily
available to somebody who could profit from it.
Now, we have 50 Goldman personnel who have been approved to
receive confidential information about the warehouse. If you
will look at Exhibit 40,\1\ pages 2 and 3, those are two lists
of Goldman personnel who are allowed to receive confidential
Metro information. Exhibit 40. And that list includes, if you
look at it, people who trade commodities and who supervise
commodity traders. Is that right? That is for you, Mr.
Gabillon.
---------------------------------------------------------------------------
\1\ See Exhibit No. 40, which appears in the Appendix on page 1236.
---------------------------------------------------------------------------
Mr. Gabillon. This list includes some people that are
involved in trading, but not in metal trading.
Senator Levin. OK. But they are involved in trading?
Mr. Gabillon. I believe there is one board member who is
involved in natural gas trading.
Senator Levin. And that is a commodity?
Mr. Gabillon. Yes.
Senator Levin. He is a commodity trader?
Mr. Gabillon. But he is not a metal trader.
Senator Levin. Right. Not metal, but he is a commodity
trader. Now, I do not believe that we should have to rely on
Goldman employees not sharing this information with other
Goldman employees, information which is important to the
economic interest of the company that they work for. I just do
not think we can rely on a private policy to make sure that
this does not happen. The stakes here are too great, and it
ought to be--as far as I am concerned, it should be illegal to
share this kind of information. It is also unethical, that is
clear, but when you have a huge economic interest that is on
the other side of ethical interests, too often the ethical
interests give way.
Now, Mr. Wibbelman, in June 2013, Mr. Whelan--that is Mark
Whelan, I believe--quit. And take a look at Exhibit 30,\1\
which is Mr. Whelan's resignation email. And here is what he
writes. He says: ``I have some questions and concerns regarding
the Chinese Wall Policy that is in place which regulates the
interaction between Metro International, its customers, and J
Aron.'' Now, J. Aron--and I want to finish the email, and then
I will tell you who J. Aron is. But he says: ``I have some
questions and concerns regarding the . . . Policy that is in
place which regulates the interaction between Metro . . ., its
customers, and J Aron.'' And then he goes on to say, ``This
morning's confrontation was extremely questionable.''
---------------------------------------------------------------------------
\1\ See Exhibit No. 30, which appears in the Appendix on page 1060.
---------------------------------------------------------------------------
Now, J. Aron is Goldman's leading commodities subsidiary
that executes its trades. Is that correct, Mr. Wibbelman or Mr.
Gabillon?
Mr. Wibbelman. Yes.
Mr. Gabillon. Yes.
Senator Levin. OK. And what was the confrontation all
about, Mr. Wibbelman?
Mr. Wibbelman. So the trader in the middle of our night
approached Mr. Gabillon with a complaint effectively about
Metro in a transaction. But it was referred immediately to
Goldman Compliance, who investigated the issue, and the issue
was about Goldman's, J. Aron's trading information. In other
words, the Chinese Wall Policy is meant to protect information
from Metro from flowing up to Goldman. This was about J. Aron's
own trading information, and so it was not really confidential
information; it was really just flowing in the other direction
than the policy is intended to block. In other words, Goldman
could tell people about their own trading positions if they
chose to.
Senator Levin. And there is nothing in the Chinese Wall
Policy, even if it is implemented properly, that stops Goldman
from sending direction and information to you?
Mr. Wibbelman. Well, this is about their own business in
which we were usually conversing.
Senator Levin. They own you, right?
Mr. Wibbelman. Yes. But we are owned by the private equity
side of Goldman, not the trading arm.
Senator Levin. I understand. Goldman owns you.
Mr. Gabillon. But I think----
Senator Levin. No, wait. Goldman owns you. Is that right?
Mr. Wibbelman. We are owned by a subsidiary of Goldman,
yes.
Senator Levin. And there is nothing in even the Chinese
Wall Policy, if it were implemented, if you could rely on it,
which affects information flowing from Goldman to you?
Mr. Wibbelman. That is not what the Chinese Wall Policy is
intended to do. That is right.
Senator Levin. And is there anything that prevents
information coming from Goldman to you?
Mr. Wibbelman. They have their own confidentiality policies
about their own information, but that is not what this is
about.
Senator Levin. But the Chinese Wall Policy does not stop
that flow?
Mr. Wibbelman. It does not.
Senator Levin. OK.
Mr. Wibbelman. It is not intended to.
Senator Levin. Is there anything that stops Goldman from
giving you direction, saying we want you to do X, Y, and Z? Is
there anything that stops them from doing that?
Mr. Wibbelman. So the way that it was set up, Senator, is
that Metro operates in a silo, and J. Aron operates in a silo,
and occasionally we have--we do sort of commercial business
like with any other customer. And so we really do not listen
much to J. Aron about anything other than their own business.
Senator Levin. But there is nothing that stops that
information from flowing?
Mr. Wibbelman. There is no----
Senator Levin. There is no policy that stops the
information from flowing to you?
Mr. Wibbelman. I do not know about J. Aron's internal
policies.
Senator Levin. You do not know about a policy?
Mr. Wibbelman. Not about their policy----
Senator Levin. Or Goldman's policy.
Mr. Wibbelman. So I know about what Metro can----
Senator Levin. No. I know what Metro can convey in that
direction. I am talking about the other direction.
Mr. Wibbelman. Correct. I do not have any visibility into
that.
Senator Levin. All right. So the Chinese Wall Policy, even
if it is not a tissue paper, is a one-way information barrier.
Mr. Wibbelman. It is, but we are the ones with what is
supposed to be the confidential information, right? So they
have information which may or may not be confidential, and that
is for them to determine.
Senator Levin. Did Goldman traders routinely talk to Metro
employees about their metal and about seeking discounted or
free rent? Is that a routine matter?
Mr. Wibbelman. It is at least an occasional matter, and at
various times it has been--we talk to them about their own
metal or about just their ability to acquire metal, yes.
Senator Levin. And about discounted or free rent? Have you
talked to Goldman traders about that?
Mr. Wibbelman. Have, yes.
Senator Levin. Goldman approved the freight incentives? The
freight incentives, the subsidies, that was approved, as you
said already, by Goldman?
Mr. Wibbelman. Yes, we had transactions in which there were
freight incentives involved, yes.
Senator Levin. All right. And it approved each and every
one of the six merry-go-round deals and decided not to take
steps to shorten the queue, when it could have? Goldman can
shorten that queue anytime it wants. You have already
acknowledged that. They can load out more. They can tell you to
load out more. And you have the power to load out more and to
reduce the queue. At the same time all of this is happening,
Goldman is trading in aluminum-related financial instruments
whose prices are impacted by those decisions. If that is not a
recipe for manipulation, then I have not seen recipes for
manipulation. It is just vivid. I mean, they are engaged in
financial transactions involving aluminum. They can change the
queue and the length of the queue which affects the premium,
and that premium, even by Goldman's argument, is an important
part, it is a growing important part, now 20 percent, of the
all-in price for aluminum. I mean, that is just a recipe,
again, for the kind of manipulation which--we have to prevent
that, I believe.
Now, company policy I know says on a slightly different
issue, information about your transactions, Mr. Wibbelman, are
not supposed to go to Goldman. I understand that. But a whole
bunch of their employees get that information who are engaged
in trading. Maybe not trading metals. Engaged in trading. And
just to rely on a company policy in terms of information
sharing, which is very beneficial and useful to a trader, is
not good enough for me.
Do you think we ought to make it illegal for a company to
be using that kind of non-public information?
Mr. Wibbelman. Well, Senator, to answer that, I would say
that one thing you need to do if you do that is to take a look
at the whole complex of actors in the international system and
not just banks, because the banks act somewhat commercially,
and economically they do. But there are other actors that act
with sovereign interests and as unregulated traders. And they
also own warehousing companies, and they also have large
inventories, and they have trading positions, and they act
vertically.
So we act separately with intentionally separate economic
interests, and they act vertically with a lot of cooperation.
Senator Levin. Well, we cannot protect our economy from
other--we can, but not in this particular discussion. There are
other ways of protecting our economy from wrongdoing from other
countries. But we have to protect our economy from banks----
Mr. Wibbelman. Well, Senator, what I would say is that----
Senator Levin. Excuse me. We have to protect our economy
from banks that engage in huge involvement in commodities which
can open up some real possibilities about their own health, and
that means the economy's health. But I am particularly
interested in this potential here and this reality of
manipulation, because there is just no doubt that queues were
affected, influenced, and manipulated in contracts which this
warehouse company entered into, a warehouse company owned by
Goldman. There is no doubt that these six deals that we talked
about, which you obviously welcomed as a warehouse company and
Goldman approved, had a direct influence, as we can see from
the chart, on the length of the queue, given the correlation
between the length of that queue and the premium price of
aluminum and the importance of that premium price, by
everybody's measure--even Goldman acknowledges it affects the
all-in--not the total all-in price, but it affects the size of
the LME price, because Goldman argues that if the premium price
goes up, the LME price then goes down. That is Goldman's
argument. So, therefore, the length of the queue even by
Goldman's argument has an impact on how the pieces of that
price, that all-in price, come together. And Goldman is trading
on those pieces.
Mr. Wibbelman. Senator, I would say one thing, and that is
that----
Senator Levin. You do not have to--you can respond. I will
give you a minute. But I am talking about Goldman here.
Mr. Gabillon. Senator, can I----
Senator Levin. We will give you a chance to respond.
Mr. Gabillon. Thank you.
Mr. Wibbelman. I would just like to say one thing, which is
that there are, as I mentioned, many international actors in
the system and you have to give us credit--Metro credit for
having brought in 4.6 million metric tons of aluminum into the
system, and that created, again, a buffer stock for these
consumers without which they would have only a single source of
supply, the actual producers of metal. Someday those producers
might only be in Russia, right?
And so we brought a strategic stockpile into the United
States. I mean, China has an actual entity which actually
collects strategic stockpile----
Senator Levin. The issue is not whether you bring a
strategic stockpile into the United States. The question is the
rules of the game relative to that strategic stockpile, and we
cannot allow that stockpile to be used to manipulate a premium
on aluminum. We cannot allow that because that premium, in the
eyes of most, affects the price of aluminum, and even in the
eyes of Goldman affects the LME price, because Goldman argues
the LME price goes down as the premium goes up, and that means
that the overall price, the all-in price is not affected by
these kinds of maneuvers.
OK. If Goldman is right, then they still have this huge
potential to use the queue length in order to affect the
premium, and they deal in these premiums, and they deal in the
LME price in their financial transaction side. That is what we
cannot allow. I do not have any problem in your business
gaining more aluminum. It is the way in which Goldman is using
this product, this particular facility.
Mr. Gabillon. So, Senator, if I may, sir?
Senator Levin. Yes.
Mr. Gabillon. So we are absolutely aware of the risk that
you mentioned, and this is why we have all those information
barriers. And as I mentioned earlier, we do not rely only on
the Goldman Sachs surveillance that takes place. PwC has
audited the information barriers twice in the last--it is now a
requirement under the LME rule. It has happened twice already.
It is going to happen every year going forward. And all those
audits have been successfully passed.
Our information barrier policy goes above and beyond the
LME. I am responsible on the board. I see all the information.
There is no confidential information that goes to those 50
people.
Senator Levin. You do not mean that there is no
confidential information that goes to those 50 people. Those 50
people get confidential information.
Mr. Gabillon. No. I think most of the 50 people here are in
our financial control and compliance and legal to actually help
the risk--to control the risk on this company.
Senator Levin. Are they all allowed to get that
confidential----
Mr. Gabillon. No, they are not. Compliance conveyed--even
the information I receive, Senator, is not actionable as a
trader. It is delayed, it is sanitized, it is aggregated. It is
not per location. It is all controlled. We have a system in
place on that.
Senator Levin. Different people get that information in
different real time. Is that correct?
Mr. Gabillon. Not real time----
Senator Levin. No. Some of those 50 people get it in real
time.
Mr. Gabillon. No, nobody ever gets----
Senator Levin. Are they allowed to get it in real time?
Mr. Gabillon. No, they are not.
Senator Levin. OK. We are going to take that up later.
Mr. Gabillon. We are up here to discuss it. The other point
I would make----
Senator Levin. OK. I want to go back to one thing that Mr.
Wibbelman said, by the way, when you say you are a reasonable
source of supply, with a 600-day wait----
Mr. Wibbelman. But people are choosing to cancel warrants
during that time because they perceive the relative value,
right? Here is the issue. The other warehouses in the world,
the metal is not available without the consent of the seller,
right?
Senator Levin. Of course.
Mr. Wibbelman. The difference was Metro's warehouses really
from day one, the metal has been freely available, and that is
what has been giving people the chance to make a value decision
on whether it has been worthwhile or not to cancel.
Senator Levin. Is it freely available with a 600-day wait?
Is that aluminum available?
Mr. Wibbelman. Those are the warrants at that time that
were in circulation. If you would trade on the LME----
Senator Levin. I am just asking, is that aluminum freely
available? That is all I am asking.
Mr. Wibbelman. It is available to own, and they make a
decision----
Senator Levin. Not own. To get.
Mr. Wibbelman. It was available to get, but----
Senator Levin. Not was. Is.
Mr. Wibbelman. Well, the warrants were available to get.
Senator Levin. Not warrants. Is the aluminum available?
Mr. Wibbelman. But they generally know that, and then they
do not----
Senator Levin. I am asking, is that aluminum, which is
subject to a 600-day wait, available? That is all I am asking.
And the answer is no, that aluminum is not.
Mr. Wibbelman. It is relatively more available than the
metal in all of the other warehouses where the seller does not
want to sell.
Senator Levin. Well, it is more available--if you cannot
buy it anywhere else, then it is more available if there is no
other aluminum you can buy. I am just asking you----
Mr. Wibbelman. What I am saying is there are a lot of
actors in the system, and they have big stockpiles of metal,
and they are not selling.
Mr. Gabillon. I think Mr. Wibbelman refers to all the other
warehouses in the LME system that are not flowing at all, not
even with a queue with no flows.
Senator Levin. Fine. If you cannot buy aluminum anywhere
else, that is fine. I am just asking whether aluminum with a
600-day wait is freely available. That is all I am asking. And
the answer is no, that aluminum is not. It is a 2-year wait.
That is the answer. It is the obvious answer. That is OK. I am
not going to get even obvious answers. I understand that.
Here is what we have, and I am going to wind up here.
Goldman acquires a business, and everything changes, and that
is Metro's business we are talking about. Metro had not ever
paid enormous freight incentives before. They had paid some,
but they went up in a huge way, the amount of freight
incentives, subsidies. Metro had never entered a merry-go-round
deal before. These were unique. It had never had enormous
queues before. A couple of Metro salespeople who had been in
the company for a decade quit after raising concerns about
these practices.
Now, here is where Goldman sits in all this. Goldman is in
the catbird seat. It controlled or had a say over every
variable about Metro and through Metro. It impacted aluminum
prices, current and future. It impacted the premium. It
impacted the LME price by Goldman's argument. Other people will
argue--and we will hear from them--that it directly also had an
impact on the all-in price, but even by Goldman's argument,
again, it impacted the LME price. And I think it is clear that
I am not a statistician--every statistician says there is a
huge correlation between the length of that queue and the
premium.
Goldman employees had a say over how much incentives Metro
would pay to attract aluminum, and they approved previously
unprecedented levels of incentives. They had a say and agreed
to the merry-go-round deals. They approved them to keep
aluminum in the warehouses, block the exits, and that resulted
in longer queues and higher premiums.
Goldman itself--and this one is now undisputed, by the way,
undisputed, even with these witnesses. Goldman canceled
warrants and lengthened the queue. Goldman could have shortened
the queue that it helped create by directing Metro to load out
more metal, but it did not. All the while Goldman is engaging
in its own trading of financial instruments related to
aluminum, including trading in futures contracts.
We thank you. We thank you for your cooperation with the
Subcommittee, by the way. Both of your companies have been
cooperative with the Subcommittee in terms of providing
information to us, and we appreciate that, and we will now move
to our second panel.
Mr. Gabillon. Thank you.
Senator Levin. We will now call our second panel of
witnesses for today's hearing: Jorge Vazquez, Founder and
Managing Director, Harbor Aluminum Intelligence Unit LLC,
Austin, Texas; and Nick Madden, Senior Vice President and Chief
Supply Chain Officer, Novelis Inc., Atlanta, Georgia. We very
much appreciate both of you being with us today. We look
forward to your testimony.
According to our rules, everyone who testifies in front of
us is sworn in, so we would ask you both to please stand and
raise your right hand. Do you swear that the testimony you will
provide to this Subcommittee will be the truth, the whole
truth, and nothing but the truth, so help you, God?
Mr. Vazquez. I do.
Mr. Madden. I do.
Senator Levin. Your written testimony will be made part of
the record in its entirety. The red light will come on in front
of you about 5 minutes from now. We would ask that you try to
limit your oral testimony to 5 minutes, if you could, and
before that red light comes on, there would be a light change
from green to yellow about a minute before the end of the 5
minutes.
So, Mr. Vazquez, why don't you go first, and then Mr.
Madden.
TESTIMONY OF JORGE VAZQUEZ,\1\ FOUNDER AND MANAGING DIRECTOR,
HARBOR ALUMINUM INTELLIGENCE LLC, AUSTIN, TEXAS
Mr. Vazquez. Thank you. Good afternoon, Chairman Levin,
Senator McCain, and other Members of the Subcommittee. Thank
you for your invitation to provide my views on areas related to
aluminum warehousing and market premiums.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Vazquez appears in the Appendix
on page 148.
---------------------------------------------------------------------------
I would like to summarize my opinions in the following four
points:
Since 2010, the North American aluminum consumer has lacked
an efficient market of last resort to go to. Harbor estimates
that North America will end 2014 with an aluminum production
deficit of 2.4 million tons of aluminum. Although 1 million
tons of metal is stored in LME Detroit, an aluminum consumer
who would like to source metal from these warehouses faces a
load-out waiting time of 665 days. As a reference, prior to
2010, waiting times averaged less than 2 weeks. This long
waiting time of 665 days and the capital requirements to source
the metal out from these warehouses makes it prohibited for the
consumer to effectively use the LME as a backup. This is taking
place as North America is experiencing a growing aluminum
deficit.
A critical mass of metal was allowed to be formed in
Detroit Metro. This has created unprecedented effects. By
January 2009, as a result of the aluminum market surplus
generated by the economic crisis, LME Detroit had accumulated
342,000 tons of aluminum in its warehouses. Baltimore had also
the same volume, but diluted among survival warehousing
companies.
This concentration of metal in one warehousing company gave
Metro the ability to offer more warehouse incentives than any
other company, the ability to outbid the aluminum consumer, and
the start of a self-feeding cycle that allowed the company to
permanently increase the metal stored in its warehouses in
spite of a growing market deficit.
One month after Detroit's critical mass and dominance
position was established, Goldman Sachs acquired Metro. When
Goldman acquired Metro, LME Detroit had an equivalent of less
than 44 days of a load-out queue. Five months later, LME
Detroit started to experience ongoing massive and unprecedented
cancellations which lengthened the queue to an unprecedented
waiting time of 702 days by May of this year.
In my view, the lengthening of Detroit's queue to
unprecedented waiting times has impacted market premiums, the
all-in price of aluminum, and the aluminum consumer. While the
logistical cost to source metal from Russia and the Middle
East, North America's main aluminum suppliers, has remained
stable since 2009, the cost of sourcing metal from LME Detroit
has increased more than tenfold.
As the cost of sourcing metal from LME Detroit increased,
so did the reference point for consumers, traders, and
producers to negotiate with. As a result, the Midwest Premium
is today ten times higher than what it was in 2009.
Harbor estimates that the lengthening queue in Detroit has
cost the North American aluminum manufacturer at least $3.5
billion since 2011. There are warehouse practices that may pose
a conflict of interest.
Paying warehouse incentives to attract metal is a standard
and historical practice. What is certainly not a common
practice, however, is when LME warehouse operators offer and
pay an incentive to warehouse customers to cancel metal and
wait in the queue. That practice poses serious conflicts of
interest because incentivizing the lengthening of load-out
queues can materially impact market premiums.
Thank you.
Senator Levin. Thank you. And, by the way, if you would
just spend a minute telling us what Harbor Aluminum does, what
is your role and goal?
Mr. Vazquez. I am the Founder and Managing Director of
Harbor Aluminum, which is an independent, privately owned
consulting firm that specializes in analyzing the aluminum
industry and its various markets, and in providing market
intelligence to our customers. We serve over 300 clients along
the entire supply chain in every region of the world.
Senator Levin. Thank you.
Mr. Madden, we will hear from you next..
TESTIMONY OF NICK MADDEN,\1\ SENIOR VICE PRESIDENT AND CHIEF
SUPPLY CHAIN OFFICER, NOVELIS INC., ATLANTA, GEORGIA
Mr. Madden. Chairman Levin, and Ranking Member McCain, I
very much appreciate this opportunity to speak to you today and
to answer your questions.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Maddin appears in the Appendix on
page 164.
---------------------------------------------------------------------------
My name is Nick Madden, and I am the Senior Vice President
and Chief Supply Chain Officer of Novelis. Our company is
headquartered in Atlanta. We are the world's leader in aluminum
rolling and recycling, and we are also the largest buyer of
aluminum in the world, with a buy of about 3 million tons. I am
responsible for that, and I have been in the industry for 36
years.
For the last 3\1/2\ years, Novelis has been very public in
our advocacy to restore normal functioning to the market,
specifically around the London Metal Exchange warehouse
practices. The warehouse issue is having a profoundly negative
impact on our customers' businesses, and our customers include
some of the most famous brands in the world, with beverage
companies like Coca-Cola and Anheuser-Busch, automakers like
Ford, General Motors, Chrysler, and BMW, and consumer
electronics manufacturers like Samsung and LG.
As an aluminum roller, we seek to keep ourselves neutral to
movements in the London Metal Exchange price. But last year,
our Asian operations took a $40 million hit as a result of this
issue.
The consequences are equally serious for consumers in the
United States. Supply and demand in the aluminum market has
been completely upended in recent years, and since 2010, when
the banks and trading companies bought into the warehouses,
aluminum premiums have tripled. Now premiums are at the highest
levels ever in history, and last year this was coincident with
inventories being at the highest level ever in history. It is
an unprecedented situation in the history of the global
aluminum market.
So for companies like us--we are an aluminum converter--we
have three key issues:
First, inflated premiums. We estimate that consumers around
the world--and this is a conservative estimate--are paying at
least $6 billion a year more than they should be.
The second is supply chain risk. If I buy metal from
Detroit today, I have to wait until September 2016 to pick it
up.
And then, finally, price exposure. With the premium now at
20 percent not 5 percent of the all-in price, we can no longer
manage price risk effectively.
But the most serious issue is the inflated cost. Whether it
is for a truck or a smartphone or a beverage can, the American
consumer ultimately will pay the price, and we liken this to a
hidden tax on the price of today's aluminum products.
All this is happening at a time when the aluminum industry
is in actually a very healthy situation. We see strong growth
around the world, but the most exciting growth is in the
automotive sector, specifically in North America. And my
company has invested $400 million to meet that growth and added
375 highly skilled jobs in our plant in Oswego, New York.
So you can imagine our frustration when we see threats to
the supply chain and to the competitiveness of aluminum as a
result of what appears to us to be an engineered squeeze in our
market. While the LME has finally begun to act, progress is
slow, and the situation on the ground gets worse every day.
So what is the fix? Because I know everything cannot be
fixed today, but if I had a magic wand and could make things
improve, there are three things that we would like to see
happen which we think would benefit our company, our industry,
and the American consumer.
The first of those is banks and trading companies should
not be allowed to own warehouses.
Second, we need to clarify the scope of the CFTC to ensure
that there is no vagueness over its coverage of the warehousing
attachment to the LME market.
And, third, warehouses should not be allowed to charge rent
once a warrant has been canceled, and we believe if you
implement that, the incentive for this whole problem would
disappear overnight.
So, again, as the world's largest buyer of aluminum and on
behalf of Novelis, I thank you for this opportunity and would
be very happy to answer questions.
Senator Levin. Well, thank you both for coming and for your
testimony. It is very powerful testimony.
Mr. Madden, I think you perhaps have already answered this,
but I am going to ask a question in a way that perhaps you
could expand a bit on what your testimony is. I think as a
result of our investigation and Report probably you have
learned for the first time about the participants and
circumstances behind some of the warrant cancellations at the
Metro warehouses in Detroit since 2010 that contributed to the
hugely longer queue, including some of those merry-go-round
trades, the large cancellations by Goldman and JPMorgan as well
as Metro's premium-sharing arrangements. And on a practical
level, you have given us some of the impact already on your
customers and on you.
Were you surprised when you heard about these practices?
Mr. Madden. I was kind of surprised, but not entirely. I
would say it equated with our worst fears of what could be
happening, because this behavior of massive cancellations is
unprecedented. And you asked that question earlier. I know of
no occurrence in history at the aluminum--since the LME started
trading in 1978, which is when I started working in the
industry, I know of no precedent. So, yes, this surprised--the
actual activity surprised us. But am I completely--something
strange was going on, but it was very opaque to us because all
these transactions happened in a non-reported way.
Senator Levin. Well, were you horrified by what you saw?
Mr. Madden. Well, it makes us look naive; being the biggest
buyer in the world, we did not know this was going on. But we
do believe that the activity was definitely prolonging the
queue, and we do believe absolutely that there is a direct
linkage between the premium and the queue, and, therefore, we
think this issue--and this is what we have been kind of talking
publicly about for the last 3\1/2\ years, that the issue around
Detroit--and now it has moved to Vlissingen in Europe as well--
is pushing up premiums to levels never seen in history.
Senator Levin. Now, Mr. Vazquez, if you can tell us in your
judgment the relationship--two relationships: First, between
the length of the queue in a warehouse and the premium, what is
the relationship between the premium and the so-called all-in
price? Those two things, first between the queue and the
premium, and then between the length of the queue and the
overall all-in price. Sometimes I call it ``market price.'' I
guess it is somewhat different from market price, but for most
intents and purposes, market price.
Mr. Vazquez. Our work, our mathematical work, our empirical
tests are really clear to indicate that queue length determines
or impacts greatly the premium. And not only there is a strong
correlation between the length of the queue and the premium,
but there is causation, meaning mathematically,
econometrically, the queue causes the premium. And the reason
for that is that----
Senator Levin. When you say ``causes''----
Mr. Vazquez. Yes, causes.
Senator Levin. It is a part of the premium.
Mr. Vazquez. Yes.
Senator Levin. Or has a direct relationship to the length?
Mr. Vazquez. Yes. It is both, yes. Not only there is a
correlation, because sometimes there are two variables that may
be correlated, but they are not really--one does not cause the
other. But in the case of the queue and in the case of the
premium, not only there is correlation but there is causation,
meaning----
Senator Levin. Why is that?
Mr. Vazquez. Because the premium is the full logistical
cost of sourcing metal. When a consumer or a buyer looks to buy
metal, they have three options: They can go to the trader, they
can go to the smelter, or they can go to the LME. How much it
costs to move the metal all the way from the smelter to the
consumer plant is an important factor behind the premium.
The full logistical cost of moving metal from the trader's
warehouse to the consumer's warehouse also impacts the premium.
And the full cost of buying a warrant, canceling the warrant,
paying storage fees, paying the FOT charge, which means how
much you pay to load out the metal and put it in a truck, and
then from there to your own warehouse, to the consumer
warehouse, is another important logistical cost.
So the combination of these logistical costs determine the
premium. So the backup that the consumer has is the LME. That
is the market of last resort. If the trader or the producer is
charging too much in terms of premium, the consumer can go to
the LME and source the metal himself, paying storage. But if
the backup has a prohibitive cost, if the queue is so long that
you have to pay, like today, 665 days of rent, then the trader
and the producer know that your option is not really an option,
and it is too expensive. So the point of reference, the point
of negotiation goes up.
In the past, when queues were less than 2 weeks or were
less than 30 days, the consumer, whenever they were negotiating
with the trader and the producer, said, ``You want to charge me
so much for premium? Forget it. I can go to the warehouse and
source it myself. And the equivalent cost is such that it is
cheaper than what you are charging me.''
So the consumer has always used the LME as a leverage, as a
point of reference when negotiating with the producer and the
trader. But if you take that away, then the trader and the
producer can charge at least what is the cost for the consumer
to load out the metal from the LME warehouse into his plant. So
that is the backup that the consumer has.
Senator Levin. Goldman is arguing that when the premium
goes up, the LME price goes down because the all-in price will
always be about the same. That is their argument. If you buy
it----
Mr. Vazquez. Senator, evidence tells us the opposite. Why
the opposite? There is no clear, robust empirical data that
tells us that the LME moves inversely to the premium. They move
in tandem. There is no--the LME price impacts the all-in price.
The premium impacts the all-in price. There is no objective
data, analysis, that tells us that the LME falls when the
premium goes up. Quite the opposite.
Senator Levin. Before I turn it over to Senator McCain, do
you agree with that, Mr. Madden?
Mr. Madden. I do.
Senator Levin. That the argument of Goldman that when the
premium goes up, the LME price goes down because the all-in
price always stays about the same--you just do not buy that?
Mr. Madden. No, I do not. I can think of a parallel in
history, so the last time we saw stocks at the levels we have
today was in the early 1990's after the collapse of the Soviet
Union, and lots of metal flooded out of Russia into the United
States, and so on. At that point the LME price was down at
$1,070 a ton at the low point. And the Midwest Premium was
between 0 and half a cent. So when the demand is very weak or
there is so much oversupply, you would expect both the premium
and the underlying price to be weak. What we have today is, as
I said, the highest stocks in history, and, therefore, one
would expect the fundamentals are not great. But we have the
highest premiums ever in history. There is no parallel, there
is no time ever in the history of this market that we have seen
a Midwest Premium of 23 cents, and historically it ranged from
0 to 7 cents a pound. So this is a whole new phenomenon that we
are trying to get to grips with.
Senator Levin. Thank you. Senator McCain.
Senator McCain. So as a followup, it probably would not be
possible, could it, unless one company or corporation had 85--
as Goldman Sachs does, controlled 85 percent of the LME
aluminum in the United States. I do not see how you can draw
any other conclusion. Is that yours?
Mr. Vazquez. Yes, it is. See, it is really difficult to
move the LME price, to manipulate the LME. But the volumes that
move the premium, 100,000 tons under current conditions can
move the premium. It is much easier to move the premium than to
move the LME price. And if you have 85 percent of the volume
that is in North America within LME warehouses, well, that is
an interesting data point to observe.
Senator McCain. Something that really is startling about
this to me that has really made an impression during the course
of this hearing: Why would anyone that is interested in service
to the customer and a product at the lowest price, why would
that organization, in this case Metro, pay its clients to move
metal from one Metro warehouse into another warehouse, which
sometimes is a mile away? What could possibly logically, if you
are trying to do any--impose any efficiencies, why would you
want to pay people so that you can move it from one warehouse
to another? Please, maybe for the record, you can explain that
practice, which I think is called ``merry-go-round deals.''
Maybe you, Mr. Madden?
Mr. Madden. Yes, I mean, I read about this first in David
Kocieniewski's article in the New York Times, and I honestly
did not really understand what he was saying at that point. And
now I see it in black and white, I understand. And I can only
assume that if it was my business, I want to keep hold of that
metal in any way I can because it is generating rent. But I
also have to satisfy the LME obligation.
Now, this is my theory because I do not actually know
exactly what the driver is, but my theory would be if I make
metal move out at the LME rate but it does not really move out,
it just goes somewhere else, and then ultimately gets re-
warranted, I have retained control of that pool of metal and,
therefore, I can continue to count on rent provided there is a
queue. And so if I can then----
Senator McCain. So you are going to make--even though you
are paying your client to move their product from one warehouse
to another, you are still going to make more money that would
be more than the amount you are paying your client. And so
ultimately all that cost is borne by the consumer sooner or
later.
Do you want to add to that, Mr. Vazquez?
Mr. Vazquez. Yes, the reason why there is an incentive for
a warehousing company to make sure that the metal comes back to
the LME warehouse that they operate is because they can make
more money off of it. And, of course, they want to keep the
critical mass of metal because having the critical mass of
metal keeps this business model going on.
Senator McCain. That is why you want 85 percent of the
supply. If that was not the case, then obviously this practice
would be non-productive.
Now, again for the record--and let us assume that there are
some complexities here--there is now a 670-day waiting time
from the time that a consumer orders the product, the aluminum,
to the time that it would get to that consumer. Is that
correct?
Mr. Vazquez. Correct.
Senator McCain. One more time, explain how that has
ballooned from--what was it, 30 days? I think something like
that. Explain to me how that happens for the record, again. I
apologize if it is repetitious, but it is staggering to think
that 600 days would elapse between the time you order something
that is in a warehouse in the United States of America and it
gets to the consumer or the user.
Mr. Vazquez. Well, the size of the cancellations are
completely unprecedented. And, the size of the exit door is too
small compared to the size of the volume of the metal in the
warehouse. That is the second reason. And the third reason, in
my opinion, is that the system was not designed to make sure
that no critical mass of metal could be concentrated in one
warehousing company without having the proper exit door if the
time for need for that metal came. So that is my reflection.
That is my opinion. The exit door was not appropriate, the
system was not appropriate to make sure this did not happen.
Senator McCain. And, obviously, the LME does not seem to
feel it necessary to take some action, apparently.
Mr. Madden, do you want to add anything to that?
Mr. Madden. Yes, I would be happy to. So we have talked to
the LME a lot. I am a member of the LME Aluminum Committee, and
the Physical Market Committee which was introduced very
recently when they changed the rules, and I see, too, a shift
change in the LME leadership. So the business was acquired at
the end of 2013--2012, excuse me, by the Hong Kong Exchange.
Prior to that, it was owned by--and I think it was mentioned
earlier. It was owned by the members. So, for instance, some of
the investment banks that are talking here today and tomorrow
were actually significant shareholders of the LME with
shareholdings of around 10 percent each.
So the company was kind of regulating, managing itself, so
a major change in a policy--like we were pressing for them to
move the load-out rate to 9,000 or 10,000 tons a day for a
warehouse like Detroit. They were very reluctant to move it. In
the end, they conducted an inquiry by European Economics. They
got recommendations, and they chose to take what I would say is
one of the softer options. We then became--complained about it
in the press and so on. So they were extremely slow to react.
Since the changeover, I see a complete change of mind-set
for them because the new investors have paid a lot of money for
that exchange, and its reputation is being dragged through the
mud. It is losing credibility all the time because of this loss
of convergence in the market in the physical delivery points
like Vlissingen and Detroit.
So I see a kind of energy now developing in the LME to
change rules, but when they do try and make a move, they get
sued. So they tried to introduce a new load-out rate which
would more equalize the inputs and outputs, which today would
not make any difference, in all honesty, but in the future we
would be less likely to see this recur. But Rusal, an aluminum
company--because what a lot of people do not realize is that
one of the major beneficiaries of this are the aluminum
producers themselves as well as the banks and the trading
companies. Rusal sued them because they tried to block the
change. And I think the LME's mind-set now is it is really
difficult for us to introduce new rules because whatever we do,
there is going to be a stakeholder with some vested interest
who is going to take action against us.
Senator McCain. So what is your recommendation? I think
this problem has been pretty graphically demonstrated, Mr.
Chairman. What is your fix? We will start with you, Mr.
Vazquez.
Mr. Vazquez. I think the exchange needs help, needs a
higher authority to help the exchange make sure----
Senator McCain. What about the SEC getting involved?
Mr. Vazquez. I just think that we need a higher authority.
It could be the solution, because I do see a change in attitude
from the exchange, a clear change of attitude, a positive
change of attitude. But it seems to me that they lack the
authority to move as fast and as decisively and effectively as
I think they should.
Senator McCain. Well, is one of the answers that no one
entity should control 85 percent of the supply? For the record.
Mr. Vazquez. Yes.
Senator McCain. Mr. Madden.
Mr. Madden. Yes, I agree with Jorge. I think the LME needs
help. It needs regulatory help to help it implement what I know
it believes to be healthy changes in the market and probably
the most--the one I mentioned which I think is the most helpful
is to ban the charging of rents once a warrant is canceled, or
at least within some reasonable period, 30 days.
Senator McCain. Don't you think there is a regulation that
if someone is moving a commodity from one warehouse to another
and paying the owner of that commodity in order to do so,
doesn't this border on manipulation of the market?
Mr. Madden. It is difficult to comment because it is kind
of new information. I think it is a day old. But it is an
extremely imaginative approach to maintaining a profitable
warehouse company, is to not allow stuff to leave. I think they
are able to take advantage of the LME rules. They are able to
use the minimum rate as a maximum.
Senator McCain. And it eventually drives the price of
aluminum up.
Mr. Madden. Absolutely.
Senator McCain. Which then drives up the cost of anything
in an aluminum container.
Mr. Madden. Absolutely.
Senator McCain. So we are really talking about who really
pays the price here is the consumer.
Mr. Madden. Ultimately.
Senator McCain. Well, I want to thank you for your
testimony. I think it has been extremely helpful, Mr. Chairman,
and it made this situation, I think, a lot more clear for the
record. And I thank the witnesses.
Thank you, Mr. Chairman.
Senator Levin. Thank you.
Now, in addition to the warehouse company, with these
merry-go-rounds, maintaining and increasing the amount of metal
in the warehouse company, getting rent, storage fees, that is
the warehouse company's interest. Of course, it is owned by
Goldman, so if the warehouse company does better, Goldman does
better in that regard. But I am at least equally interested in
what the cancellation does in terms of increasing the queue,
which affects the premium, while Goldman is trading in
transactions relating to aluminum. That gives them a huge
opportunity, does it not, Mr. Vazquez?
Mr. Vazquez. Yes, if you really know the market, you know
that if you cancel massive amounts of metal, the queue is going
to lengthen, and you know that premiums are going to go up. So
if premiums go up and you have metal outside the exchange,
inside the exchange, or trading derivatives, or just simply
having a long position, your mark-to-market value of your
overall position goes up when premiums go up.
Senator Levin. And is there not something even more potent
than that, as potent as that is? If you have advance
information that queues are going to go up and you are engaged
in trading in derivatives, which are impacted by premiums, if
you have that advance information and these huge traders like
Goldman thrive on information, and if they can get advance
information that queues are going up longer, doesn't that give
them a huge advantage in terms of their financial transactions
in the market?
Mr. Vazquez. Definitely, knowing that there is going to be
not only a big cancellation but a set of cancellations of
important volumes, if you know that ahead of time, definitely
that has a benefit.
Senator Levin. And when Goldman employees on that board,
that warehouse board, are involved in decisions on
cancellations and know there are contracts, which are not
public, that require cancellations, from the warehouse
perspective that maintains the amount of metal in the
warehouse; but from a trader perspective, to know in advance
that agreements are being entered into, which, if lived up to,
require cancellations, and that means longer queues, and that
means greater premiums, is that information not of huge benefit
to a trading company that deals in derivatives and in futures?
Mr. Vazquez. I believe so.
Senator Levin. Do you agree with that, Mr. Madden?
Mr. Madden. Yes, and it is kind of ironic if you think
about the theory that they profess, that the all-in price does
not really change, and, therefore, then you would know to short
the LME if you are going to increase the queue because the
higher Midwest Premium would mean the LME had to go down. So
you are absolutely right. Whatever you believe, if you are
aware that the queue is going to lengthen, you know the premium
is going to strengthen.
But I think the real benefit is, of course, on all the
other aluminum they own. So there is a rent, but then when they
crystallize the value of the metal that they own, however, the
$3 billion worth of metal, because that is where all that value
is being created, because the value of it is going up all the
time, because the LME component would be hedged, except the
only opportunity for price appreciation and value creation will
be the--it is the mark-to-market of the premium increase.
Senator Levin. So there is a huge advantage here for
Goldman. They own a warehouse that is putting in more and more
aluminum, now what, 75 percent of whatever the LME, total
aluminum in this country is in Goldman-owned warehouses. Then
they have advance information about the length of the queue
because they are approving contracts, working on contracts,
which will require warrant cancellations, and, therefore, the
length of the queue will be increased. And they have advance
information on that.
And now what you have added, Mr. Madden, is something which
is pretty potent, too. They own a lot of aluminum. Goldman owns
a lot of aluminum. And if the price of aluminum is positively
impacted through all of this, if the price of aluminum itself
is going to go up through those activities, then they benefit,
as you call it, mark-to-market, but the value of what they own
physically is also going up, so they have an advantage in their
trading world, because they are dealing in derivatives and
futures and have advance information on things which will
happen which will affect the price of those derivatives.
Mr. Madden. That is what I believe.
Mr. Vazquez. Plus any physical position they may have.
Senator Levin. There is some evidence here that this
warehouse company shared premium payments with a metal owner
when the metal is delivered to the physical market, so that the
premium payments themselves are shared with the metal owner. Is
that permitted by the LME, do you know?
Mr. Madden. I do not know.
Senator Levin. OK.
This is Exhibit 32.\1\ This was a page, and I will read it
to you. If you were here earlier--and I think you were--you
would have heard me read from this. It is the management brief
which was supplied to Metro board members, all of whom are
Goldman employees. And if you look at that management brief
that was presented, it said the following: ``Extraordinary
income from counterparties sharing physical premium with
Metro''--in other words, they were making additional income
from the counterparties sharing that physical premium, but this
is something that 13 agreements in the United States Metro
shared in a fee that was tied to the premium--which would give
Metro another incentive to lengthen the queue, by the way, if
that is the case, which it was.
---------------------------------------------------------------------------
\1\ See Exhibit No. 32, which appears in the Appendix on page 1063.
---------------------------------------------------------------------------
You have given us, I think, a number of suggestions as to
how to end this situation. Mr. Madden, I believe you gave us
three. One was that the CFTC should be able to cover this
market, I believe. Are you going to weigh in on that with the
CFTC?
Mr. Madden. We have already.
Senator Levin. OK.
Mr. Madden. And I was pleased that they did take action--I
cannot remember precisely when--and requested the warehousing
companies and the producers who have been supplying the trading
company to freeze correspondence and make it available. So they
did actually assert themselves.
Senator Levin. But they have not acted yet except to tell
people to freeze your correspondence. Is that right?
Mr. Madden. I do not know what they did subsequently. That
was not public, yes.
Senator Levin. OK. I want to ask just a few questions about
the so-called information barrier requirements. These are not
law. They are policy, and that means they are left up to the
companies to implement, and these companies have a financial
interest which runs the opposite direction from preventing
themselves from getting information.
Mr. Vazquez, could a trading company like Goldman that is
in a position to approve a warehouse company's budget for
freight incentives or rent discounts use that to improve its
trading position in transactions relating to aluminum?
Mr. Vazquez. I believe so.
Senator Levin. And do you have an opinion on that, Mr.
Madden?
Mr. Madden. I mean, it is not where we operate, but I have
to believe it creates an opportunity.
Senator Levin. I will not ask you to look at it because I
will quote from it. I think there has been enough said about it
already. Exhibit 36d\2\ is a March 2013 packet which was given
to the Metro board of directors, and here is what it provides.
It provides projected freight incentives and real discounts. So
the Metro board of directors is given projections of
incentives, subsidies, and rent discounts. Is that information
commercially valuable? Would a trader want to know if you are
trading in metals?
---------------------------------------------------------------------------
\2\ See Exhibit No. 36d, which appears in the Appendix on page
1157.
---------------------------------------------------------------------------
Mr. Vazquez. Yes, definitely. The more information you
have, the better for your trading strategy.
Senator Levin. And the amount of metal coming in or out of
a warehouse, would that be valuable to a trader?
Mr. Vazquez. It definitely is something you would like to
know in terms of trading spreads, and also in terms of trading
warrants. See, there are different types of metal coming in in
terms of the purity, the quality of the metal. Knowing from
what smelter the metal is coming and what trader is bringing
the metal, it is also information that is valuable to know.
Senator Levin. Would you agree with that, Mr. Madden?
Mr. Madden. Yes.
Senator Levin. Well, we thank you both very much for your
testimony. It has been very powerful testimony. And where we
are, we are going to adjourn here for 45 minutes or until after
the votes are finished in the Senate. We hope it would be no
later than an hour from now. But where we are at this point in
the hearing is that what we have seen very clearly is, after
Goldman bought Metro, the freight incentives tripled; merry-go-
round deals were done for the first time; queues went from 40
days to 665 days; the premium tripled; Metro profited, Goldman
profited; and consumers lost out.
That is where we are at. We will pick this up with our
third panel at--it is 1:30 now. The votes are now starting at 2
o'clock. We are going to shoot for 2:45. We are going to
adjourn until 2:45. I hope everybody will let their Senators
know and let the public know and all of our witnesses who are
on the third panel know.
We thank all of our witnesses. It has been a very useful
morning and early afternoon. We thank you two specifically for
coming in to help us.
Mr. Vazquez. Thank you, Chairman.
Mr. Madden. Thank you, Chairman.
[Whereupon, at 1:31 p.m., the Subcommittee adjourned, to
reconvene at 2:45 p.m., this same day.]
Senator Levin. We will come back to order, and I would now
like to call our third panel of witnesses for today's hearing:
Simon Greenshields, Co-Head of Global Commodities at Morgan
Stanley, New York; Gregory Agran, Co-Head of Global Commodities
Group at Goldman Sachs, New York; and John Anderson, Co-Head of
Global Commodities at JPMorgan Chase, New York.
We very much appreciate your being with us today and the
cooperation with this Subcommittee in terms of providing
information.
Pursuant to Rule 6, all witnesses who testify before us are
required to be sworn. So I would ask all of you to please stand
and raise your right hand.
Do you swear that the testimony you're about to give will
be the truth and nothing but the truth; so help you, God?
Mr. Greenshields. I do.
Mr. Agran. I do.
Mr. Anderson. I do.
Senator Levin. Under our timing system, before the red
light comes on, you will be seeing a shift from the green light
to a yellow light, and that will give you an opportunity to
conclude your remarks.
Your written testimony will be printed in the record in its
entirety.
Please try to limit your oral testimony to 5 minutes.
Mr. Greenshields, I think we will have you go first.
TESTIMONY OF SIMON GREENSHIELDS,\1\ GLOBAL CO-HEAD OF
COMMODITIES, MORGAN STANLEY, NEW YORK, NEW YORK
Mr. Greenshields. Thank you, Senator. Chairman Levin and
Members of the Subcommittee, my name is Simon Greenshields.
Thank you for this opportunity to be here today.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Greenshields appears in the
Appendix on page 268.
---------------------------------------------------------------------------
I am Co-Head of the Commodities Division at Morgan Stanley.
I am proud to work with an extraordinary group of professionals
whose experience and expertise has helped to develop an
industry-leading enterprise.
Morgan Stanley has been in the commodities market for more
than 30 years. We are committed to being responsible market
participants, providing price risk management solutions and
physical supply services to our clients and counterparties.
We also believe in a strong regulatory framework and the
sound management of the full spectrum of risks associated with
the business.
At Morgan Stanley, we put safety first, and we are
dedicated to operating our business in a sound manner.
I had a brief opportunity to review the Subcommittee's
Report, and I look forward to studying it at length in the
coming days.
We already know that we can learn a lot from the work of
Congress and the perspectives of our peers and regulators.
At Morgan Stanley, we are focused on our core strengths--
providing intermediation, risk management and supply services--
where we believe that we can provide the most value to our
clients.
We are in the process of exiting some parts of our
commodities business, particularly the ownership of physical
assets. We believe that this approach will work best for Morgan
Stanley and positions us where we think we should be in light
of the evolving market conditions and regulatory expectations.
We would also agree with you that regulatory guidance
should be clear and that oversight should be robust, to ensure
the risks undertaken in these markets are prudent and
appropriately mitigated. More reporting and clarification
through notice and comment rulemaking could also be helpful to
promote confidence in the overall market.
At Morgan Stanley, we will not take on the risk of engaging
in activity unless we fully understand it and we can manage it
effectively.
We appreciate and want to be responsive to the feedback we
receive from our regulators and other key stakeholders, and we
understand the critical importance of transparency.
We are in the business because we believe we are adding
value responsibly. Our clients and counterparties are
cooperatives, cities and corporations, ranging in size from
small businesses to global enterprises. We want to help them
succeed.
We appreciate the hard work of your staff and look forward
to responding to your questions.
Senator Levin. Thank you very much, Mr. Greenshields.
Mr. Agran.
TESTIMONY OF GREGORY AGRAN,\1\ CO-HEAD, GLOBAL COMMODITIES
GROUP, GOLDMAN SACHS & CO., NEW YORK, NEW YORK
Mr. Agran. Thank you, Senator. Chairman Levin, Ranking
Member McCain, and Members of the Subcommittee, my name is
Gregory Agran, and I am Co-head of the Goldman Sachs
commodities trading, where I have overall responsibility for
the firm's trading activities. Commodity trading activities,
excuse me.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Agran appears in the Appendix on
page 274.
---------------------------------------------------------------------------
As you know, for much of modern financial history, a close
connection has existed between capital markets and commodities.
The interplay between financial and physical commodity markets
is crucial to determining the returns that thousands of
companies earn for their products as well as the risk they bear
in producing them. By one measure, almost 40 percent of the
equity capitalization of the S&P 500 index has meaningful
exposure to commodities.
A core function for Goldman Sachs is to act as an
intermediary or market maker for a range of clients. We perform
this role across markets for interest rate, currency, equity,
credit and commodity products, each of which we refer to as an
asset class.
Many of these transactions are settled financially, in
which the parties make payment based on the terms of the
transaction. A certain portion of these transactions are
settled physically, where one party delivers an asset to the
other in exchange for a payment.
Depending on the asset class, the asset that is delivered
may be a bond, a number of shares, or a specified volume or
currency or commodity.
We have been an active market maker in commodities and
commodity derivatives since 1981. Though these activities
involve physical commodities, they otherwise mirror our market-
making and purely financial instruments. And it is in this role
that we serve as a bridge between producers on the one hand,
and consumers and investors on the other, whose interests and
exposures offset each other but do not perfectly match.
Our clients in the commodities business include many of the
largest companies in the world across virtually every sector.
Many of these companies, as well as several municipal and trade
organizations, more than 100 in total, have been outspoken
about the importance to them of having financial institutions
participate in the commodity markets, including with respect to
physical markets.
Apart from helping clients finance their inventories or
manage their risk, the Subcommittee staff has focused on
specific instances in which the firm makes an investment in
commodity-related areas.
While this is a relatively small part of our commodities
business, we do undertake extensive due diligence and risk
analysis beyond just an analysis of the economic risks. This
includes examining environmental impacts, legal liability,
insurance considerations and even whether the business we are
considering has operated under high standards of compliance.
I want to briefly address three issues on which the
Subcommittee staff has focused. While the significance and role
of these issues are minor in the context of our overall
commodities activities, I believe it is important to correct
any misimpressions.
First, our sales and trading in aluminum are unrelated to
the firm's ownership of Metro. Metro was never integrated into
our market-making business, and we maintain a strict
information barrier between the two.
Confidential information relating to Metro is not shared
with Goldman Sachs metal sales and trading personnel. As the
information we have provided to the Subcommittee confirms,
there has not been a single instance where confidential
information went to our metals trading personnel.
Second, we have provided to you information involving
uranium trading, a very small part of our business. In 2009, to
provide a broader array of products to our mining company and
public utility clients, we acquired Nufcor, a company that had
acted as a market-maker in uranium and related financial
derivatives.
After extensive due diligence, we believed then and remain
confident now that this activity does not present environmental
risk to an entity acting in the limited capacity in which we
act. In this business, our activities are limited to buying and
selling unenriched uranium and entering into related financial
derivatives.
Of course, unenriched uranium is not a harmful radioactive
substance. Moreover, we do not take physical possession of
uranium; let alone transport, deliver, or process it.
Finally, our ownership interest is merely reflected as book
entries at highly secured depositories that are subject to
substantial government oversight.
Notwithstanding these various considerations, given the
misconceptions about this business, we have decided to manage
down Nufcor's assets to zero.
Finally, I would like to address our stand-alone investment
in CNR, a coal mining investment in Colombia. The acquisition
of CNR arose from a pre-existing contract to purchase coal over
a period of time.
Notwithstanding the Subcommittee's statement regarding CNR,
since Goldman Sachs made the investment, CNR has achieved the
highest international standards for environmental and safety
management and is the only company in the region to have done
so.
I would also note that the limited liability protection of
the investment's corporate structure, together with the
company's capable management team, ensure that our risk in
relation to this investment is limited to our invested capital.
We hope our extensive engagement with the Subcommittee
staff over these many months has contributed to a greater
understanding of the role that financial intermediation plays
in the commodity markets in addition to these areas in which
you have expressed an interest.
I look forward to answering your questions today with that
goal in mind.
Senator Levin. Thank you very much, Mr. Agran.
Mr. Anderson.
TESTIMONY OF JOHN ANDERSON,\1\ CO-HEAD, GLOBAL COMMODITIES
GROUP, JPMORGAN CHASE & CO., NEW YORK, NEW YORK
Mr. Anderson. Thank you, Senator. I am John Anderson, and I
serve as Co-Head of the Global Commodities Group within
JPMorgan Chase.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Anderson appears in the Appendix
on page 277.
---------------------------------------------------------------------------
I am here to discuss the history of JPMorgan's involvement
in physical commodities and the status of our ongoing
divestiture of much of that business.
While some of the topics identified by the Subcommittee may
not be in my particular area of responsibility or expertise, I
have attempted to gather the relevant information from others
at the firm so that my statements today may not reflect my
personal knowledge but, rather, my attempt to help the
Subcommittee understand the issues.
As we sit here today, much of JPMorgan's physical
commodities assets and business has been sold. Last month, we
closed on the sale of a large portion of the business to
Mercuria Energy Group. In addition, the firm has sold and
continues to sell other portions of the business to different
buyers.
Going forward, JPMorgan's commodities business will remain
focused on a financial derivatives business; its associated
physical activities will be limited to an exchange warrants
business in base metals, traditional bank activities involving
precious metals, and a commodities finance business that may
involve taking title to physical commodities as the underlying
collateral to that financing.
At the outset, I think it would be helpful to explain how
physical commodities fit into JPMorgan's overall customer
business.
The firm manages a customer-driven commodity derivatives
business. JPMorgan is not a user of, or a speculative investor
in, physical commodities. But, rather, as a market-maker,
JPMorgan provides risk management and financing solutions to
its customers.
For example, an airline that needs to obtain jet fuel on a
regular basis and wants to hedge its exposure to fluctuations
in the price of the fuel. By offering a financial derivative to
the airline, JPMorgan's commodities business delivers not only
a hedge against future price fluctuations but also a
predictability that allows the airline to focus on the safe
operation of its business. The firm then hedges this exposure.
JPMorgan's physical commodities business involving energy-
related commodities expanded substantially when, at the behest
of the government during the height of the financial crisis,
the firm acquired a varied collection of assets from Bear
Stearns. With the sudden acquisition of Bear Stearns and the
later acquisition of RBS Sempra, JPMorgan received ownership
interests in a small number of power plants and tolling
agreements.
Today, JPMorgan has divested or re-tolled all but three of
these power assets. All three of these remaining power plants
are passive investments and are being managed by third parties,
and all three are either currently in the process of being sold
or marketed for sale.
I would now like to address in detail two specific issues
raised by the Subcommittee.
The first is JPMorgan's compliance with regulatory limits.
At JPMorgan we operate our commodities business in
conformity with the applicable rules, and we are in regular and
ongoing dialog with our regulators about our physical
commodities business.
The business is supervised by two primary regulating
entities--the OCC and the Federal Reserve.
The OCC oversees the physical commodities activities done
within the bank. The OCC requires that physical activities be
only a nominal percentage, 5 percent, of the bank's overall
commodities activity. These restrictions are designed to ensure
that the bank only engages in physical commodities activity as
hedges to its financial customer business and that only a small
amount of overall activity in the bank is in the physical
markets.
The Federal Reserve regulates JPMorgan's physical
commodities activities in bank holding company subsidiaries,
outside the bank, and imposes a different 5 percent limit of
its own. Whereas, the OCC imposes an activity limit, the
Federal Reserve is focused on limiting the overall market risk
of the company's physical inventory.
JPMorgan has never reached the Federal Reserve's limit.
With regard to the OCC's, and as a result of a large
client-initiated trade, JPMorgan exceeded this limit in
December 2011. This was and is the only time that this has
happened in the roughly 20 years that that limit has been in
place. JPMorgan immediately took steps to address this and was
in regular communication with both the OCC and the Federal
Reserve during this time.
JPMorgan is and has always been committed to candor and
transparency with its regulators. At no time has it been
JPMorgan's intent to misrepresent the relevant facts or
circumstances or to circumvent the applicable Federal Reserve
or OCC limits.
Finally, the Subcommittee has asked about JPMorgan's
involvement with copper, including the firm's prior plans to
launch an exchange-traded fund.
The consideration of issuing a copper ETF was separate and
apart from JPMorgan's customer-driven physical commodities
business. JPMorgan did not amass a copper inventory in
anticipation of the previously proposed ETF nor did it ever
attempt to do so.
In no uncertain terms, all of JPMorgan's copper trading is
related to its customer-driven business, and it does not engage
in proprietary trading in copper or any other commodity.
JPMorgan considered, but never launched, a copper ETF, and
there are no current plans to move forward with this product.
The safety and soundness of the firm is JPMorgan's No. 1
priority. We are very proud of the various risk management
practices we have in place and our capital strength and
fortress-like balance sheet.
I am happy to respond to any questions you may have. Thank
you.
Senator Levin. Thank you very much, Mr. Anderson.
Mr. Agran, please turn, if you would, to Exhibit 3.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 3, which appears in the Appendix on page 833.
---------------------------------------------------------------------------
Exhibit 3 is a Goldman Sachs submission to the Federal
Reserve that compares Goldman's physical commodities trading to
its financial commodities trading.
The document shows that in terms of total commodities
activity Goldman's physical trading commodity is significantly
smaller than its financial trading. For example, Goldman's
crude oil trading is about 0.3 percent physical and 99.7
percent financial.
Am I reading that correctly?
Mr. Agran. Now which page are you on, Senator?
Senator Levin. Page 2.
Mr. Agran. Yes, that is correct.
Senator Levin. So your financial trades relating to
commodities represent a far greater percentage of your
commodity activities than the trades of the physical
commodities themselves.
Mr. Agran. Both by volume and by revenue, Senator.
Senator Levin. Now, Mr. Greenshields, would you say that
Morgan Stanley's breakdown between physical and financial
trading is similar; it does a lot more financial trading than
physical trading?
Mr. Greenshields. Yes, Senator, I would say that is
accurate.
Senator Levin. And, Mr. Anderson, what about JPMorgan's?
Mr. Anderson. Yes, I would agree with that as well.
Senator Levin. OK.
Mr. Anderson, take a look at Exhibit 1h\2\ in your book.
---------------------------------------------------------------------------
\2\ See Exhibit No. 1h, which appears in the Appendix on page 823.
---------------------------------------------------------------------------
This chart was prepared by JPMorgan in 2011, when it owned
tolling agreements with 31 power plants across the country and
it also owned or leased gas storage facilities for about 78
billion cubic feet of natural gas since it was supplying
natural gas to a number of those plants.
Now U.S. banking law is supposed to encourage banks to
concentrate on the business of banking--taking deposits, moving
funds, and providing credit.
And when I look at that network of power plants and natural
gas storage facilities, however, it strikes me as a vast
commercial industrial venture, not a banking activity.
Now I am also struck by the risks involved--multiple sites
where natural gas leaks, explosions or fires could occur.
An analysis performed by the Federal Reserve Commodities
Team in 2012 concluded that JPMorgan, as well as three other
similar institutions, had insufficient capital and insurance
allocated to cover potential losses from a catastrophic event.
It determined that JPMorgan, as well as other financial holding
companies, were from $1 billion to $15 billion short of what
was needed to cover losses from a catastrophic event.
I understand the Federal Reserve contacted JPMorgan to
discuss how it was calculating the size of the potential losses
from a catastrophic event and disagreed with assumptions that
were being used by JPMorgan to a reduced projected total loss
of $497 million from an oil spill down to a total of $50
million. That is a 90 percent loss in your estimate compared to
theirs.
Has JPMorgan since changed its loss calculation
methodology, since that report, and allocated more capital and
more insurance to cover potential losses from a catastrophic
event?
Mr. Anderson. Yes, there are lots of questions behind that,
but I think you are primarily focused on the insurance and
capital coverage. Is that correct?
Senator Levin. Yes.
Mr. Anderson. Yes, so at the time of that Fed report, I
believe they did feel that the overall institution was not
carrying enough operational capital against its operational
risks.
In terms of specific to commodities, your example of the
$400 million being diversified down to $50 million for an oil
spill is correct in how the calculation worked.
The overall calculation recognized a potential of 4 to 5
percent--I think it was $490 million you quoted--loss from an
oil spill liability, which would have been the loss if it had
been a stand-alone company and actually ended up realizing that
liability.
When you then diversified it within the commodities
business as a whole, and then further within the investment
bank as a whole, it diversified down to $50 million.
And I know that sounds like a small number, but this model
that calculated it is driven by correlation assumptions and
make sure that there is enough capital held against the largest
possible event, as well as incremental capital.
And the largest possible event across the investment bank
was not in commodities, and I do not have the knowledge
specifically as to what it was.
But you followed that up by asking if we had put in
additional capital since that dialog with the Federal Reserve.
I know that our operational capital has almost quadrupled since
that time.
Senator Levin. Did the Federal examiners tell JPMorgan
personnel that the methodology should change relative to an oil
spill?
Mr. Anderson. Yes, they specifically--most of the
operational capital was calculated on a historic look-back
method. So, if you had a loss in a mortgage business, it would
be taken into account, for example.
The oil business, because it was new to us, we had no
historic losses. So we used a forward-looking model and an add-
on approach to add incremental capital to our operational
capital.
And the Federal Reserve preferred that we not have a
forward-looking model, that we use only the historic model.
Senator Levin. And did you change your methodology relative
to oil spills after the Federal Reserve asked you to do that?
Mr. Anderson. Yes, we did.
Senator Levin. Now take a look, if you would, Mr. Anderson,
at Exhibit 70b.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 70b, which appears in the Appendix on page
1555.
---------------------------------------------------------------------------
This is a 2009 application filed by JPMorgan with the
Federal Reserve, seeking what is called complementary authority
to enter into tolling agreements with power plants.
Now pages 7 and 8 is what I will be asking you about.
Tolling agreements typically involve one party supplying
fuel to run the power plant, paying its costs, and getting in
exchange all of the power plant's electricity output, which
that party would then try to sell for a profit.
The 2009 application from JPMorgan indicates that its
subsidiary, JPMorgan Ventures Energy Corporation--and I think
the acronym for that is JPMVEC. Is that the way you guys
pronounce it?
Mr. Anderson. That is correct.
Senator Levin. JPMVEC booked its electricity in natural
gases.
So this is from your own application, and this is what
JPMorgan wrote:
``The complementary activities will further complement the
existing business by providing JPMVEC with important market
information.
``The ability to be involved in the supply end of the
commodities markets through tolling agreements provides''--and
these are key words--``access to information regarding the full
array of actual producer and end user activity in those
markets.
``The information gathered through this increased
participation will help improve JPMVEC's understanding of
market conditions and trends while supplying vital price and
risk management information that JPMVEC can use to''--and here
are some more key words--``improve its financial commodities
derivative offerings.''
So this application indicates that one of the reasons that
JPMorgan wanted to get into the power plant business was to
increase its access to important market information in the
electricity markets, including information about market
conditions and trends, and vital price and risk management
information.
So far, would you agree with me?
Mr. Anderson. Yes.
Senator Levin. And then one of its stated purposes for
JPMorgan's getting into the power plant business was to obtain
information that it could use with respect to electricity-
related financial instruments, which are traded in the
financial markets.
Is that true? Did I read that correctly?
Mr. Anderson. I do not know what you are reading now, but I
would agree with what you said.
Senator Levin. That was the same line. It was the second
half of the same line.
Mr. Anderson. Yes, I agree.
Senator Levin. OK.
Now this application is not about getting information on
JPMorgan's own business, which is usually what is allowed in
this kind of a situation--to get information from your own
business, get information on your business.
This is about getting information about all those power
plants spread out across the country, as shown in that chart,
commercially valuable information about electricity production,
congestion areas and price trends--what you call in that
application, important market information, information about
market conditions and trends, and vital price and risk
management information--that you would then be able to obtain
commercially valuable, nonpublic information.
Is that correct?
Mr. Anderson. I do not know whether that information would
have been public or not.
But the point of this application was, yes, to enable us to
see with more transparency what was happening in energy markets
so that we could make better prices to our market-making
business and clients and provide them with incremental
solutions.
Senator Levin. And not just better prices but also getting
that commercially valuable, nonpublic information--and it is
nonpublic information in those plants before it is made public;
it is something that you would have if you were managing those
plants--your traders of financial instruments, could use it,
that information, to trade electricity-related financial
instruments like futures, swaps and options in the financial
markets.
Is that right?
Mr. Anderson. This approval was primarily so that we could
do tolling activities, which is a financial contract on, as you
said, the output of power from a power plant, which would then
be the firm's contract and the firm's information, and it could
then use that flow and that insight into the most accurate
price to provide the best prices to our market-making client
franchise.
Senator Levin. So not just the most accurate price, but it
would give you an advantage, would it not, being in that
business, too, in your dealings in financial commodities, the
derivative offerings that you were involved in?
You would have nonpublic information to help you in the
financial commodities derivative offering world that you were
engaged in. Is that a fair statement?
Mr. Anderson. Via the tolls we would have private
information that we could use to provide better services to our
clients.
Senator Levin. Not just the tolls but in those deals
involving tolls, you would gain information which would help
you to trade electricity-related financial instruments--
futures, swaps, options.
Mr. Anderson. That is right, just in those tolls.
If there was any plant ownership associated, that would not
be shared with traders. It would be held as an independent
passive investment.
Senator Levin. What do you mean you would not share it with
traders? Is there a Chinese wall there?
Mr. Anderson. Yes, there is a barrier that----
Senator Levin. Is that in law?
Mr. Anderson. I believe it is, as part of the merchant
banking laws, that if you own an investment as a merchant
banking investment you cannot operate it; you cannot pass
information between the two organizations.
Senator Levin. Well, most of these facilities were not
owned as part of a merchant banking deal. Twenty-four of 27
were under complementary authority, first of all.
Mr. Anderson. As tolls, right. Yes.
Senator Levin. Second, as far as I can tell, there is no
prohibition on the sharing of information, even for the
merchant banking operation.
Mr. Anderson. OK.
Senator Levin. Should there be?
Mr. Anderson. Between merchant banking and----
Senator Levin. And your people were engaged in trading.
Mr. Anderson. Yes.
Senator Levin. Should there be a Chinese wall?
Mr. Anderson. There are Chinese walls. So we have lots of
internal----
Senator Levin. No, but in this area, should there be?
You said there is, and we disagree with you.
Mr. Anderson. Well, there are internal Chinese walls for
certain--I thought there were also legal obligations between a
merchant banking investment and a trading organization.
Senator Levin. I do not think there is.
But my question is, in any event, should there be a legal
prohibition, not just a voluntary policy adopted by a company
whose economic interest runs in the opposite direction of the
Chinese wall?
In other words, the Chinese wall is supposed to be a
detriment to the use of information. And the use of that
information is very valuable to the company.
So, if the Chinese wall is abided by, if there were one, it
is still voluntary; it is still policy. It is not regulation,
and it is not law.
My question is since you thought there was such a wall, in
any event, and should be such a wall--maybe I am reading too
much into your words, but I sure believe there ought to be.
My question to you is should it be legally prohibited to
share information that is of market relevance between the
operation of a company and the trading people in your company;
should there be?
Mr. Anderson. I, honestly, do not have an opinion.
I am not a lawyer or a legal expert. So I cannot give you--
--
Senator Levin. Well, no, but you----
Mr. Anderson [continuing]. All the facts.
Senator Levin. You have ethical guides, don't you?
Mr. Anderson. Absolutely, yes.
Senator Levin. Should you be able to use that information
in the trading world? That is the question. That is an ethical
question.
Mr. Anderson. No, we should not, and that is why we have
these internal walls and barriers, to protect from that.
Senator Levin. And since you should not use it, is there
any reason why we should not prohibit from being used?
Mr. Anderson. Again, I cannot comment without having all
the facts and being an expert in the area.
Senator Levin. OK.
Now the same people who get information about the physical
power plant operations and place bids to supply electricity in
California, for example, also trade electricity-related
financial instruments in the futures and swaps financial
markets.
In 2013, JPMVEC was named in the FERC settlement agreement,
charging JPMorgan with engaging in manipulative bidding
strategies. JPMVEC traders were the ones that designed and used
the manipulative strategies that produced $124 million in
excessive electricity payments in California and Michigan that
JPMorgan then paid back, with penalties and interest, totaling
$410 million.
Is that correct?
Mr. Anderson. That is correct.
Senator Levin. Now JPMorgan has told us it will take until
2018, another 4 years, for it to completely exit the power
plant business.
Why should it take 3 years?
Why is it going so slow?
Mr. Anderson. That is a good question.
So we remain owners of three power plants today, of the 31
that were acquired from the Bear Stearns acquisition.
Since that acquisition, we have been in steady disposition
mode, and in fact, if you look at a graph of our business, it
is in a steady decline ever since 2018.
The three remaining power plans we do have are all in a
sale process. One is actually contracted to sell today, another
one should be under contract within the next quarter, and the
third one, we are hoping next year.
In terms of beyond next year, you said, we will still be in
the business through 2008.
We are out of the business as of last month. We do not
own--we do not operate or control any of these. We do not have
a financial interest in any of them.
They are run--other than these three power plants that are
still owned and we are trying to sell, but we do not operate
those. They are run by third parties.
In terms of the tolls in California that run through 2018,
it is strictly a financial contract at this point. We have a
toll that we are long from the original Bear Stearns
acquisition and offsetting mirror tolls that make us short. So
we are a credit intermediary in those transactions with no
financial upside or downside from it other than if there were
to be a credit default on one side.
Now we would ideally like those two counterparties to face
each other and JPMorgan to be able to step out from the middle,
but they have asked us to stay in the middle as a credit
sponsor intermediary.
Senator Levin. Now I believe you told the Federal Reserve
in 2011 that those three power plants, the ones you owned
outright, that you would sell those three power plants and that
they would be sold, I believe if I am reading this correctly,
by now, essentially.
Did you have an extension of time from the Federal Reserve
to sell those three power plants?
Did they give you an extension of time? Do you remember
that?
Mr. Anderson. So at the time of the Bear Stearns
acquisition, we had a 2-year timeframe given to us by the
Federal Reserve to hold all of these activities that were new
to us at the time.
We then had three possible 1-year extensions.
Senator Levin. So they did give you extensions.
Mr. Anderson. So they gave us extensions, yes.
Senator Levin. Now as we set out in our Report, JPMorgan
and its bank are subject to limits on the size of their
physical commodity holdings. These are limits set by their two
primary regulators--the Federal Reserve and the Office of the
Comptroller of the Currency, the OCC. And that is a way to
limit the risks associated with physical commodity activities.
But by exploiting certain loopholes and using aggressive
interpretations, often without telling regulators beforehand,
JPMorgan and its bank have been able to accumulate physical
commodity holdings far in excess of the limits while claiming
to stay under the limits.
To date, the regulators have closed some of the loopholes
but not others.
And so take a look, if you would, Mr. Anderson, at Exhibit
56a.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No. 56a, which appears in the Appendix on page
1417.
---------------------------------------------------------------------------
This is an application filed in 2005, asking for
complementary authority again to engage in physical commodity
activities, page 22 of that Exhibit 56a.
And this is what JPMorgan wrote:
If they were granted complementary authority that it was
seeking, it ``commits to the board that it will limit the
amount of physical commodities that it holds at any one time to
5 percent'' . . . 5 percent . . . ``of its consolidated Tier 1
capital.''
No caveats. No loopholes. Just a commitment to limit the
amount of physical commodities that it holds at any one time.
Do you see that line?
Mr. Anderson. Yes, I do.
Senator Levin. Now take a look, if you would, at Exhibit
90.\2\
---------------------------------------------------------------------------
\2\ See Exhibit No. 90, which appears in the Appendix on page 1691.
---------------------------------------------------------------------------
And Exhibit 90 is an excerpt from a document that JPMorgan
prepared for its quarterly meeting with the Fed. I guess the
FDIC and the OCC were involved as well.
So, if you look at page 2 of Exhibit 90, the page is
entitled Physical Inventory Limits from the Fed and the OCC. It
then lists various components of JPMorgan's physical commodity
holdings as of certain dates.
And in the first column under the date 9/28/12, it shows
that as of that date JPMorgan had oil holdings worth $3.2
billion; tolls, which is a reference to the power plants that
you have been talking about, worth $2 billion; and then some
other items in a total for JPMVEC--that is your leading
commodities subsidiary again--a total of $6.6 billion.
Underneath that, it says its physical inventory as a
percentage of Tier 1 capital is 4.5 percent.
Do you see that?
Mr. Anderson. Yes.
Senator Levin. So that is what JPMorgan reported to the
Federal Reserve as its total physical commodity holdings as of
9/28/2012.
But that total excluded another number on this chart a bit
further down, where it says Base Metals Held in Bank and shows
$8.1 billion. That $8.1 billion of metals in the bank was
bigger than all of the physical commodities held in other parts
of the financial holding company, put together, because they
had totaled $6.6 billion.
Is that correct?
Mr. Anderson. You said that we reported $6.6 billion as the
total of the whole organization's physical commodities. That is
slightly inaccurate.
That is what we reported, as it says at the top here, of
JPMVEC and non-bank subs.
Senator Levin. OK.
Mr. Anderson. And then separately, below it, it does report
base metals in the bank, yes. Correct.
Senator Levin. Oh, I am going to get to the base metals in
a minute.
In the meantime, the $6.6 billion was correct, right?
Mr. Anderson. Yes.
Senator Levin. OK.
Now those numbers, both those numbers, both the $8.1
billion and $6.6 billion, excluded all copper, platinum,
palladium, gold, silver and any merchant banking holdings held
by either the bank or the holding company, which by the way
were significant in size.
So to simplify things, we asked your legal counsel for the
amount of just the copper, platinum and palladium held by
JPMorgan on September 28, 2012, and we were told that those
holdings on that date totaled $2.7 billion.
And when we add up all the three numbers--$6.6 billion,
$8.1 billion, and $2.7 billion--the total is $17.4 billion, and
that represents 12 percent of JPMorgan's Tier 1 capital at the
time.
So when JPMorgan was holding at least $17.4 billion in
physical commodities, equal to nearly 12 percent of its Tier 1
capital, how could JPMorgan claim that it met its commitment to
keep ``the amount of physical commodities that it holds at any
one time to 5 percent of its consolidated Tier 1 capital''?
Mr. Anderson. I think this report is very clear that, yes,
we reported exactly what was in the VEC and non-bank chain as
$6.6 billion. That represented 4.5 percent against the limit
for those entities of 5 percent.
You know, you are adding $8.1 billion----
Senator Levin. Well, for those entities, the limit was a
total limit of physical commodities, wasn't it?
Mr. Anderson. No, that is not correct.
Senator Levin. The one I read, didn't I read that
correctly?
I asked you if I had read that correctly before--the
commitment which was made.
Mr. Anderson. That letter was referring to the non-bank
chain. So that limit is applicable to the non-bank chain, which
the Federal Reserve agrees with.
The OCC has a separate limit that applies to the bank
chain, and it is a different type of limit entirely. It is an
activity limit, not an amount of metal you can hold or physical
inventory you can hold, that might pose a risk to the bank.
The only way you can hold physical commodities in the bank
is as a hedge. It cannot be unhedged. You cannot have outright
positions in it. So it does not pose financial risk to the
bank.
It is a separate limit to make sure the bank does not
migrate beyond a low, minimal level of activity in commodities.
Senator Levin. In the representation that you made,
however, in your application here, that I read to you before,
JPM Chase commits to the board that it will limit the amount of
physical commodities that it holds at any one time.
It did not limit it the way you just limited it.
Mr. Anderson. But the rule is specifically applicable to
non-bank chain.
Also, in preparing for today, we talked about the Federal
Reserve's knowledge of our base metals business and the
inventory throughout the whole organization. And I know at the
time, in 2005, they discussed--and they are probably our
attorneys and maybe business people at the time--with the Fed
that we had a base metals business in the bank.
Senator Levin. So you are saying that prior to 2012 the
Federal examiners knew that JPMorgan Chase was excluding the
bank from the 5 percent limit. That is what you are
representing here today?
Mr. Anderson. I do not know what they knew or not.
I know we had conversations about it. So I think they
should have known, yes.
Senator Levin. Well, I think we will hear tomorrow what we
have heard already in our investigation; the Fed did not know
that JPMorgan was excluding its bank's metals until December
2011, and then it found it out by accident.
So you have some discussions to hold with the Fed.
Mr. Anderson. Yes, that is surprising to me.
As I said, we have open, transparent dialogs with our
regulators on an ongoing basis and a regular basis.
I, personally, have participated in quarterly meetings with
both regulators in the same room for many years now, certainly
prior to 2012.
Senator Levin. Well, I think that is an issue which----
Mr. Anderson. OK.
Senator Levin [continuing]. They are going to take up with
you, I hope----
Mr. Anderson. Yes.
Senator Levin [continuing]. Because that is not what we
have been told and it is not what your commitment said.
Your commitment did not exclude that.
So you can say they knew it was excluded, but that is not
what you represented in your commitment.
And so a number of loopholes here are kind of taking over,
and they need to be closed if the limit and JPMorgan's
commitment is going to be an effective safeguard and limit size
and amount of risk from physical commodity activities.
Mr. Anderson. OK.
Senator Levin. Let me ask Mr. Greenshields a few questions
here.
This is about Morgan Stanley's effort to construct a plant
in Texas, designed to produce compressed natural gas that would
be placed in large containers for export.
In 2013 and 2014, Morgan Stanley formed three shell
corporations, all with the name of Wentworth, as is shown in
that chart that we are putting up here, if we can get the chart
up.
But it is also Exhibit 1g \1\ in your book. So you can see
what chart I am referring to.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1g, which appears in the Appendix on page 822.
---------------------------------------------------------------------------
This is the Wentworth ownership structure. The idea was to
have Wentworth Companies in charge of the plant-building
effort.
Now if you look at Exhibit 45a,\1\ ``Application of
Wentworth Gas Marketing, LLC for long-term authorization to
export compressed natural gas.''
---------------------------------------------------------------------------
\1\ See Exhibit No. 45a, which appears in the Appendix on page
1307.
---------------------------------------------------------------------------
That application was filed by one of the Wentworth
Companies with the Department of Energy in May 2014. That is
just 6 months ago or so.
It was made public by the Department of Energy and became
the basis of a media report in August, which is when many
people, including some at the Federal Reserve, learned about
the venture.
The application indicates on page 1 that Wentworth Gas
Marketing is seeking authority to export 60 billion cubic feet
of compressed natural gas, known as CNG, over a 20-year period.
Wentworth Gas Marketing, LLC is one of three Wentworth
Companies formed by Morgan Stanley back in October 2013 and
April 2014.
And then on page 3 of that same exhibit, Wentworth's
``principal place of business'' is listed as Purchase, New
York. So it is using the same address as the building that
houses Morgan Stanley's Commodities Division.
Am I correct so far?
Mr. Greenshields. You are, Senator. Thank you.
Senator Levin. Now please look now at Exhibit 47.\2\
---------------------------------------------------------------------------
\2\ See Exhibit No. 47, which appears in the Appendix on page 1364.
---------------------------------------------------------------------------
This is a letter dated 9/19/2014, provided by Morgan
Stanley's legal counsel, and this is responding to the
Subcommittee's questions about Wentworth.
And on page 5 of that exhibit, there is a list of board
members for the Wentworth entities. And what that shows is that
all three Wentworth Companies have the same board members, and
those members are exclusively senior employees from Morgan
Stanley's Commodities Group.
Is that correct?
Mr. Greenshields. That is correct, Senator, yes.
Senator Levin. Under the column entitled Wentworth Entity
Position, what is the position a person holds in Wentworth?
You are listed as the Manager and President of the
Wentworth entities, and it shows that you are also employed by
MSCG, which is Morgan Stanley Capital Group, and that your MSCG
title is Chairman, President and Chief Executive Officer.
Is that right?
Mr. Greenshields. That is correct, Senator. Yes.
Senator Levin. The other board members listed here are the
Vice President/Chief Operating Officer of Morgan Stanley's
North American Power and Gas, the Vice President/Global Head of
Morgan Stanley's Oil Liquids, and the Vice President/Head of
Morgan Stanley's North American Power and Gas.
In other words, the senior executives listed as running the
Wentworth Companies are senior executives in Morgan Stanley's
Commodities Division.
Is that correct?
Mr. Greenshields. That is correct.
Senator Levin. Now if you will look again at page 5 and at
page 8 of that same exhibit, it states that none of the three
Wentworth Companies had employees and that all three rely upon
the expertise and day-to-day involvement of employees of Morgan
Stanley. This includes the breadth of the firm, including
support in legal, tax, risk management and many other areas, to
carry out the activities.
Is that correct?
Mr. Greenshields. That is correct.
Senator Levin. OK.
So as of September at least of this year, a couple months
ago--and maybe things have changed in the last couple months:
The Wentworth Companies had no employees of their own. All
of their employees were Morgan Stanley employees. Morgan
Stanley employees were relied on to carry out Wentworth's day-
to-day activities.
In addition, Wentworth had no offices of its own. Its only
offices were the Morgan Stanley Commodities Division's offices
in Purchase, New York.
Wentworth's senior executives were the senior executives in
Morgan Stanley's own Commodities Division.
And so I hope you would agree that the Wentworth
Corporations functioned as shell entities and that you and your
staff were actually overseeing this project and managing the
business.
Mr. Greenshields. You are correct, Senator. It is a shell
subsidiary corporation.
Senator Levin. So there is no doubt, since Wentworth is a
shell, that if anything goes wrong it is Morgan Stanley that is
on the hook.
Mr. Greenshields. It is correct that if anything went
wrong.
I will point out that we are selling this business, and I
think we have reported that several times.
In addition, this is not an operational company, Senator.
Construction has not even begun. The reason it does not have
any employees is that it really would be very little for these
employees to do at this point.
Senator Levin. But, as this, the intention was that you
were going to sell this at some point.
In the meantime--the question is whatever liability was
incurred in the meantime, if and when you sell it--I know that
is your stated intent now. But nonetheless, if anything goes
wrong before that happens, if it happens, it is your company,
Morgan Stanley, that would be on the hook in terms of
liability.
Is that correct?
Mr. Greenshields. Ultimately, we accept full
responsibility, Senator.
Senator Levin. OK.
I would like to talk for a moment, Mr. Greenshields, about
Southern Star.
Southern Star, founded in 1904, headquartered in Kentucky,
it is the primary gas transmission and natural gas storage
facility provider in certain areas of the Midwest, with
approximately 6,000 miles of pipeline serving Colorado, Kansas,
Missouri, Oklahoma, Texas, and Wyoming.
Its pipeline system has a delivery capacity of
approximately 2.4 billion cubic feet of natural gas per day,
and its primary function is delivering gas to local natural gas
distributors in its service areas.
I understand that Southern Star is not part of the
Commodities Division that you head; instead, it is a merchant
banking investment held through an investment fund called
Morgan Stanley Infrastructure Partners, or MSIP, located within
a separate Morgan Stanley business segment called Merchant
Banking and Real EState Investing Group.
Infrastructure funds have become very popular at financial
holding companies. They are being used to purchase commodity-
related businesses all over the country and the world. They
include power plants, natural gas facilities, hydroelectric
dams, wind farms, and more.
And Southern Star is a classic example.
Morgan Stanley told the Subcommittee that Southern Star is
100 percent owned by its Infrastructure Fund in which Morgan
Stanley has only about a 10 percent ownership interest.
Morgan Stanley presents itself as having only a relatively
small indirect ownership interest in Southern Star, but in
fact, the relationship is far closer than that.
Morgan Stanley gave us a chart showing, ``the complete
ownership structure chart for MSIP.'' It was a bowl of
spaghetti showing about 40 boxes and triangles in every
direction. We are told that virtually all of them were shell
entities with no employees or offices, just legal structures
showing who owned what.
The most important real entity, real in terms of having
actual employees and offices, is Morgan Stanley Infrastructure,
Inc., or MSI, which actually manages the investment fund.
MSI is also a business unit within Morgan Stanley's
Merchant Banking and Real EState Investing Group.
MSI currently has about 37 employees, all of whom are
Morgan Stanley employees. All of them work exclusively on the
Morgan Stanley Infrastructure Fund's projects.
So MSI, Morgan Stanley Infrastructure, is run by Morgan
Stanley employees, sits in Morgan Stanley offices, decides on
what the Morgan Stanley Infrastructure Fund is going to invest
in.
Morgan Stanley is also the largest single investor in the
Infrastructure Fund, which owns 100 percent of Southern Star,
which is its largest current investment.
Now, Mr. Greenshields, when Morgan Stanley says it has only
a 10 percent indirect interest in Southern Star, that is not
really the whole story, is it?
Mr. Greenshields. Senator, as you identified earlier, this
is on the other side of the wall. I really know very little
about this investment.
Senator Levin. All right.
Morgan Stanley's use of an Infrastructure Fund to raise
money for and invest in commodity-related businesses like
Southern Star is not unique. It is too common an approach to
not take note of.
But when folks are looking at what financial holding
companies are doing relative to physical commodities, they too
often ignore what is going on through an infrastructure or
other investment fund as if those funds' activities are somehow
outside of, or apart from, the financial holding company.
But here, the Morgan Stanley Infrastructure Fund is located
in Morgan Stanley's offices.
Do you know if that is true or not?
Do you know whether or not the Infrastructure Fund is
located in Morgan Stanley offices?
Mr. Greenshields. I believe it is, Senator, yes, in 1585.
Senator Levin. Do you know whether it uses Morgan Stanley
employees?
Mr. Greenshields. I believe that there are directors that
sit on the board, yes.
Senator Levin. And do you know whether its decisions are
made by Morgan Stanley employees?
Mr. Greenshields. I do not know.
Senator Levin. OK.
Morgan Stanley has been an active trader in the natural gas
market for decades. It trades natural gas at the same time it
has ownership interest in Southern Star, and nonpublic
information from Southern Star is provided on a regular basis
to employees in the Merchant Banking and Real EState Investing
Group.
In your prepared statement, Mr. Greenshields, you said that
you were ``not privy to MSIM's investment in Southern Star''
because MSIM is separate from the Commodities Division and is
handled out of a business unit again called Merchant Banking.
You also said in your prepared statement that Morgan
Stanley has ``information barriers in place to prevent the
transfer'' of material nonpublic information between the
Commodities Division about MSIM's investment.
Why isn't that information shared?
Why do you have barriers to prevent the transfer of that
material nonpublic information?
Mr. Greenshields. There is no good reason for the
Commodities Division to have that information, and if there is
no good reason, we see no need to share it.
Senator Levin. Well, as I said in my opening statement, the
opportunity for that information to be shared and used is a
real one, and banks such as yours are in the position to make
full use of that information. The only barrier is a self-
imposed barrier, as far as I know.
Is that true?
Is that just a self-imposed barrier, or is that imposed by
law?
Mr. Greenshields. You are correct, Senator. It is self-
imposed.
Senator Levin. And so that barrier can be ignored at any
time, circumvented at any time, pulled down at any time.
And I just think it is wrong for the public to have to rely
on a voluntary policy such as that, which is not enforceable
and which does not have the weight of law behind it because,
obviously, the use of material nonpublic information by a
commodities division from information that it got from physical
commodities operations is simply unacceptable.
I think you agreed that information should not be used. Is
that correct?
Mr. Greenshields. That is correct, Senator. We do not
believe it should be.
Senator Levin. And is there any reason why we should not
put the weight of a regulation or a law behind that?
Mr. Greenshields. I certainly would not object.
I think it is something we do anyway, as we stated. So, if
it were a legal requirement, I do not think Morgan Stanley
would object.
Senator Levin. You have no problem with our making sure
that it becomes a legal requirement?
Mr. Greenshields. I, personally, do not. I would have to
check with my lawyers and my managers, but that will be my
view.
Senator Levin. Senator McCain.
Senator McCain. Thank you, Mr. Chairman.
Mr. Anderson, in 2012, JPMorgan paid Federal regulators
$410 million to settle charges that it manipulated electricity
markets in both California and the Midwest.
And so recently, JPMorgan purchased large stockpiles of
copper.
So should we be concerned that you are going to manipulate
the market the same way that you did with electricity markets
in both California and the Midwest and paid $410 million to
settle?
Mr. Anderson. First, let me say that that whole situation
was regrettable. And in hindsight, we hold our employees to the
highest standards both legally and morally, and we believed we
were operating within the rules.
That said--or, these employees did--in hindsight, had they
been in open communication with the FERC and local regulators,
as we are with the OCC and Fed, we may have been able to avoid
that whole situation to begin with. So it is clearly
regrettable.
In terms of copper, we have not amassed a large position in
copper. First of all, we do not proprietarily trade copper. We
have a customer-driven business that we make markets for in
copper.
I think the situation you are referring to was in 2010,
where we built up, via our client franchise, about $1.5 billion
worth of copper in the December time period, December 2010,
which was fully hedged.
So we were very agnostic as to the direction of prices. We
did not have a financial interest in whether prices went up or
down at the time.
Senator McCain. Mr. Agran, Goldman's subsidiary owns and
operates two coal mines in Colombia.
Last year, the wives and children of mine workers led
strikes that completely halted all coal mining operation for 9
months. It was reported that Goldman's subsidiary requested
that the Colombian police and military remove the protesting
women and children.
And then there is an allegation that in the 9-month labor
strike that your subsidiary paid protestors $10,000 each.
Is that true?
Mr. Agran. Our subsidiary paid former employees of the
contractor, which was at the heart of the dispute, a settlement
in order to--so that we could resume work, Senator.
And we cross-referenced those employees to company
payrolls, as well to either union or administrative labor
membership.
Senator McCain. I guess I have a question for all three of
you.
You know most Americans believe that you are financial
houses that have made a lot of money.
Clearly, in my view and probably that of most people, you
are still too big to fail, but that is beside the point.
And yet, why do you get into businesses like coal mines and
electricity markets--that, at least in one case, has been
manipulated--and copper, and all that.
What is the point, I guess?
And maybe you can help me out here, beginning with you, Mr.
Greenshields.
Mr. Greenshields. Thank you, Senator. That is a very good
question.
Morgan Stanley does not invest in coal mines.
We do participate in the electricity market, both in the
United States, and also in Europe. We provide market-making
services in both financial products and physical products. And
that is our primary business.
Our primary business is market-making and the provision of
liquidity, and we are improving--as a result of that, we are
improving price transparency. So all these things we think are
good things for our customer base.
There have been certain circumstances where we have owned
assets. We are downsizing that, however. We sold TMG, which is
our storage business, and we are looking to sell other parts of
our business, including the CNG business.
But there are times when owning assets allows an entity
such as Morgan Stanley to provide physical product to its
customers, and that is the primary reason.
Senator McCain. Mr. Agran.
Mr. Agran. Well, similarly, we see the core market-making
function that we provide in commodities analogous to the
function we provide in interest rate products, foreign
currencies or equities. So the basic product of risk
intermediation is consistent across the asset classes, Senator.
Senator McCain. So you get into situations such as happened
at the two Colombian coal mines which I really do not think
enhanced your image.
Mr. Agran. I agree. The operational challenges at CNR are
significant, Senator. That is not an investment that has been
easy for us to oversee.
But I think that it is important to recognize that banks
provide capital. We lend. We underwrite stock and bond
offerings. And in this situation, we made an investment, but
ultimately, that is all it is. It is an investment in a coal
mining company, Senator.
We are not a coal miner.
Senator McCain. Mr. Anderson.
Mr. Anderson. Yes, Senator, market-making in commodities is
an important service to the market as a whole.
JPMorgan Chase has literally millions of customers, most of
which touch or need commodities in some way, shape, or form.
So to be able to provide them with hedging services, risk
management services, and risk management advice, makes their
financial expected outcome more solid. They can count on
running the business that they are running and not have to
worry about fluctuations in interest rates or foreign exchange
or commodities or whatever the asset class happens to be.
We have highlighted today some very regrettable activities.
Our business is a people business, and people, unfortunately,
make mistakes.
It is important for us to fix those mistakes, to continue
to emphasize a strong culture and, most importantly probably,
to be open and transparent, to raise our own mistakes, to talk
about them and work with our regulators to remediate them.
Senator McCain. I guess you are the wrong person to ask,
but it seems to me if you control between 50 and 80 percent of
all the copper available on the world's leading metal exchange,
I am not sure that is a good thing--that one corporation, be it
maybe through a subsidiary, controls somewhere between half and
four-fifths of the copper that is on the leading metal
exchange.
Maybe that is just a comment, but it seems to me if you
have control of that much of a vital commodity--and copper
certainly is that--that at least lends itself to a possible
manipulation of prices.
I think history shows that when one individual or company
or corporation owns an overwhelming amount of whatever that is,
that it does not leave it open to competition or to prevent
manipulation. I think that is pretty well historically true.
Mr. Anderson. I would be happy to address that if you want
me to.
Senator McCain. Please, go ahead.
Mr. Anderson. That is a good point.
I think you are referring to December 2010--the stocks in
the LME system were quite low relative to global supply.
So at the time, we did go through the 50 percent threshold,
which at the time was less than 10 percent of global stocks.
But it is important to note it was not our position. We
were neutral in terms of our outright position.
And it was part of our market-making business, where
clients were buying a derivative, and the best hedge for the
firm and the safest hedge for the firm was to buy the inventory
as a hedge to that derivative.
And they were only a couple weeks apart.
So you can see if you go through the timeframe, within 2
weeks, we delivered against all those short derivatives
contracts. We delivered our inventory, and we dropped down to,
I think, around 15 percent.
But that market is specifically set up to avoid the exact
situation you described. The LME has lending guidance, and
their lowest band is any individual that holds more than 50 to
80 percent of the LME supplies, they are then forced to lend
into that market and make that copper available.
The next band is 80 to 90 percent, and then the third band
is 90 to 100 percent.
And the lending guidance becomes more punitive the larger
your position.
So you are effectively forced to put the metal back into
the market to make sure that the situation you are concerned
about will not happen.
Senator McCain. I thank you. Thank you, Mr. Chairman.
Mr. Anderson. Thank you.
Senator Levin. Well, we also saw an additional reason this
morning, when we saw how the manipulation of a warehouse and
warehouses holding aluminum, that those activities affect the
value of the financial commodities that Goldman is trading.
So, in addition to the holding of 50 percent or 80 percent
of the copper market, and all that can lead to in terms of
copper itself, where the action relative to the storage of that
entity--in this morning's case, aluminum--can directly affect
the premium paid for that aluminum and where there is trading
that directly relates to that premium and to that LME price,
you have a situation now where those two worlds are linked,
even if that information does not cross that Chinese wall, by
the way.
And I am not going to rely on that. I happen to believe we
have got to have regulations that make that Chinese wall real,
in law. So it is not a piece of tissue paper that can be easily
ignored and where it is difficult to prove that it has been
violated.
We have to have, I believe, regulations and law.
And I am glad, Mr. Greenshields, at least speaking for
yourself, that you would support these Chinese walls, these
separations, being put into regulation or law.
And I wonder, Mr. Anderson, whether you would agree with
Mr. Greenshields on that.
Mr. Anderson. I certainly believe information barriers are
critical.
Senator Levin. Do you think we have to put some law behind
it or just leave it up to the voluntary policy of companies
whose financial interests run exactly in the opposite direction
of the wall?
Mr. Anderson. I do not think they run in opposite
directions.
Senator Levin. Well, sure they do.
Mr. Anderson. If you violate those----
Senator Levin. No, not violate, but isn't it clear that
information is valuable and if you have information about
shipments of whatever and if your traders have that information
and, in the case of aluminum if you can directly, by your
order, by your decision, that you are going to cancel warrants,
that you effect directly in that case, directly, what the
premium is going to be, what the line is going to be, which in
turn is correlated to the premium?
I mean, that is not a matter of information going through a
wall. That is a matter of a decision made by a major holder of
aluminum.
Don't we have to put some force behind those walls?
Mr. Anderson. Again, without having all the facts in how it
would impact the overall organization or the U.S. financial
system, I do not know that I am qualified to answer.
I am happy to say the same thing that my colleague did----
Senator Levin. OK.
Mr. Anderson [continuing]. That from my perspective and for
my commodities business that I co-run, I would see no issue
with that because we abide by the self-imposed ones anyway.
So if they are legal, that would be fine as well.
Senator Levin. All right.
Now, Mr. Agran, let's talk about Goldman's involvement with
uranium.
I will not replow anymore than I already have at this
morning's hearing, but let's talk about uranium.
In 2009, Goldman purchased a company called Nufcor, which
bought uranium from mining companies, stored it and sold it to
nuclear power plants. Nufcor also traded uranium in the
physical and financial markets. Nufcor was a longstanding,
well-known company in the field.
The internal Goldman memorandum that presented the case for
buying Nufcor--and this is Exhibit 9,\1\ page 2--said that
Nufcor had six employees and that Goldman would likely reduce
it to two or three employees.
---------------------------------------------------------------------------
\1\ See Exhibit No. 9, which appears in the Appendix on page 914.
---------------------------------------------------------------------------
None of the employees who worked for Nufcor stayed with the
company when Goldman bought it. So the company directed its own
employees to run the business.
Essentially, Nufcor became a shell operation under the
complete control of Goldman employees who purchased and traded
the uranium, entered into new contracts with nuclear power
plants and dealt directly with the storage facilities.
Now, by making Nufcor a shell company and using Goldman
employees to carry out its business activities, did that not
clearly increase Goldman's potential liability should a
catastrophic event occur?
Mr. Agran. Senator, I do not think that is the case.
Nufcor is a limited liability company, Senator, and our
market-making entity in uranium. And that affords the
shareholders of the LLC, as all LLC structures do, certain
shareholder protections.
Senator Levin. Well, do you think Goldman is going to be
liable for----
Mr. Agran. No, ultimately, I do not, Senator.
Senator Levin. Do you think when Goldman runs a company the
way it did--buys the company. Its people--everyone quits at the
company. Goldman then puts the people in to run the company,
and then it directs its own employees to run the business of
the company.
You think that that limited liability corporation called
Nufcor is going to protect Goldman from liability of a
catastrophic incident?
Mr. Agran. One is on the employee issue. My understanding
is having no employees does not compromise its status as an
independent entity and that it is not unusual for LLCs to not
have employees.
But if I could, could I give you one example, Senator, of
how I even think the market sees Nufcor and understands its LLC
status?
When we transact with utilities, Senator, it is not
infrequent that they would ask Goldman Sachs to provide limited
financial guarantees.
Senator Levin. I am sure of that.
Mr. Agran. Well, but what--so what that is showing is that
the utilities understand that Nufcor--that Goldman is not
liable to Nufcor.
So, in some selective cases, we have granted guarantees for
performance, financial performance on contracts. But we have
not offered anyone a comprehensive guarantee on Nufcor's
liabilities.
Senator Levin. So there are certain circumstances at least
that you would then accept Nufcor's liabilities. There are
certain circumstances.
Mr. Agran. The ones where we financially guaranteed them,
yes.
Senator Levin. Mr. Agran, would you please look at Exhibit
6\1\?
---------------------------------------------------------------------------
\1\ See Exhibit No. 6, which appears in the Appendix on page 866.
---------------------------------------------------------------------------
And on page 6 of that exhibit, Goldman explains to the
Federal Reserve ``While there is no explicit scenario for
environmental/catastrophic damage for any business line or
corporate area, exposure related to participation in commodity
markets primarily resides in the damage to physical assets risk
category in Global Commodities.''
Now here is what you continue to say: ``Global Commodities'
operation risk loss during storage and transportation of its
physical commodity assets is limited to the value of those
assets as catastrophic/environmental risk resides with the
facility operators.''
So as recently as July of last year, Goldman had no capital
allocated for a catastrophic event.
Is that correct?
Mr. Agran. That is incomplete.
If you would like me to elaborate, I can.
Senator Levin. Yes. I am just saying, do you have capital
allocated?
I am not talking about insurance.
I am talking about capital allocated for a catastrophic
event. That is my question.
Mr. Agran. We have capital. Yes, we have operational risk
capital at the firm, Senator.
Senator Levin. For catastrophic events?
Mr. Agran. Would you like me to explain our methodology
because I think that is the easiest way?
Senator Levin. Well, if the answer is yes, sure, or no.
Either way, please explain.
Mr. Agran. I will explain.
Senator Levin. Without answering yes or no.
Mr. Agran. No, we do not have any specific capital. So let
me explain our methodology and how we arrived at that.
Senator Levin. All right.
Mr. Agran. We do a detailed analysis, Senator, including
scenario analysis around environmental risk.
And after that analysis, we concluded that the limited
nature in the way that we engage in these markets and our
comprehensive insurance program; we were not required to hold
any additional capital to the $8 billion of operational risk
capital that we already hold.
Senator Levin. OK, let's take a look.
Are you familiar with the concept of negligent entrustment?
Mr. Agran. Vaguely, yes.
Senator Levin. Well, can, as far as you know, Goldman be
found liable if it negligently hires an incompetent operator,
such as a mining company?
Mr. Agran. Yes, if we negligently entrust commodity or
operations, we could be held liable.
Senator Levin. Or, a nuclear storage facility?
Mr. Agran. Potentially.
But, Senator, can I address the nuclear storage facility?
Senator Levin. Sure.
Mr. Agran. We are only transactional at six facilities.
They are all highly regulated for trading unenriched uranium,
which in your own letter you acknowledge is a nontoxic.
And we trade it in book entry form.
We do not take physical possession. We do not transport it.
We do not process it. We are--our license does not even allow
us to remove it from the facility if we wanted to.
Senator Levin. That is OK. You have answered the point
about negligent entrustment, and that is where the liability
can come in, even with those limitations.
Mr. Agran. Well, can I say one more thing on negligent
entrustment?
Senator Levin. Sure.
Mr. Agran. We do have a vendor vetting process, where we
are sensitive to the fact that negligent entrustment is a
potential liability to us.
We have a physical commodity review committee as well as a
vendor vetting policy, and that allows us to become comfortable
that we will not fall into that situation.
Senator Levin. So I know you have vetting processes. That
is always the case, but sometimes those vetting processes, when
they fail, then the doctrine of negligent entrustment comes
into effect.
So you can be held liable if you negligently entrust
someone.
And believe me; if there are catastrophic accidents here,
cases are going to be made. And then you have got to be in a
position where you can survive those catastrophic events, and
you are not in that position.
But I want to go back to something which Senator McCain
raised, and that is the coal mines in Colombia, owned by
Goldman, operated by third parties hired by Goldman's wholly
operated subsidiaries.
Goldman's commodities trading arm is an exclusive marketing
and sales agent for the coal produced by those mines and
arranges for the sale of 100 percent of the coal. It takes
about 20 percent for itself and then arranges for the sale of
the other 80 percent to third parties.
The mining is done pursuant to operations and plans that
had to be approved by Goldman's wholly owned subsidiary.
And are you saying that despite those facts, no
jurisdiction, not even Colombia, or even a subdivision of such
jurisdiction or any other country, could find that Goldman's
wholly owned affiliate has any liability at all in the
circumstances?
Is that what you are saying?
Mr. Agran. My understanding is, yes, the shareholder
protections that are in place would insulate us from that
liability.
Senator Levin. Going back then to one final question and
then I will end with a comment and then turn it over to Senator
McCain if he has additional questions.
Mr. Agran, take a look at Exhibit 4,\1\ if you would,
please.
---------------------------------------------------------------------------
\1\ See Exhibit No. 4, which appears in the Appendix on page 835.
---------------------------------------------------------------------------
Now this is a presentation by the Goldman Commodities
Division to the Goldman Board of Directors on October 28, 2011.
At the last page, it says, ``Global Commodities Threat from
Non-Traditional Competitors'' and then discusses some of
Goldman's competitors including Glencore.
And then last bullet point says something very important:
Goldman Sachs may command valuation multiples for Goldman Sachs
commodities similar to Glencore if--and here is the comment--
the business was able to grow physical activities unconstrained
by regulation and integrated with the financial activities.
And that is one of my major concerns here is the
integration with financial activities of these commodities
operations.
In a formal presentation, it appears to state that its
object is to integrate physical trading with financial trading.
Am I reading that wrong?
Mr. Agran. You are not reading it wrong.
Senator Levin. I am going to save my closing comment.
Senator McCain. No.
Senator Levin. OK.
When we began this investigation 2 years ago, all three of
your financial holding companies were heavily involved with a
wide range of commodity activities from coal mines to power
plants to natural gas facilities.
Now each one of you is pulling back somewhat.
And I am glad that at least two of the three of you are
pulling back significantly even though we have comments from
the leadership of Goldman Sachs that these physical commodities
are important strategic parts of Goldman Sachs' operation. So
that is a very different kind of an approach than we have heard
today and earlier than today from Morgan Stanley and from
JPMorgan Chase.
This is what the CEO of Goldman, Lloyd Blankfein, was
quoted in the media as saying: The commodities--he is talking
about physical commodities--is a ``core, strategic business''
for Goldman. A core, strategic business.
Your other two companies here seem to be pulling back from
those commodities, and I am glad to hear that.
In an October 2013, earnings conference call, in response
to questions from analysts, Goldman's Chief Financial Officer,
Harvey Schwartz, described commodities as ``an essential
business for our clients'' and said, ``We have no intention of
selling our (commodities) business.''
Again, I am referring to physical commodities.
At the same time, Goldman has recently sold many of its
power plants, and it has put up its uranium, coal, and
warehouse businesses for sale.
And what are the plans, Mr. Agran, for the physical
commodity activities?
Why don't you give us that answer for the record, if you
would?
Mr. Agran. Well, I echo the statements of our executives
for the core market-making activities, Senator. We see those as
analogous to the other market-making activities we are engaged
in at the firm.
As far as purchase of physical assets within the
commodities business, we have no plans to do that in the
future.
Senator Levin. Well, at least two of the three of these
banks apparently are planning to exit the field, although
somewhat gradually, that has caused so much concern, which has
grown so vast, which has created such risk and which creates
such potential for the manipulation of the financial markets.
At the same time, we have a lot of questions about Federal
regulation, as to how it has worked or not worked, relative to
physical commodities and their relationship to financial
commodities.
We are going to hear tomorrow from those regulators to see
what their reaction is to the current state of the world and
how they are going to try to make this financial world of ours
more safe and more fair and less free of the potential of
manipulation. So we look forward.
We thank you, our witnesses, all of our witnesses.
We thank you again for the cooperation of your companies
with our investigation in terms of providing materials.
And I just want to ask my colleague, Senator McCain, if he
has a closing question, and if not, we will stand adjourned
until tomorrow, with thanks to all of you.
[Whereupon, at 4:31 p.m., the Subcommittee was adjourned.]
WALL STREET BANK INVOLVEMENT WITH PHYSICAL COMMODITIES
----------
FRIDAY, NOVEMBER 21, 2014
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The subcommittee met, pursuant to notice, at 9:36 a.m., in
room SD-106, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
Present: Senators Levin and McCain.
Staff present: Elise J. Bean, Staff Director and Chief
Counsel; Mary D. Robertson, Chief Clerk; Tyler Gellasch, Senior
Counsel; Adam Henderson, Professional Staff Member; Angela
Messenger, Detailee (GAO); Joel Churches, Detailee (IRS); Ahmad
Sarsour, Detailee (FDIC); Tom McDonald, Law Clerk; Tiffany
Eisenbise, Law Clerk; Tiffany Greaves, Law Clerk; Henry J.
Kerner, Staff Director and Chief Counsel to the Minority;
Michael Lueptow, Counsel to the Minority; Elise Mullen,
Research Assistant to the Minority; Kyle Brosnan, Law Clerk to
the Minority; Christina Bortz, Law Clerk to the Minority; and
Chapin Gregor, Law Clerk to the Minority.
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Good morning, everybody. This is the second
day of our hearings on Wall Street bank involvement in physical
commodities. Yesterday, we explored the physical commodity
activities of three banks--Goldman Sachs, JPMorgan Chase, and
Morgan Stanley--and heard from bank executives and also from
experts who helped put those activities in context. Today we
are going to explore the implications of our findings and how
to get stronger protections against the abuses, real and
potential, that could damage the banking industry, commodity
markets, and in a worst-case scenario, the U.S. economy and
U.S. taxpayers. We will also focus on how to build stronger
protections against market manipulation and unfair trading by
financial institutions with easy access to capital provided by
the Federal Reserve, that is, by the American taxpayer.
Yesterday's hearing showed that, in recent years, Goldman,
JPMorgan, and Morgan Stanley have been heavily involved in a
wide range of physical commodity activities and businesses,
including building multi-billion-dollar stockpiles of aluminum,
copper, oil, and natural gas, and running businesses like power
plants, oil and gas storage and pipeline companies, and
commodity warehouses. Now, when I say ``banks,'' by the way, it
is shorthand to cover both federally insured banks and their
holding companies.
The evidence presented yesterday showed those Wall Street
banks engaging in vast, complex commercial enterprises that are
eroding the longstanding U.S. principle of separating banking
from commerce.
Yesterday's hearing also showed that at the same time the
Wall Street banks were stockpiling commodities and running
commodity-related businesses, they were engaging in massive
transactions to buy and sell those same physical commodities,
and were also trading commodity-related financial instruments
like futures and swaps.
The simultaneous trading of commodities in the physical and
financial markets raises concerns related to market
manipulation and unfair trading. In 2013, the Federal Energy
Regulatory Commission fined JPMorgan $410 million after finding
that JPMorgan commodity traders used power plants to execute
manipulative bidding strategies that produced profits for the
bank at the expense of electricity customers. We will hear more
about that and other electricity manipulation cases today.
Yesterday, we also heard about a warehouse company,
purchased by Goldman Sachs and overseen by a board consisting
entirely of Goldman employees, that manipulated its warehouse
operations in a way that impacted the price of aluminum for
consumers, while at the same time Goldman was trading aluminum-
related financial products. The Goldman-controlled board of
directors approved the merry-go-round transactions that have
done much harm to consumers and aluminum markets.
Yesterday's hearing also disclosed that Goldman employees
were given access to valuable non-public information from the
warehouse company related to aluminum, information that could
have been used to benefit Goldman's aluminum trading. Both the
warehouse company and Goldman had information barrier policies
in place at the time, but given the recent history of banks
improperly sharing information to manipulate electricity,
LIBOR, and foreign exchange rates, reliance on voluntary
policies at banks that have an economic interest in ignoring
those policies is simply not enough protection for consumers.
Finally, yesterday's hearing disclosed the extent to which
physical commodity activities like uranium trading, coal
mining, and oil and gas activities exposed Wall Street banks to
wide-ranging and unpredictable risks, from natural disasters to
mechanical malfunctions to labor unrest to volatile commodity
prices.
The Subcommittee's investigation and Report are not the
first to expose the problems associated with Wall Street bank
involvement with physical commodities. In 2010, the Federal
Reserve formed its own Commodities Team to conduct a multi-year
special review of the physical commodity activities of ten
large banks. That special review found that the ten banks were
heavily involved in a wide-ranging and expanding set of
physical commodity activities and generally had insufficient
capital reserves and insurance coverage. In fact, the review
determined that four of the banks with the largest physical
commodity activities, including the three examined by the
Subcommittee, had shortfalls ranging from $1 billion to $15
billion to cover potential losses from a catastrophic event.
Should even one of those banks, embedded in every corner of our
economy, experience a catastrophic event for which it is
unprepared, the U.S. banking system could be effected and U.S.
taxpayers be forced to face another bailout.
All this activity was occurring despite, as I have
mentioned, a longstanding separation of banking and commercial
activities and despite the potential threats to the safety and
soundness of bank holding companies. The legal arguments
advanced by the banks to minimize their liability risk are
questionable and likely to be of little comfort in the event of
a natural disaster or a catastrophic accident. The Federal
Reserve should approach those arguments with skepticism and
make sure that its responsibility to protect the financial
system from 2008-style shocks remains paramount. Beyond the
issue of risk, it is urgent that the Federal Reserve also
consider the implications of these activities for the integrity
of U.S. commodity markets and the prevention of market
manipulation and unfair trading by Wall Street banks.
Today, to address these problems, we are going to hear that
the Federal Reserve has made a commitment to issue a new
proposed rule in the first quarter of 2015. That is good news,
although the 2012 findings of the Federal Reserve's own special
review, together with our findings, make that rulemaking long
overdue.
The Federal Reserve is considering arguments that Wall
Street banks provide hard-to-replace services in some of these
areas. But the separation between banking and commerce has
served markets and our economy quite well for decades. And the
erosion of that barrier is clearly doing harm today. Any
discussion of these physical commodities activities must begin
and end with the need to protect our economy from risk, our
markets from abuse, and our consumers from the effects of both.
Wall Street banks with near-zero borrowing costs, thanks to
easy access to Fed-provided capital, have used that advantage
to elbow their way into commodities markets. Bad enough that
this competitive advantage hurts traditional commercial
businesses; worse that it opens the door to price and market
manipulation and abusive trading based on non-public
information.
Today's hearing will receive testimony from Governor Daniel
Tarullo, a member of the Board of Governors of the Federal
Reserve. We will also hear from Larry Gasteiger, the Acting
Director of Enforcement at the Federal Energy Regulatory
Commission, who has had to deal directly with bank manipulation
of the electricity market.
On our first panel, we will hear from Professor Saule
Omarova of Cornell University, one of the first legal experts
to chronicle the rapid and largely underappreciated breakdown
of the barrier between commercial activity and banking; and we
will hear from Chiara Trabucchi of Industrial Economics, Inc.,
an expert in the area of financial responsibility and liability
risk.
The Subcommittee, based on 2 years of investigation, has
recommended a series of actions to rein in excessive risk and
conflicts of interest stemming from Wall Street bank
involvement in physical commodities. Those recommendations
include the issuance of a single, comprehensive limit on bank
holding companies' exposure to physical commodities, no matter
what authority is used to accumulate those holdings. They also
include our recommendations narrowing the scope of the Gramm-
Leach-Bliley authorities that allowed the explosion of Wall
Street involvement in these activities to begin with. And they
include instituting new safeguards to prevent Wall Street banks
from using commercially valuable, non-public information
obtained from their physical commodity activities to manipulate
markets or to gain unfair trading advantages. The
Subcommittee's Report and these 2 days of hearings will help
provide a factual foundation for those and other reforms as the
Federal Reserve, FERC, and other regulators consider new rules
to protect businesses, consumers, and the economy.
On a personal note, it has been a privilege for me to work
with a staff that not only consistently displays knowledge,
tenacity, and dedication, but that represents a true example of
bipartisan cooperation. The staff of this Subcommittee,
Majority and Minority, have done important and lasting work on
behalf of the American people, and I am grateful for all that
they have done.
I can think of no better partner than Senator John McCain.
His dedication to energetic, effective oversight is just one of
his major contributions to the Senate and to our country that
make working with him so rewarding.
Senator McCain.
OPENING STATEMENT OF SENATOR McCAIN
Senator McCain. Thank you very much, Mr. Chairman. Thank
you for your kind words.
Yesterday, we heard about how large financial institutions
are engaging in manipulative practices in physical commodities
markets. Over 6 years after the financial crisis, these banks
still think they are too big to fail. And, indeed, they
probably are. And they have been taking on new risk that could
lead to more bailouts by the American taxpayer through shady
merry-go-round transactions and large purchases in commodities
markets. These financial institutions have driven up costs for
end users of materials like aluminum and ultimately hurt
ordinary consumers.
The banks could not have engaged in these activities
without the permission of regulators. The Federal Reserve in
particular has the power and the responsibility to make
important changes that would prevent the sorts of abuses that
have been illustrated in this hearing.
While the Federal Reserve claims in its written statements
that it has monitored this situation and explored possible
actions, it has clearly not done enough to prevent harmful
commodity activities by the banks. And the persons who
ultimately are harmed by all of this, of course, is the average
consumer, the average citizen, who has no knowledge, unless it
paid attention to this hearing, of the extent of the
manipulations that have been carried out by the largest
financial institutions in America and, indeed, probably the
world.
I look forward to hearing from the witnesses why the
Federal Reserve has allowed the problems identified by the
Subcommittee to fester in our financial system and how it
intends to fix them going forward.
I thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator McCain.
And I now would like to call our first panel of witnesses
for this morning's hearing: Ms. Saule Omarova, a Professor of
Law at Cornell University, Ithaca, New York; and Ms. Chiara
Trabucchi, a Principal at Industrial Economics, Incorporated,
Cambridge, Massachusetts.
We appreciate both of you being with us today. We look
forward to your testimony, and pursuant to our rules, all
witnesses who testify before the Subcommittee are required to
be sworn, and at this time I would ask both of you please to
stand and to raise your right hand. Do you swear that the
testimony you are about to give to this Subcommittee will be
the truth, the whole truth, and nothing but the truth, so help
you, God?
Ms. Omarova. I do.
Ms. Trabucchi. I do.
Senator Levin. We will use a timing system today. About a
minute before the red light comes on, the light will change
from green to yellow. That will give you an opportunity to
conclude your remarks. Your written testimony will be printed
in the record in its entirety. We would appreciate it if you
could try to limit your oral testimony to 5 minutes.
Ms. Omarova, we will have you go first.
TESTIMONY OF SAULE T. OMAROVA,\1\ PROFESSOR OF LAW, CORNELL
UNIVERSITY, ITHACA, NEW YORK
Ms. Omarova. Chairman Levin and Senator McCain, thank you
very much for an opportunity to testify here today. My written
statement and prior writings lay out in sufficient detail my
views on this subject, so I will keep my remarks to a few key
points.
---------------------------------------------------------------------------
\1\ The prepared statement of Ms. Omarova appears in the Appendix
on page 282.
---------------------------------------------------------------------------
I will recap briefly why, from the perspective of U.S.
banking history, policy, and law, such involvement raises
potentially significant concerns and, therefore, demands
serious legislative and regulatory attention.
I will also briefly address some of the main arguments
against restricting banks' physical commodity activities
typically advanced by banks themselves, their agents, and
clients.
Those advocating the regulatory status quo often claim that
there is nothing new or special and, therefore, nothing
problematic about allowing banks to run physical commodity
operations. These industry advocates tend to sample episodes
from ancient or medieval European or Asian history to prove
that banks in general have always been natural commodity
traders.
This cherrypicking from foreign countries' distant past,
however, is irrelevant for purposes of interpreting U.S.
banking laws and regulations, which are based on the
longstanding American tradition of keeping banks out of any
non-banking commercial businesses.
The principle of separation of banking from commerce has
always been and continues to be the cornerstone of the U.S.
banking financial system. This structural separation has been
traditionally viewed as necessary in order to preserve the
safety and soundness of the U.S. banking system by shielding
banks from the risks of commercial activities, to ensure a fair
and efficient flow of credit in the economy by preventing
unfair competition, market manipulation, and banks' conflicts
of interest, and to prevent excessive concentrations of
financial and economic power.
Early American bank charters were granted by State
legislatures and typically prohibited chartered banks from
dealing in merchandise. In 1825, New York became the first
State to restrict banks' activities by statute. The National
Bank Act of 1863 limited federally chartered banks' activities
to those in the narrow band of ``the business of banking''
alone.
The Bank Holding Company Act of 1956 extended the same
principle to banks' parent companies, or bank holding
companies, or BHCs, by generally limiting their activities to
those closely related to banking.
The passage of the Bank Holding Company Act marks the
beginning of the truly relevant history for banks in
commodities. Since 1956, for any U.S. banking organization, the
decision to participate in the production, processing,
transporting, or trading physical commodities, all purely
commercial activities, has never been just a matter of their
own or their clients' profitability or convenience. It is first
and foremost a matter of their legal authority. In order to
enter the physical commodity supply chain at any point and in
any capacity, a bank or any bank affiliate has to find a
specific legal or regulatory authorization to do so. And what
this means is, that under U.S. law, these types of business
decisions are deemed too important to be left purely to
individual banks' managers and owners, and instead are
fundamentally linked to broad considerations of public policy.
The Gramm-Leach-Bliley Act of 1999 amended the Bank Holding
Company Act to allow a subset of bank holding companies,
financial holding companies, or FHCs, to expand their
commercial activities subject to certain limits. As we know
now, since the early 2000's, several large U.S. FHCs have
availed themselves of these newly created statutory powers to
grow extensive physical commodity operations.
As I argued before, this trend undermines the fundamental
principle of separation of banking from commerce and raises a
wide range of potentially significant policy concerns with
safety and soundness of financial institutions, systemic risk,
potential public subsidy leakage, market integrity, consumer
protection, the sheer governability of financial institutions,
regulatory capacity to oversee them, and excessive
concentrations of financial and economic powers.
The banking industry, of course, dismisses all of these
policy concerns as irrelevant. The industry's claims, however,
are generally familiar. Banks make them every time they object
to any attempt to regulate their activities. These arguments
are typically either nonresponsive, nonsensical, or patently
false.
For example, the typical nonresponsive argument is that
banks' commodities trading benefits their clients. Even if it
were true, that argument completely ignores the fundamental
question: To what extent those private benefits to individual
clients stem from banks' access to public subsidy.
An example of a nonsensical argument is the industry's
claim that, because nothing bad has happened yet, there is no
reason to worry that it might happen in the future. And, of
course, this claim could have been made about the Deepwater
Horizon accident up until the day it actually happened.
An example of a patently false claim is an assertion that
oil drilling is no different from making mortgage loans and
that banks manage all of these risks perfectly well. In fact,
oil is different from money, and traditional credit
intermediation is different from trade intermediation. And
claims of perfect risk management are questionable without
specific proof, even with respect to banks' core financial
activities, let alone things far outside the realm of their
traditional expertise.
So these are just a few examples of the banking industry's
arguments, all of which essentially distract attention from the
real questions and, in effect, deny the American public the
answers we deserve. I urge lawmakers and regulators not to lose
sight of what is really at stake in this important public
policy debate.
Thank you very much.
Senator Levin. Thank you very much, Ms. Omarova.
Ms. Trabucchi.
TESTIMONY OF CHIARA TRABUCCHI,\1\ PRINCIPAL, INDUSTRIAL
ECONOMICS, INCORPORATED, CAMBRIDGE, MASSACHUSETTS
Ms. Trabucchi. Chairman Levin and Ranking Member McCain,
thank you for the invitation to testify in today's hearing. My
name is Chiara Trabucchi, and I am a Principal with Industrial
Economics, Incorporated, in Cambridge, Massachusetts. My
expertise relevant to this matter is in environmental risk
management and financial assurance frameworks.
---------------------------------------------------------------------------
\1\ The prepared statement of Ms. Trabucchi appears in the Appendix
on page 302.
---------------------------------------------------------------------------
My testimony focuses on the environmental and catastrophic
event risks that confront businesses involved with physical
commodity activities as well as mitigating strategies adopted
by financial holding companies to manage these risks.
My remarks today address the consequences of these
companies engaging in commodity-related activities, including
investments in industrial facilities such as power plants,
pipelines, natural gas facilities, and refineries.
Businesses involved with these types of activities face
specialty or non-standard risks. Incidents documented in the
public record evidence that activities involving the
extraction, storage, transport, or refining of natural
resources can cause several types of injury including, for
example, human health effects, fatalities, ecological damage,
property damage, business interruption, or surface/subsurface
trespass. The means by which injury occurs often vary by
commodity type; common pathways include pipeline rupture or
explosion, impoundment failure, mine collapse, contaminant
release, industrial accident, mechanical failure, or transport
accident.
History has shown that catastrophic events involving
environmentally sensitive commodities can result in incident
response costs and compensatory damages that exceed the market
value of the commodity involved; a single environmental or
catastrophic event can result in billions of dollars in
incident-related expenditures. In some cases, financial impacts
can exceed the available capital and financial assurances of
the businesses involved, resulting in bankruptcy.
Prudent risk management dictates that firms operating in
these sectors establish risk mitigation strategies to mitigate
and minimize the likelihood of an environmental event and, if
an event should occur, have the financial resources to remain
financially responsible for their actions.
By doing so, the firm is better able to assure
shareholders, whether public or private, that the value of
their investment will not erode and, with time, will gain
value. Traditional environmental financial assurance models
require that risks be mitigated either directly as an expense
or indirectly through third-party financial instruments,
including, for example, insurance.
In an effort to avoid the need for, or minimize the amount
of, third-party financial assurances or committed capital,
firms with business ventures in physical commodity markets may
choose to employ other risk-mitigating strategies.
One strategy involves reliance on the corporate veil as a
legal shield. In the context of environmental risk management,
this strategy involves establishing a series of holding
companies whereby the facility engaged in activities directly
related to the physical commodity is separated from the top-
tier parent company by a series of corporate layers. It also
may involve spinning off the liabilities of a physical
commodity business into a shell corporation to shield the
assets of the top-tier parent company. In either case, the
financial holding company believes itself shielded from legacy
environmental liabilities or catastrophic events occurring at
the lower-level subsidiary or affiliate.
A second mitigating strategy is to engage in physical
commodity activities in foreign markets with less sophisticated
environmental regimes than those present in the United States.
In so doing, the financial holding company believes that it,
and the U.S. taxpayer, is insulated from environmental risks at
the foreign subsidiary.
A third mitigating strategy is to undervalue expected loss
scenarios. One approach, for example, is to assume that
ownership of the asset or physical system will transfer to
another entity prior to an environmental or catastrophic event
occurring. Merchant banking investments can be held only for a
limited amount of time. Thus, financial holding companies may
underestimate the environmental risk exposure because the
physical asset forms part of its portfolio only on a short-term
or transitory basis.
All of these risk-mitigating strategies can contribute to
moral hazard where the financial holding company believes
itself insulated from risk and, therefore, may act imprudently
with respect to the nature and scope of its involvement with
physical commodity-related activities. The consequential
impacts of these strategies vary, but may include assigning an
artificially low risk premium to environmentally risky
ventures, limiting disclosure of contingent liabilities
associated with environmental or catastrophic events, and
delaying or avoiding needed infrastructure improvements. Any
reluctance to make capital improvements can place the financial
holding company at potentially greater risk of environmental
and financial consequences when compared to peers that upgrade
their infrastructure. It also may yield a short-term
competitive advantage over market participants who do undertake
long-term capital investments.
Further, when the time comes to divest its merchant banking
investment, the financial holding company may find it
challenging to find a buyer who is willing to absorb the risk
profile of potentially long-tailed legacy liabilities.
To the extent the financial holding company does record a
probable loss, it may assure only the lost market value of the
commodities involved and not the expected value of incident
response costs. Further, the company may argue that even if
deemed liable for an environmental event, the amount of
liability is negligible when measured against its overall
capital structure.
The failure to recognize the breadth of potential exposure
arising from its involvement in physical commodity activities,
coupled with the failure to maintain sufficient financial
assurances, could compromise the stability of the financial
holding company and its subsidiary depository institutions.
This could lead to an inappropriate risk transfer to the public
in the event the holding company and its non-banking subsidiary
are unable to meet their financial obligations. To the degree
the affected company is a global systemically important bank, a
risk transfer of this sort may send a potentially destabilizing
shock through the financial markets.
The financial crisis of 2008 highlighted the speed with
which a global market contagion can take effect when a large
corporation undervalues its long-tailed risks.
Notwithstanding the varying degrees of supervisory
standards and capital ratios imposed on financial holding
companies engaged in physical commodity activities, the ability
of these companies to meet prescribed ratios may be immaterial
if they have undervalued the long-tailed environmental risk
exposure of their investments, either because they believe they
will be legally insulated from liability or because they
believe they are too big to fail.
In the event the strength of the capital ratio is diluted
and risky investments proceed because the potential financial
consequences of prospective environmental liabilities are
undervalued, then some or all of an unfunded liability may be
left for the U.S. taxpayers to bear in the event of an
environmental or catastrophic event. My written testimony
further elaborates on these areas.
I would be pleased to answer any questions. Thank you.
Senator Levin. Thank you very much, Ms. Trabucchi.
Professor Omarova, please take a look at a chart, which is
Exhibit 1h,\1\ and we are going to put the chart, our larger
version of it, up for everybody to see. This was a chart that
was prepared by JPMorgan in 2011 when it owned or had tolling
agreements with 31 power plants across the country, and also
owned or leased gas storage facilities for about 78 billion
cubic feet of natural gas since it was supplying natural gas to
a number of those plants.
---------------------------------------------------------------------------
\1\ See Exhibit No. 1h, which appears in the Appendix on page 823.
---------------------------------------------------------------------------
Now, when I look at this network of power plants and
natural gas storage facilities, it strikes me as a vast
commercial, industrial venture, not a banking activity. How
does it strike you?
Ms. Omarova. Well, it strikes me as actually a terrifying
picture of what is going on here. As a former banking attorney,
to me this is precisely what the law did not mean to happen at
all. This is a financial-industrial conglomerate, and it is not
just the law itself that seems to be offended by this type of a
picture. But there is a general expectation among American
citizens and taxpayers that our banks are doing banking
business.
I talk a lot to various people, my friends, who are not
necessarily banking lawyers; they have no idea about this stuff
going on. They are nurses, cab drivers, and engineers. And when
I tell them the research I have been conducting in the past 2
years, they are invariably shocked. And no matter what JPMorgan
says about why this type of expansive network of power and
other commercial activities is absolutely necessary to them in
order to provide financial services to the people, I think they
are missing something very important in that core, shared
intuition that we all have: banks should not be doing this
stuff.
Senator Levin. And what about the risks, Ms. Trabucchi?
Ms. Trabucchi. Well, I think when you have an organization
that is this diversified where the span of it is across so much
of the United States, and you are involved in physical
commodity activities that are highly sophisticated in nature,
and that result in highly sophisticated degrees of risk, I
think it is a very dangerous proposition to have that
consolidated in a portfolio where you have different actors who
are not necessarily as sophisticated about how to manage those
risks as they are in their inherent industry, which is finance.
The environmental risk profile and the financial risk
profile are inherently different, and so the tools and
techniques that are used to manage environmental risks are not
the same as those used to manage financial risk.
Personally I think that this is a very troubling trend, and
it is a recent trend. And so to the degree it continues or
expands, I think the environmental risk profile will grow.
Senator McCain. Mr. Chairman, could I interrupt a second?
Senator Levin. Please.
Senator McCain. As follow-up to that in general, as we see
this expansion--in one case at one time one of these
institutions owned 80 percent of the entire supply of copper
that is traded on the exchanges--am I exaggerating too much
when I say this is reminiscent of the days of the robber barons
when the railroads were controlled by one individual? And,
again, when you corner the world that traded supplies of a
vital commodity, in that case copper, I was astounded by that.
Maybe you could respond to that. Am I too alarmed?
Ms. Omarova. Absolutely not. I am really glad you said
that. That is precisely that back almost 100 years ago, this
country was up in arms against: This kind of seamless wedding
of money and control over raw materials and transportation and
pure commerce. Right? Because we were worried about the fact
that people who control money and control raw materials can
control too much of our society in general. And it does not
matter that today, in 2014, we appear more sophisticated, we
have greater technology, and we can say, well, there are all
these mathematical models that somehow make this picture less
alarming. Ultimately at its core, it is just as dangerous as it
was 100 years ago.
Ms. Trabucchi. From my perspective, again, my background is
environmental risk management and financial indemnity models. I
think what is troubling is you have actors who are inherently--
that the public inherently believe are there to provide
financial credit and to provide--or assist in financial
assurance. And often those are the actors to whom your
commodity actors go in order to help assure their risks.
Now what you have is a combination of--or a concentration
of activities in one sector, and so they are self-regulating.
And, in my view, whenever you have self-regulation, it torques
your risk profile, and you do not have the checks and balances
necessary to make sure that the financial assurances map to the
probable risk profile and map to the loss ratios, because the
sectors are too interconnected.
So when you are calculating a probable loss ratio and you
are the one who is going to incur the loss, there is a moral
hazard that arises. You do not have the incentive to
appropriately manage your risks because you are also banking
your own----
Senator McCain. Because you are not taking the risk.
Ms. Trabucchi. Well, they would argue they are not taking a
risk. I think that you are talking to somebody who believes----
Senator McCain. But that is what I mean. I mean there is no
risk to them under this----
Ms. Trabucchi. It is a risk to the U.S. taxpayers.
Senator McCain. Right.
Ms. Trabucchi. The presumption is that there is a de facto
public-private risk-sharing arrangement where the public has
not necessarily been privy to that the arrangement. And I think
that is the danger here; the inherent model of environmental
law, environmental regimes, is to place environmental risk with
the actor who incurs that risk and ensure that they remain
financially accountable and financially responsible, not the--
--
Senator McCain. Which in this case, under their structure,
they are not responsible.
Ms. Trabucchi. Well, I think it is a matter for the courts.
I think if there is an event----
Senator McCain. Should it be a matter for the courts, or
should it be unequivocal, the responsibility? And I apologize,
Mr. Chairman----
Senator Levin. No. Please.
Senator McCain. But it raises up just one more question for
both of you. After the terrible financial collapse of 2008, one
of the commitments we all made--Republican, Democrat,
administration, all of us--was that none of these institutions
would ever again be too big to fail. I would like to ask your
opinion. Given a lot of the information that we have just seen,
have we achieved that goal or come to close to it, anywhere
near it?
Ms. Omarova. Well, not only did they not become smaller and
less likely to fail, or come to the brink of failure, and much
easier to resolve without any public bailouts, but to the
contrary, particularly in this physical commodities area, they
have grown much bigger. Not only are they bigger in terms of
their size, but they have actually made themselves, according
to them, their own advocates, indispensable not only as
providers of finance but as providers of coal, jet fuel, oil,
natural gas, aluminum, copper, and so on and so forth, or at
least actors in the supply chain that have a lot of control
over the availability of those raw materials.
So, in effect, they are acquiring businesses that
potentially can make them even more important to be bailed out
or at least to claim they need to be bailed out, should
anything happen. And it also creates new and unfamiliar,
unstudied to this day, channels of transmitting risk, systemic
risk, from finance into these non-financial areas and vice
versa.
So now, for example, if it is true that JPMorgan and
Goldman Sachs are so uniquely indispensable to all of those end
users out there in the real economy who need jet fuel or
electricity, and suddenly something bad happens in their
financial businesses--which usually seems to happen
periodically--and somehow they are on the brink of a failure
and there is a question, ``Should we let them fail?'' And
suddenly policymakers will have to deal with the potential
impact of letting them fail on those various utilities and
airlines, and whoever they are.
And so that to me is another factor to start doubting that
the problem of ``too big to fail'' is being resolved. I think
it is being exacerbated.
Ms. Trabucchi. I think the precept here is they should not
be allowed to be too big to fail, that when you are talking
about environmental risk management and financial assurance,
every actor in every industry in every function that they
provide, they should remain financially accountable. And there
are numerous----
Senator McCain. Do you believe that they are----
Ms. Trabucchi. Presently too big to fail? As I sit here
right now, not having done a review of their specific financial
holdings, I am not prepared to say with certainty one way or
the other. What I will say is, again, they should not be
allowed to be too big to fail. They should not be engaged in
activities that are beyond their risk profile or beyond their
ability to manage their risk profile. Some of the information
that I read in the Subcommittee Report suggests that they do
not know how to analyze or quantify probable loss scenarios, it
is actually not true. There are industries specifically
designed to measure and monetize risk. They are choosing not to
do so. And so to the degree, I think, regulators allow them not
to, then they are enabling too big to fail, and they do not
need to do so.
Senator McCain. Sorry for the interruption, Mr. Chairman,
but I thought your line of questioning begged these additional
questions. I thank you, Mr. Chairman.
Senator Levin. That was very on target.
As a followup of that, one of the issues here, the
differences between a regular oil and gas company and the
financial holding company is their capital ratio. So an oil and
gas company has a capital ratio on average of 42 percent.
Financial holding companies have an average capital ratio of 8
to 10 percent.
Professor Omarova, tell us, what does that mean? And what
is the difference? What is the significance of those numbers?
Ms. Omarova. Well, when we speak of capital ratios, what we
are really talking about is the amount of financing that a
particular company raises from its own private owners, from its
shareholders, as opposed to from creditors. So we are talking
about leverage.
So, for a regular oil company or a commodity company that
you refer to, that ratio, that 42 percent is not necessarily
dictated by law. It is the market, the free market that
determines that in order for the creditors to really be willing
to deal with that company, they want to see more of the
financing coming from the owners as opposed to other lenders.
And banks and financial institutions are very different in that
respect. They can operate, and they are expected frequently to
operate in their financial businesses, with a lot higher amount
of leverage. That is why they are regulated.
But that privilege, what it means is that financial
institutions, especially banking organizations, get the public
backup in case something goes wrong, and the creditors are
still willing to deal with this company with low capital,
right? Because they know that somehow the U.S. Government will
back up those liabilities ultimately. And that is a tremendous
advantage because what it means is that----
Senator Levin. The advantage to the banks.
Ms. Omarova. To the bankers, of course. That is why all of
the banks' clients, for example, are currently, crying that,
oh, my goodness, if you kick banks out of this business, then
we will have to deal with less ``creditworthy counterparties.''
What that really means is that those counterparties out there
in the market do not have that kind of public subsidy, because
banks should not be more creditworthy by market standards. Look
at their capital levels, 8 percent versus 40 percent, right?
There is no reason to think that this is a better counterparty
to deal with but for the public backing that banks enjoy, and
that is a tremendous advantage over other non-subsidized
private companies in the market.
Senator Levin. You made reference to concentration of
power, and we heard yesterday about a severe concentration of
power in the aluminum storage market. And here is what has
happened, and I do not know if you have read the Report, but
let me try to summarize it.
Goldman Sachs acquired a large warehouse business in 2010
called Metro, and after Goldman acquired Metro, Metro tripled
the incentives that it paid to attract aluminum to its many
warehouses in the Detroit area. It paid millions of dollars in
incentives to existing warehouse clients to engage in what we
call ``merry-go-round deals,'' and here is the way it worked.
The warehouse clients agreed to cancel what are called
``warrants.'' These are warrants of the London Metal Exchange.
This lengthened the queue to get out because if the warrant is
canceled, you have to then get in line to get your aluminum out
of the warehouse.
And then what they did was they canceled their warrants--
they were paid to do this--lengthened the queue to get aluminum
out of these warehouses, and the result was the following: That
the line, the queue, to remove metal from these warehouses went
from 40 days to 665 days, forcing metal owners to wait nearly 2
years to get their metal out of storage.
Now, what happened is that Metro built a virtual monopoly
on the U.S. London Metal Exchange aluminum storage market. They
captured 85 percent of the market share by 2014. The longer
lines which resulted requiring that these warrants be canceled
in order to get the subsidy resulted in and were correlated to
the tripling of a premium for aluminum. To buy aluminum, you
have to pay a premium plus a London Metal Exchange cost, but
the premium is a big part of the price, and a big growing part
of the price for aluminum.
So Goldman owns warehouses and is directly involved in a
decision to increase the line from, again, usually a few days
to 600 days, which is correlated with a dramatic increase in
the premium that people pay for aluminum. And at the same time,
Goldman, through its financial transactions, is involved in the
price of aluminum, futures for aluminum, swaps for aluminum,
and they have this information because they are involved in the
decision and the payment to people to effectively lengthen the
line by going into queues. And there is a direct correlation
between a longer line and the premium that is paid for
aluminum.
Now, that may sound kind of complicated, and it is. But
that is the kind of concentration of power that involves market
manipulation through the use of these warehouse operations. And
it is information which Goldman not only is privy to, unlike
anybody else, except the people running the warehouses for
them, they are creating the situation themselves. It is not
just knowing of information which affects the value of aluminum
futures in which they are dealing. They are actually creating
the situation as well as learning of the situation. And so they
are involved in these merry-go-round deals, and I guess the
question--they have obvious informational advantages in their
derivatives trading operations.
Now, did you read the Report or is this familiar enough to
you now that you can give us a reaction to this?
Ms. Omarova. Well, this is familiar to me enough. Of
course, no one can ever claim that what Goldman Sachs is
actually doing within its operations is fully well known to
them, unless you are part of their operation. And I did not see
yesterday's Goldman Sachs executives' testimony. I have read
some reports that indicate that it was an act worth seeing.
However, this is a very interesting situation that
exemplifies precisely the dangers from the market integrity
perspective of allowing large financial institutions that are
active in creating and trading financial instruments linked to
prices of commodities, on the one hand, to enter businesses in
the actual physical commodity supply chain, so that they cannot
only get some information from these operations but actually be
able to physically move the prices.
And, of course, they will tell us--and they probably did
tell you yesterday--that none of that is happening, everything
is absolutely cleanly separated, and they are really only doing
it for the best of the society. But the reality of it is that,
why would a financial institution, for example, even try to
become a warehousing company? Until very recently, metals
warehousing did not look like the kind of hot business that all
the banks were really getting into, right? There must be a
reason for them to extend themselves so that they actually own
warehouses. And the reason is precisely their ability to devise
and implement much more complex strategies for profiting from
these prices, not only by extracting rental income from the
warehousing or even by raising certain aluminum prices in
certain markets, but also by perhaps engaging in very complex
financial games around that stuff.
And once that kind of a game starts determining what is
happening in the market for aluminum, for example, that really
distorts the dynamics that have been present for decades and
centuries. And so everything becomes a lot more difficult to
understand: Why things are happening the way they are
happening. And perhaps that is part of the reason why it is so
difficult for us to argue with Goldman Sachs executives on the
specifics--``have you manipulated, have you not manipulated?''
But if you kind of step away from the specifics and look at
what exactly is happening, it is quite clear that this is an
extremely troubling trend, and it should NOT be allowed to
continue.
And, for example, the very fact that those ``merry-go-
round'' clients are primarily financial institutions, those
clients are the clients of Goldman Sachs in its capacity as a
financial institution. So perhaps if it were not Goldman Sachs
but some bona fide metals warehousing company that was running
Metro's warehouses, that company might not have been able to
create such incentives and to pay that much money to producers
of aluminum to store aluminum in its warehouses, on the one
hand, but also to find those types of convenient clients to
engage in this merry-go-round that they can find because they
deal with these hedge funds and private equity funds and
whoever they are.
And this is a very important factor to keep in mind when we
think about the concentrations of power and the new forms of
manipulation that may be taking place there.
Senator Levin. Thank you.
Senator McCain.
Senator McCain. I think I have asked my question, Mr.
Chairman, but Ms. Omarova raised this: Why would Goldman Sachs
want to get in the warehouse business? That is a very
interesting question, and I wonder if they have ever been in
the warehouse business anywhere else in America.
I thank you, Mr. Chairman.
Senator Levin. Thank you. I just have one additional
question, I guess, of Professor Omarova. Banks have been found
to have engaged in serious manipulative conduct involving
things like electricity prices and LIBOR and foreign exchange
rates and more. Those same banks have access to near-zero
interest rates to borrow money and lower capital requirements
that almost any private sector company conducting physical
commodity activities which do not have that kind of huge
advantage. So cheaper credit and lower capital requirements
translate into clear competitive advantages when banks start
getting into commercial businesses, as you have pointed out,
like power plants, oil storage facilities, coal mining, and so
forth.
Now, since the Federal Reserve is the source of those
competitive advantages, does it have a responsibility to ensure
that banks do not use those competitive advantages to engage in
market manipulation or unfair trading?
Ms. Omarova. The short answer is yes. The Federal Reserve
absolutely has the responsibility to ensure that financial
holding companies through their many commercial subsidiaries or
otherwise do not conduct activities that are essentially taking
unfair advantage of their access to a public subsidy system.
And it is disheartening to me that the Federal Reserve has not
done so, and even when the Federal Reserve actually was forced
to publicly state its intent to look into this issue last year,
in 2013, after some hearings in the Senate, even then their
focus seems to be mostly on the safety and soundness of the
financial institutions themselves.
It is a very important issue, no question about that. But
it is by no means the sole issue at stake here. The Bank
Holding Company Act historically was adopted as an anti-
monopoly, antitrust kind of an act, and that spirit of the Bank
Holding Company Act needs to be upheld today in the face of
these kinds of activities, these kinds of charts being shown to
us here. And it is the Federal Reserve's primary responsibility
to make sure that whenever a financial holding company gets
into any non-financial business, that the financial company
produces specific ongoing proof to the Federal Reserve, as our
agent and a watchdog on behalf of the American taxpayer, that
the extraordinary step of extending public backup for private
companies' liabilities, stuff that we do with banking
institutions, is not extended throughout the economy without
the American taxpayers knowing about it. That is absolutely an
important point, and that is precisely the point that to this
day we have not seen addressed by the regulators or the
industry.
Senator Levin. Ms. Trabucchi, the three financial holding
companies have all told us that they have been careful to set
up their affairs so that they do not directly own or operate a
physical commodity facility, and so they cannot be held liable
for losses. I think Senator McCain asked a question like this
yesterday about if BP were a bank, I think was the question he
asked, so let me ask--it is really his question. If BP were a
bank, what would be the impact on that bank of that oil spill?
Ms. Trabucchi. Well, thankfully, BP is not a bank If you
look at BP's recent Fiscal Year end 2013 annual report, you
will see that they have recorded losses or anticipated losses
of approximately $43 billion with incident-related expenses to
date in the realm of approximately $25 billion.
I think that the challenge you have are these financial
holding companies believe that the legal shield they have
instituted through a series of corporate veils, whether that
corporate veil involves holding companies or shell companies or
investing in subsidiaries and affiliates in foreign countries,
that the legal shield is a de facto shield from financial
responsibility. And I think what the Deepwater Horizon spill
has shown, as well as several other incidents in the public
record, is that parent companies do end up becoming financially
responsible for the activities of their subsidiaries and
affiliates, not simply because they are liable or not liable,
but there are many other reasons why they might choose to do
so.
So, from a financial perspective, I think it is dangerous
for financial holding companies to engage in a multiplicity of
physical commodity-related activities with the presumption that
there is no risk, and if there is a risk, the legal shield will
protect them, and if the legal shield does not protect them,
the amount is negligible and, therefore, not worthy of
recording on their financials, I think that is a very dangerous
prospect for the banks, and I think it is a dangerous prospect
for the U.S. taxpayer. There are numerous other incidents. I
think Deepwater Horizon is one with which the public is
familiar. But there are many other environmental and
catastrophic incidents that are billion-dollar incidents.
Senator Levin. Now, during our investigation, Ms.
Trabucchi, we came across some fact patterns which were
unusual, to put it mildly. We found, for instance, that Morgan
Stanley had used three shell companies, known as ``Wentworth,''
to build a compressed natural gas facility. Those companies had
no employees or offices of their own. They were managed and run
by Morgan Stanley employees. They were located in Morgan
Stanley's Commodities Division's offices in Purchase, New York.
Does that type of shell arrangement increase the chances
that Morgan Stanley would be held liable if that plant were
struck by a disaster?
Ms. Trabucchi. In my opinion, yes.
Senator Levin. Now, how about the situation at Goldman
where it bought a uranium trading company, Nufcor, and the
employees that ran the business left, Goldman employees took
over running the business? Does that fact pattern increase
Goldman's potential liability?
Ms. Trabucchi. Assuming those employees were involved in
the direct operation of the facility, then yes.
Senator Levin. And what about a situation involving
JPMorgan which directly owns three power plants but in each
case it contracted with a third party to run the plant? Now, as
a direct owner--what is your reaction to that?
Ms. Trabucchi. Under various legal case precedents, if you
are a direct owner or operator of a facility that has an
environmental incident, you could be held directly liable for
the actions of that subsidiary. I think when you are talking
about contracting the activities, then it becomes a little bit
more nuanced. And I think that the notion of contracting,
really again it gets down to direct operations. Was one party
directing the other party to operate a facility or operate
activities in a certain fashion that resulted in an
environmental incident?
Senator Levin. Ms. Trabucchi, the financial holding
companies that we have looked at have hundreds of billions,
sometimes trillions of dollars in assets, and some have claimed
that even a catastrophic event would not have a significant
impact on their finances or their stability. But isn't it
correct that most of those trillions of dollars belong to their
clients and that almost all banks have capital ratios, again,
of less than 10 percent, meaning that if disaster strikes, they
do not have sufficient funds to deal with the fallout?
Ms. Trabucchi. Yes, I think this is an interesting point
and an interesting question, because I think that this is an
area where you can see the most difference between financial
holding companies operating in physical commodities and actual
industrial actors who are familiar with the sophisticated
nature of their commodity and their industry.
Generally speaking, those actors who are in the physical
commodity business must comply with very sophisticated
environmental laws and environmental regimes that require
financial assurance. And those financial assurance
instruments--for example, insurance, surety bonds, potentially
putting in place a trust fund--also allow for self-insurance
where you can benchmark the strength of your financial
statements against the facility's risk profile.
What you need to do is evidence solvency and liquidity,
which are often multiples of the prospective monetized risk. It
is not just a measure of the size of the entity.
So I think the short answer to your question is just
presuming a capital ratio is sufficient to benchmark financial
assurance for environmental risk is short-sighted.
Senator Levin. Exhibit 6,\1\ in that document this is what
Goldman said to the Federal Reserve----
---------------------------------------------------------------------------
\1\ See Exhibit No. 6, which appears in the Appendix on page 866.
---------------------------------------------------------------------------
Ms. Trabucchi. I am sorry. Did you say----
Senator Levin. It is on page 6 of Exhibit 6, and I will
read it, which may or may not obviate the need to find it in
that huge book of exhibits.
Ms. Trabucchi. OK.
Senator Levin. Here is what Goldman said to the Federal
Reserve: ``While there is no explicit scenario for
environmental [or] catastrophic damage for any business line or
corporate area, exposure related to participation in commodity
markets primarily resides in the damage to physical assets risk
category in Global Commodities.''
Now, then Goldman continued as follows: ``Global
Commodities' operational risk loss during storage and
transportation of its physical commodity assets is limited to
the value of those assets as catastrophic [or] environmental
risk resides with the facility operators.''
So as recently as July of last year, in other words,
Goldman had no capital allocated for a catastrophic event,
which is what a Goldman executive confirmed in his testimony
yesterday.
Do you have a reaction to that?
Ms. Trabucchi. Well, I think, again, this gets back to this
concept that they presume the legal shield is strong enough
that it obviates them from any financial accountability or
financial responsibility. And as I said, I think incidents,
recent incidents in the public record evidence that a legal
shield perhaps is not the best risk management strategy when
you are working in the physical commodities sector. And I also
think it is not a reasonable risk management strategy to
presume no risk or to presume that if there were risk and it
were monetized, that you are simply too big to fail and,
therefore, that risk does not need to be assured.
Senator Levin. Ms. Trabucchi, in your prepared testimony
you talk about financial holding companies making transitory
investments in commodity businesses like power plants, natural
gas facilities, and oil and gas pipelines, and you also
commented on that in your oral testimony. You point out that
they plan to hold the investments for only a few years and are
essentially betting that a catastrophic event will not take
place while they own or lease the facility. How important,
again, is that transitory factor?
Ms. Trabucchi. Well, I actually think it is quite important
because what we are talking about is forecasting probable loss
scenarios. And if you are aggressively underestimating the
length of time over which the loss scenario could arise because
you believe you will not own the asset or you are only going to
own the asset for a limited or short period of time, then I
think what you effectively are doing is undervaluing your risk
profile and undervaluing the dollar-denominated value that you
could be required to pay in the event of an incident or to
offset compensatory damages.
And so I think the short answer here is that,
notwithstanding the fact that these are merchant banking
investments that are for a limited time period, what you really
need to make sure you do is assess the forecasted probable loss
scenario over the life of that physical commodity, not just the
length of time you plan to own it.
Senator Levin. And if they are making the bet that we just
described that a catastrophic event will not take place during
the time that they own or lease a facility, does it mean that
it is more likely that they will not allocate sufficient
capital and insurance to cover potential losses?
Ms. Trabucchi. Yes.
Senator Levin. And does making that bet also mean that they
are less willing to dedicate the time, resources, and expertise
to comply with regulatory requirements and to make expensive
infrastructure investments that are needed?
Ms. Trabucchi. I think those sorts of decisions are
generally made based on cash-flows, and I think to the degree
they are forecasting cash-flows and they are looking to
maximize short-term profit targets and maximize investment
returns--and, again, they do not plan to hold these assets for
very long--then they are not going to want to make a long-lived
investment. From their perspective it does not make economic
sense.
Senator Levin. And could the failure to make those
infrastructure and resource investments increase the potential
for a catastrophic event?
Ms. Trabucchi. Yes.
Senator Levin. And could the failure to make those
infrastructure and resource investments also put pressure on
its peers to skimp on them as well to the detriment of the
public?
Ms. Trabucchi. I do not know that I would say it quite in
that fashion. I think what happens is their decisions to not
make those investments put them at a price advantage or a
competitive advantage over their peers, because, remember,
their peers are working in highly regulated, highly
sophisticated regimes where sometimes they have no choice; they
must make the infrastructure improvement. And so if their peers
are over here making those improvements, it is imputed in the
cost of doing business, which influences their price targets,
and you have another series of actors over here who are not
operating within the regulatory regime because they believe in
their legal shield or whatever their risk-mitigating strategies
are, and they choose not to make those improvements, arguably,
they are at a competitive advantage. They can work with their
pricing differently than their peers.
Senator Levin. All right. And if the peers are not required
by regulation to make the improvements----
Ms. Trabucchi. Then, I think you are potentially fostering
a moral hazard where it is a race to the bottom.
Senator Levin. And then that would have a negative effect
on the public.
Ms. Trabucchi. It would increase the potential likelihood
of an environmental incident and a catastrophic event, and it
would also, arguably, increase the potential that there are
insufficient financial assurances and, therefore, yes, the U.S.
taxpayer may be left----
Senator Levin. And in an environmental situation, the
public would be also worse off in that situation.
Ms. Trabucchi. Correct. There is also the injury that
arises that goes beyond simply the financial consequences.
Senator Levin. OK.
Senator Levin. Again, this goes, I guess, to Professor
Omarova. The Gramm-Leach-Bliley Act contains a special
grandfather clause that Goldman and Morgan Stanley have used to
greatly expand their physical commodity activities. Section
4(o) of the act authorizes any company that becomes a financial
holding company to continue conducting ``activities related to
the trading, sale, or investment in commodities and underlying
physical properties'' subject to certain conditions. A broad
interpretation of this language suggests that if a financial
holding company were engaged in physical commodities activities
in a very limited way prior to a certain date in 1997, this
section would allow them to broaden their activities into all
aspects of physical commodities. That is a broad
interpretation.
The 1999 Senate Banking Committee Chairman offered the
amendment that formed the basis for Section 4(o) and entitled
it ``The amendment on grandfathering existing commodities
activities.'' And the amendment also contained this short
explanation: ``The above amendment assures that a securities
firm currently engaged in a broad range of commodities
activities as part of its traditional investment banking
activities is not required to divest certain aspects of its
business in order to participate in the new authorities granted
under the Financial Services Modernization Act.'' This
provision grandfathers existing commodities activities.
Now, a grandfather clause usually protects existing
conditions from a new rule. Have you ever heard of a
grandfather clause used to justify completely new activities?
Ms. Omarova. You are absolutely correct. Grandfathering
provisions typically are enacted in order to avoid certain
unnecessary hardships or disruptions of certain existing
operations--so, mainly in the interest of fairness to the new
company that suddenly becomes subject to a new regime--and to
prevent the need for some kind of fire sale of assets. But no
grandfather provision is usually conceived as a completely
independent grant of some open-ended, absolutely new privilege
for a financial institution that becomes now a bank holding
company to engage in the future in any kind of physical
commodity activity that is absolutely not allowed under the
existing law. And that is precisely what a broad and very
mechanical interpretation of just the language of the statute
seems to say.
And I also agree with you that the legislative history of
this provision clearly shows that it was never meant to be
something to allow Goldman Sachs and Morgan Stanley to
essentially move into any physical commodities markets they
want at any point in the future without any limitations.
Senator Levin. Professor Omarova, in 2010 the Federal
Reserve Commodities Team undertook a 2-year in-depth review of
the physical commodity activities being conducted under the
grandfather clause at Goldman Sachs and Morgan Stanley, and
they at that time were the only financial holding companies
that were using that clause.
Among other measures, the review compared their activities
prior to the 1997 trigger date and in 2010, and during that
review a detailed status report was prepared indicating that
Goldman Sachs and Morgan Stanley had used the grandfather
clause to greatly expand their commodity activities and incur
numerous new risks. And here is part of what the Federal
Reserve's Commodity Team found. These are long findings, so
bear with me.
``The scope and size of commodity-based industrial
activities and trading in physical and financial commodity
markets at Morgan Stanley and Goldman Sachs has increased
substantially since 1997. There are a large number of new
commodities traded by these firms today which they did not
trade in 1997. The new commodities traded today by Morgan
Stanley number 37 and Goldman Sachs, 35.
``Much of the new business conducted by Morgan Stanley and
Goldman Sachs is in the form of industrial processes involving
commodities. The expansion of these firms into power
generation, shipping, storage, pipelines, mining, and other
industrial activities has created new and increased potential
liability due to the catastrophic and environmental risks
associated with the broader set of industrial activities.
``And,'' the report went on, ``below are examples of
industrial processes which are new or greatly expanded today
from 1997: leasing of ships and ownership of shipping companies
at Morgan Stanley and Goldman Sachs; new ownership and expanded
leasing of oil storage facilities at Morgan Stanley; ownership
of companies owning oil refineries at Morgan Stanley; ownership
of coal mines and distribution at Goldman Sachs; new ownership
of power plants at Goldman Sachs and expanded ownership at
Morgan Stanley; leasing of power generation at Morgan Stanley
and Goldman Sachs; ownership of retail gasoline outlets at
Morgan Stanley; ownership of royalty interests from gold mining
at Morgan Stanley; ownership and development of solar panels at
Morgan Stanley.
``Furthermore,'' it went on, ``the scale of bank
involvement in industrial commodity processes is not widely
understood, even within the bank regulatory community. As a
result, it is possible that losses within the banking sector
arising from these activities will be surprising.''
Now, what is your view regarding the extent of
grandfathered activities continuing, going on, after a report
like that?
Ms. Omarova. Well, in my view, this Section 4(o), the
grandfathering of commodities activities for certain new bank
holding companies, in practice, of course, the two relevant
institutions to speak of are Goldman Sachs and Morgan Stanley
that became subject to these laws in 2008--this section creates
an enormous loophole, especially if allowed to be interpreted
so broadly as to permit such an incredible expansion of
activities beyond what was conceivably contemplated by Congress
back in 1999 even.
And so it does not surprise me at all that both Goldman
Sachs and Morgan Stanley assert that there is absolutely no
ambiguity in their ability to use this grandfather clause, not
just to continue what was properly grandfathered but to just do
anything and everything in that field.
But it is the Federal Reserve's job to give some clarity on
this issue, because if we just allow Goldman Sachs and Morgan
Stanley to be the ultimate judges of what is permitted by this
language, then, of course, we are going to see their commodity
empires expand, and that creates also a competitive advantage
for them vis-a-vis even other financial institutions playing in
the field.
Senator Levin. Would you agree that this clause should not
be given a broad reading?
Ms. Omarova. Absolutely, I agree with that. It should not.
Senator Levin. And then if it were challenged in court
against a narrow reading, which is the one you recommend,
Congress could then have an opportunity to amend the language.
Is that correct?
Ms. Omarova. Well, I think Congress has the opportunity to
amend the language anytime it wants to, and perhaps it should.
Senator Levin. Without waiting for the Federal----
Ms. Omarova. Exactly.
Senator Levin. Well, let us hope we do not have to do that,
because we are not so adept at getting things done these days
either. But the Federal Reserve is in a position where they
have an obligation----
Ms. Omarova. Absolutely.
Senator Levin [continuing]. To give an interpretation to
this.
Ms. Omarova. Absolutely.
Senator Levin. By the way, do you have a view, Ms.
Trabucchi, on the grandfather clause?
Ms. Trabucchi. I do not. I actually think Professor Omarova
captured it well.
Senator Levin. Professor, as you saw in our Report, one of
the key findings in our investigation is that there is no
overall size limit on the amount of physical commodity assets
that can be held by banks and their holding companies. We also
uncovered actions taken by JPMorgan to use loopholes,
exclusions, and valuation techniques to stay under the Fed's 5-
percent limit, even while its physical commodity holdings were
growing.
As a result, as of September 28, 2012, JPMorgan had
physical commodity holdings of at least $17.4 billion, equal to
nearly 12 percent of its Tier 1 capital. At the same time, it
was using loopholes and exclusions to report to the Federal
Reserve that it had $6.6 billion, or 4.5 percent of its Tier 1
capital. It shows, that discrepancy, just how ineffective the
current limits are.
Now, physical commodities may be held under complementary
authority, in which case they are subject to the 5-percent Tier
1 capital limit. They are authorized to be held under
grandfather authority, in which case they are subject to a
limit of 5 percent of total consolidated assets or under
merchant banking authority, in which case they are not subject
to a limit if they comply with the restrictions in that
authority.
None of what I have just said counts anything that is held
in the bank under the authority of the OCC. So copper held as
bullion is also exempt from any size limits. This seems like a
patchwork of rules and limits that is subject to manipulation
and leaves physical commodity activities with no effective
overall limit.
Should the Federal Reserve have a single, overarching limit
to protect the safety and soundness of the banks and their
holding companies? And do you think that the Federal Reserve
has the legal authority to do that?
Ms. Omarova. The findings in the report about the ongoing
sort of manipulation of all of these limits in different
provisions of the law are very alarming because they illustrate
precisely the potential weaknesses of relying exclusively on a
particular size limit and then creating additional
opportunities for the financial institution to claim that a
completely different size limit would apply to the same
activity, for example. So that way, of course, they could take
their assets, commodity assets, and put them in different
little baskets, and then say, well, overall we are OK; but in
reality it is not OK.
So I do think that if the Federal Reserve decides to clean
up its regulatory approach to limit these activities based on
some kind of size or concentration, for example, then they
absolutely have to seriously consider imposing one overall size
limit on all of the assets, no matter under what authority they
are held.
Do they have authority to do so? I believe that they do
because they are--especially after the adoption of the Dodd-
Frank Act in 2010, the Federal Reserve is an important systemic
risk regulator, and they have enormous powers and a lot of
flexibility as a regulator to do what needs to be done in order
to prevent the financial system from the next crisis. And this
is perhaps one of those instances where such an authority
should be used in order to strengthen this particular aspect of
regulation.
Of course, any size limit, no matter how strictly you set
it, is only as good as it is complied with, as compliance with
it, right? So what really is important is that the Federal
Reserve elevates the level and intensity of its supervisory
efforts with respect to controlling and monitoring how those
financial institutions have complied.
Senator Levin. So you need size limits. You need them that
do not have a whole bunch of loopholes in them. You need them
to be enforced. And just, I guess, for you, Ms. Trabucchi, I
assume that you would agree that size limits are useful to
reduce risk.
Ms. Trabucchi. Yes, but I would go one step further, and I
would say that it cannot just simply be a percentage of the
total consolidated assets of a financial holding company. It
needs to be benchmarked against the probable loss scenario and
the monetized estimate of incident-related expenditures and
compensatory damages that could arise. And I think it should be
a multiple, and I also think it should be benchmarked against
tangible assets--assets that can be actually leveraged to pay
for the payment--for the expenditures of an event.
Senator Levin. I just have one final question before we
turn to our next panel.
In 2009, in response to the financial crisis, the Federal
Reserve revamped its organizational structure and created the
Large Institution Supervision Coordinating Committee, whose
operating committee created in turn a ``Risk Secretariat.'' The
Risk Secretariat's mission is to identify key risks affecting
systemically important financial institutions and provide the
resources needed to conduct in-depth risk investigations. And
in one of its first actions, it identified bank involvement
with physical commodities as an emerging area of risk that
required review.
I would assume that you would both agree with that
assessment. Is that accurate?
Ms. Trabucchi. I would.
Ms. Omarova. Yes, absolutely.
Senator Levin. And that is what your testimony is all
about, and that is what we are all about in these hearings, is
to find out what has been going on at the Fed since 2009 when
they revamped their structure, created that committee, made
that finding, and what are we going to do as a people and as a
government to reduce these risks and to take away these
opportunities for financial manipulation?
Professor, Ms. Trabucchi, thank you both very much. Thank
you for the work you do in the private world. Thank you for
coming here today.
Ms. Trabucchi. Thank you.
Ms. Omarova. Thank you.
Senator Levin. I will now call our second panel: Hon.
Daniel Tarullo, a Governor on the Board of Governors of the
Federal Reserve System; and Larry Gasteiger, Acting Director of
the Office of Enforcement at the Federal Energy Regulatory
Commission, FERC. We appreciate both of you being with us
today. We look forward to your testimony. And as you are aware
of our rules, we ask all of our witnesses to be sworn, and we
would ask you now to please stand and raise your right hand.
Do you swear that the testimony you are about to give to
the Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
Mr. Tarullo. I do.
Mr. Gasteiger. I do.
Senator Levin. We have a timing system, and I think you are
both aware of it. A minute before the time is up, the red light
will change from green to yellow and then it will be red. We
would ask that you try to limit your oral testimony to no more
than 10 minutes. And, Mr. Tarullo, we are going to ask that you
go first. And thank you again for being here. We know the kind
of schedule both of you have, including on the Hill, by the
way, so thanks so much for being here. Mr. Tarullo, please
proceed.
TESTIMONY OF HON. DANIEL K. TARULLO,\1\ MEMBER, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM, WASHINGTON, DC
Mr. Tarullo. Well, thank you, Mr. Chairman. Before
beginning my testimony, I want to offer a bit of a testimonial
on what I believe is one of the last occasions on which the
Chairman will wield the gavel at a Senate hearing.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Tarullo appears in the Appendix
on page 313.
---------------------------------------------------------------------------
I first became aware of your energy and commitment in the
1970's, reading about you in the Detroit papers, when you were
president of the Detroit City Council and I was a law student
living in Ann Arbor. I have watched that energy continue
unabated during your six terms in the Senate right up through
this set of hearings that includes today's panel. So as you
retire, let me congratulate you for all your accomplishments
during those 36 years.
Senator Levin. Well, thank you so much. You do not look old
enough to go back to my City Council days, but I am afraid I
am. Thank you so much.
Mr. Tarullo. So turning now to the subject of this hearing,
commodities activities in bank holding companies were not, of
course, the story of the recent financial crisis. But that does
not mean that they pose no risks to the safety and soundness of
bank holding companies. Actually, to a considerable extent, the
issues surrounding such activities are a product of the crisis
insofar as large, formerly freestanding investment banks with
substantial commodities activities were either acquired by or
converted to bank holding companies in 2008. So even as we
continue to put in place regulations directed at preventing the
kinds of solvency and funding troubles that gave rise to the
crisis, we need also to be forward-looking and address post-
crisis developments that could give rise to future problems.
I might note in passing that some of these post-crisis
regulatory changes that we are already in the process of
enacting--notably, the increases in risk weighting for certain
activities under new capital requirements--will themselves have
an effect on commodities activities.
Supervisory experience with these commodity activities in
bank holding companies since the disappearance of the five
larger formerly freestanding investment banks, along with our
observation of the impact of catastrophic events involving
certain commodities, led us to begin a broad review of relevant
regulatory and supervisory policies.
As is appropriate given our overall mandate for prudential
supervision, we have focused particularly on the implications
of various commodities activities for the safety and soundness
of bank holding companies. We have also revisited the factors
relevant to determinations made beginning more than a decade
ago that certain commodities activities should be regarded as
complementary to financial activities under Section 4(k)(1)(B)
of the Bank Holding Company Act.
The Advanced Notice of Proposed Rulemaking that we issued
early this year sought public comment on these and a range of
other issues, including activities conducted by bank holding
companies under the merchant banking authority and Section 4(o)
grandfathering provision, both of which were added in the
Gramm-Leach-Bliley Act.
As you might expect, the ANPR has elicited a considerable
number of responses from a range of perspectives. We are
nearing the end of the analysis of these comments and other
information relevant to the issues raised in the ANPR. So while
we do not yet have a Board proposal for specific changes in
regulatory and supervisory policies, I anticipate that we will
be issuing a Notice of Proposed Rulemaking in the first quarter
of 2015.
In closing, I would note that the Report issued by this
Subcommittee on Wednesday will be an important additional input
into the final stages of staff analysis and eventual Board
consideration of policy changes.
Thank you very much, and after my colleague gets done, I
would be pleased to answer any questions you might have.
Senator Levin. Thank you, Governor Tarullo.
Mr. Gasteiger.
TESTIMONY OF LARRY D. GASTEIGER,\1\ ACTING DIRECTOR, OFFICE OF
ENFORCEMENT, FEDERAL ENERGY REGULATORY COMMISSION, WASHINGTON,
DC
Mr. Gasteiger. Mr. Chairman, thank you for inviting me to
testify today. My name is Larry Gasteiger, and I am the Acting
Director of the Office of Enforcement of the Federal Energy
Regulatory Commission. I am pleased to testify regarding the
Commission's enforcement program and some of its recent
enforcement actions involving financial institutions.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Gasteiger appears in the Appendix
on page 325.
---------------------------------------------------------------------------
The Commission's statutory authority and responsibility to
investigate market manipulation in FERC-jurisdictional energy
markets is rooted in the Energy Policy Act of 2005, which I
will also refer to as ``EPAct 2005.''
In the aftermath of the Western energy crisis and the 2003
Northeast blackout, Congress passed EPAct 2005, which broadly
prohibited market manipulation in FERC-regulated wholesale
physical natural gas and electric markets, and provided new
authority to enforce mandatory reliability standards. Congress
also significantly enhanced the Commission's civil penalty
authority for violations of FERC rules by increasing maximum
civil penalties to $1 million per violation per day.
Since receiving its expanded enforcement authority, the
Commission has worked hard to buildup its enforcement
capabilities. Around the time of the Western power crisis, FERC
had about 20 enforcement staff. Today we have nearly 200
attorneys, auditors, economists, analysts, and former traders
working in the Office of Enforcement.
In the last few years, FERC has enhanced its ability to
identify price manipulation in both physical and financial
markets by adding surveillance tools, expert staff, and new
analytical capabilities. And in 2012, the Commission
established a dedicated unit for market surveillance and
analysis in the Office of Enforcement.
Also in the past year, FERC surveillance and enforcement
efforts have been enhanced by a new Memorandum of Understanding
with the Commodity Futures Trading Commission that provides us
with access to additional highly useful financial data on a
regular and continuing basis. We have worked hard to
effectively and efficiently put these resources to good use.
Since receiving its EPAct 2005 authority, the Commission has
imposed and collected approximately $902 million in civil
penalties and disgorgement.
Some of these enforcement actions have involved financial
institutions, including JPMorgan, Deutsche Bank, and Barclays.
I have provided a more detailed description of these cases in
my written testimony, but, briefly, the JPMorgan case involved
market manipulation in the California and Midwest energy
markets and resulted in a settlement requiring JPMorgan to pay
a combined $410 million in civil penalties and disgorgement in
July 2013. The settlement resolved the Office of Enforcement's
investigation into 12 manipulative bidding strategies that
gamed the markets by creating artificial conditions that would
cause the system to pay the company inflated rates.
Enforcement staff also determined that JPMorgan knew that
the two regional markets where these schemes played out
received no benefit from making these inflated payments, and
thus, the company defrauded those market operators by obtaining
payments for benefits that they did not deliver.
In our settlement with Deutsche Bank in January 2013, the
Office of Enforcement determined that Deutsche Bank used
physical energy transactions to affect congestion levels and
corresponding energy prices within the California market. It
carried out this conduct to increase the value of its financial
contracts in violation of EPAct 2005 and the Commission's anti-
manipulation rule. The disgorgement in that case was $172,000
with a penalty of $1.5 million.
Then the Commission's July 2013 order assessing a civil
penalty in the Barclays case addressed similar conduct to that
in Deutsche Bank. The Commission found that Barclays engaged in
manipulative physical trades to benefit corresponding financial
positions. Though Barclays' physical trading often lost money,
it nonetheless profited the company overall because its trades
helped move the index price that set the value of its larger
financial swaps benefiting position. The Commission imposed
penalties of $435 million and disgorgement of nearly $35
million. The Commission's Barclays order is currently under
review in Federal district court, so that matter is still
ongoing.
Another topic the Subcommittee has asked about is whether a
financial holding company investment with physical energy
production has affected how those financial institutions
approach the power plant business. The Commission has not taken
any view on the participation in its regulated markets by
financial holding companies versus more traditional energy
companies like generators or utilities. However, that said, the
Commission expects financial institutions, like all other
participants in FERC-regulated markets, to have good compliance
programs, to transact in a manner that follows market rules in
letter and spirit, to work cooperatively with grid operators
and the Commission when there are concerns, and to self-report
potential violations.
Everyone has to play by the rules, and encouraging a
culture of compliance is the goal of our Office of Enforcement.
It is my hope that the description of the work of the Office of
Enforcement I have provided demonstrates that the Commission
takes very seriously its duty to police the energy markets and
protect consumers. To the extent we have succeeded in our
mission, it is due to the many talented, dedicated, and
hardworking staff at the Commission, and it is my honor and
privilege to work with them, particularly the staff in the
Office of Enforcement.
In conclusion, I want to thank the Subcommittee for the
invitation to testify today, and I look forward to answering
your questions.
Senator Levin. Thank you very much, Mr. Gasteiger.
Mr. Tarullo, let me start with you with a general question
at the heart of the issue that we have been going at here
during this 2-year investigation and this 2-day hearing. The
heart of it is an American tradition, the separation of banking
from commerce. Not every country takes the approach, but it has
been central to U.S. banking law and practice since our country
got started.
What is your view of the principle? Do you think it is
important? And why?
Mr. Tarullo. Well, Senator, as you say, separation of
banking and commerce certainly since the New Deal reforms has
been a centerpiece of U.S. financial regulation and prudential
regulation. And I think traditionally it is thought to have
served three purposes:
First is trying to protect the depository institutions and,
thus, the Deposit Insurance Fund and more generally our payment
systems from the risks that can be associated with non-
financial activities, with commercial activities, which for
obvious reasons will not be in the wheelhouse of people whose
business is making loans and taking deposits.
The second reason for the separation of banking and
commerce traditionally has been a concern that, to the degree
certainly that insured depository institutions were to be
involved directly or indirectly, there will be some form of
subsidization of those activities because of the fact that the
Federal Government provides an insurance service that is not
available in the private sector.
A third and closely related reason is a sense that it would
be unfair to those operating in the commercial sphere, the non-
financial sphere, to have to compete with institutions that did
have some form of subsidized funding. And so, as you know, Mr.
Chairman, there is a long line of cases, both under Section 24-
7 of Title XII of the National Banking Act and also under the
Bank Holding Company Act, trying to draw the line between
finance and commerce, banking and commerce more generally.
But I would say that nothing that I have observed in my
time teaching in this area, writing in this area, and in the
almost 6 years on the Fed has changed my view that
fundamentally this has been a sound principle and there is no
particular reason to digress from it.
Now, having said that, as you well know, and as many have
pointed out, in 1999 the Gramm-Leach-Bliley Act poked some
fairly big holes in that traditional separation, and so part of
the ongoing issue, which I think is probably raised in your
Report, is how in the absence of additional legislation one
can, in a manner consistent with the statute, confine the risks
of all three sorts that I was just mentioning a moment ago.
Senator Levin. In 2009, in response to the financial
crisis, the Fed revamped its organizational structure, created
the Large Institution Supervision Coordinating Committee, whose
operating committee created, in turn, a Risk Secretariat, and
the mission of that Risk Secretariat was to identify key risks
affecting systemically important financial institutions and
also to provide the resources needed to conduct in-depth risk
investigations. And in one of its first actions, it identified
bank involvement with physical commodities as an emerging area
of risk that required review, and it set up and funded a
multiyear review effort by a Federal Reserve Bank of New York
Commodities Team that dug deep into the facts, producing
multiple examination reports. And then in October 2012, 2 years
ago now, it issued a summary report with a number of
recommendations.
Can you summarize the risks that were uncovered by that
special review?
Mr. Tarullo. Well, I am going to mediate that somewhat,
Senator, because I am going to summarize what was told to me in
going through that review. And I might say that I cannot
remember exactly when the date is, but it was on one of the
trips I made to New York when I was using the New York Fed as a
base to do some meetings that some of the people on the New
York Fed Examination Team asked to meet with me because they
wanted to present some of the concerns that they had. A lot of
those concerns revolved around the potential for catastrophic
risk, which we mentioned in the ANPR and to which I alluded in
my prepared remarks.
I think there is a sense--usually when you think about an
investment or a loan, any sort of asset, whether it is a loan
or a tradable security or even a piece of property, you tend to
think in terms of the potential for loss being at maximum 100
percent of the value of that asset. So if it is a loan, your
counterparty defaults, you do not get anything back. If it is a
security, a company goes bankrupt, you do not get anything
back.
But in the case of some forms of commodity activities,
because of the potential for very large tort exposure, the
potential--or tort-like exposure, the potential losses to a
firm could far exceed the value of that asset. And I think that
was at the core of a lot of what the concerns of the people who
are looking at the potential risks were.
Again, as I mentioned in my introductory remarks, the big
changes in 2008 whereby a lot of activities were imported into
bank holding companies, either by the conversion of the IB into
a bank holding company or by the acquisition of the investment
bank, brought in a lot of things that were not traditionally in
bank holding companies for the reasons that you were mentioning
in your first question. I came with that as the core of
concerns, and it is not the only thing that we are concerned
with, but it has animated our concerns ever since.
Senator Levin. Now, what our research indicates is that
overall, with few exceptions over the years, and setting aside
the issue of gold and silver, banks and their holding companies
were not very involved with commodities until the 1970's when
commodity markets for the first time started to get into non-
agricultural commodities. When it was grain and pork bellies,
the banks were not very interested.
When the commodities markets got into crude oil and natural
gas futures, that is when the banks became interested and
active in physical commodities markets. Is that generally in
keeping with your understanding?
Mr. Tarullo. That is in keeping with my understanding. The
oil crisis and its aftermath did seem to work a big change in
how people generally thought about commodities trading.
Senator Levin. And you have made reference to the enactment
in 1999 of Gramm-Leach-Bliley. Would you agree that what it did
in creating a category of financial holding companies and
authorizing them to get into a wider array of activities led to
a surge in financial holding company involvement with physical
activities--physical commodities?
Mr. Tarullo. Sure. So I think it proceeded in a couple of
steps, Senator. One was just the authorization. Then, of
course, there was the bankruptcy of Enron, which left a void,
which some of the institutions thought they could begin to
fill. And so you did then begin to see more movement into
trading activities with those complementary determinations that
I referred to in my prepared remarks.
But I think the next piece of what cumulatively was a surge
was the change from the status of the freestanding investment
banks, which brought a lot of non-trading activities under the
umbrella of bank holding companies.
So I would say cumulatively it was a surge. It proceeded in
a few somewhat distinguishable steps.
Senator Levin. One of the key issues that has been raised
in the physical commodities area involves unfair trading and
market manipulation. In 2005, when JPMorgan filed an
application with the Federal Reserve requesting complementary
authority, JPMorgan explained that engaging in physical
commodity activities would do the following, and these are
their words: It would position JPMorgan Chase in the supply end
of the commodities market, which in turn will provide access to
information regarding the full array of actual producer and
end-user activity in those markets. The information gathered
through this increased market participation will help improve
projections of forward and financial activity, and these are
the words that strike me as being so prescient, important, and
disturbing--it will supply vital price and risk management
information that JPM Chase can use to improve its financial
commodities derivative offerings.
So they are going to gain information here that is not
public information. They are going to gain information that
they can use to improve its financial commodities derivative
offering. Access to information will help its trading
operations, and, again, that is not public information.
And here is how a 2005 article described Morgan Stanley's
physical commodity activities in comments by one of its
leaders, a man named John Shapiro: ``Having access to barges
and storage tanks and pipelines gives the bank additional
options to move or store commodities that most energy traders
do not pursue. And by having its finger on the pulse of the
business, it hopes to get a more subtle feel for the market, a
crucial asset to a trader. Being in the physical business tells
us when markets are oversupplied or undersupplied.''
``We are right there, seeing terminals filling up and
emptying.''
So, again, it is the trading value. It is a crucial asset
to the trader if they are in these businesses at the same time.
And here is what some Federal Reserve examiners noted when
they were analyzing physical commodity activities by Morgan
Stanley and Goldman: ``The relationship of the firms''--Morgan
Stanley and Goldman--``with the wholly and partially owned
companies is not that of a passive investor. In addition to the
financial return, these direct investments provide the firms
with important asymmetrical information on conditions in the
physical markets such as production and supply demand
information, etc., which a market participant without physical
global infrastructure would not necessarily be privy to.''
Interesting word, ``asymmetrical'' information. I am the
Chairman of the Armed Services Committee, and we hear that word
``asymmetrical'' all the time. In a way there are some
similarities, by the way.
Finally, we have an excerpt from an October 28, 2011,
presentation by the Goldman Commodities Division to the Goldman
Board of Directors, and this is what it says: ``Goldman Sachs
may command valuation multiples for Goldman Sachs commodities
similar to Glencore if the business were able to grow physical
activities''--and here are the key words--``unconstrained by
regulation and integrated with the financial activities.''
That is Goldman Sachs' words, which they repeated
yesterday. I asked about that.
Do you believe that physical activities and financial
activities should be integrated? What happened to that Chinese
wall you guys claim between information that you gain in the
commodities world and your work in the financial world?
Now, my concern with all of these statements is that
financial holding companies want access to physical commodity
activities primarily so that they obtain access to commercially
valuable non-public information that they can use when trading
financial instruments relating to the same commodities--non-
public information relating to those commodities gained by
these financial firms, which they can then use in the trading
of financial instruments that are related to those commodities.
Now, that to me introduces unfair trading advantages,
market manipulation issues into our commodity markets.
Yesterday we explored how Goldman's wholly owned warehouse
company, Metro, contracted with metal owners in its warehouse
system to artificially inflate a queue, a line of people, who
are waiting to leave its warehouse and inflate prices of
aluminum and aluminum-related financial products. That is what
happens. The premium for aluminum is directly connected to a
long line to get out of a London Metal Exchange-approved
warehouse. The longer the line, the greater the rent is paid in
that warehouse. That rent is part of a premium, and so the
portion of a cost of aluminum now that is reflected in the
premium is now up to over 20 percent. It was 5 percent a few
years ago.
And so you have a major financial institution, Goldman,
that directly is involved in a decision to lengthen a line,
which in turn increases the premium, which is a growing and
growing part of an aluminum price, and their decision to
lengthen those lines with that effect is not public, the
decision, and they are trading in commodities, including
futures, which are obviously impacted by that non-public
information, which they can then apparently use.
Now, the Fed provides certain attractions to financial
institutions. There are certain advantages that they have. When
banks are involved in commercial institutions, like power
plants, storage facilities, coal mining, and aluminum
warehouses, the Federal Reserve is the source of competitive
advantages. You provide advantages. Doesn't the Fed have some
responsibility to ensure that banks do not use those
competitive advantages to engage in market manipulation? I know
other regulatory agencies have responsibilities here. Doesn't
the Fed that provides these advantages to companies have some
responsibility to make sure that those companies, which have
these unique advantages, are not engaged in manipulative
activities?
Mr. Tarullo. So I would say first, Senator, that a lot of
the Dodd-Frank Act and associated reforms that we are doing,
along with other regulatory agencies, are actually designed to
make sure that holding companies do not have an advantage and
that the costs of the risks that they may impose on the
financial system are fully internalized in their own costs of
doing business.
I have not had a chance to read the entire Report, but I
did take the summary and recommendations on the train with me
the other day, and I was struck by the fact that so many of the
case studies which you and your staff have investigated so
thoroughly seem to revolve around the co-activities of trading
and what I think you usefully described as ``infrastructure,''
owning extraction facilities, transportation facilities, and
the like.
That seems to create the biggest potential for the kinds of
activities that you have been referring to, and there I would
say, first, the interpretation of complementary authority,
which, as you know, we are revisiting in any case, but even
under the existing determinations, they explicitly exclude what
you would describe as the infrastructure. So under that
authority, there should be no possibility of doing that.
Under merchant banking authority, it would be my premise
that the notions of separation of the portfolio investments by
merchant banking operations from the operations of the bank
should also in turn mean that there is no commingling of
managerial and other kinds of information. So that basically
leaves us with subsection (o), the grandfathered authority, and
any residual transitional authority that firms may have to
maintain noncompliant activities during a divestiture period.
So with divestiture periods running, with the Fed's
complementary authority excluding such possibility, and with
some of the other changes that I have been mentioning, I think
it does come back to this issue of whether 4(o) continues to
permit exactly the kind of structural circumstance that you are
concerned with.
In terms of our oversight, I think I spoke to this in a
speech rather than testimony not too long ago. The accumulation
of violations--investigations and in many cases, I think,
acknowledgment of violations in a variety of non-prudential
regulatory areas, whether it is LIBOR or forex price fixing or
mortgages, and some of the things you have raised in
commodities, the work that FERC did on JPMorgan, suggests that,
in general, the compliance procedures, mechanisms, expectations
within firms for abiding by laws, which may not be prudential
from us, but they are nonetheless from our sibling regulatory
agencies, are not adequate in many cases.
And so one of the things that we have been thinking about
in general, although now specifically in the commodities
context as well, is how to assure that there are robust
enforcement and compliance mechanisms within firms to make sure
that you do not have this kind of transgression of other
regulatory areas.
The final thing I would say on this is, I am not an expert
in commodities law, but, again, as I read the summary of what
you had produced, I began to wonder whether there is a gap in
regulation more generally, whether there are some things, such
as some of the things you describe in some of these case
studies, that at present no U.S. Government regulatory agency
has jurisdiction over. I do not know if that is true, but it
felt to me as though it may be true in a couple of cases where
there is something that neither the CFTC--it is not energy; it
is not going to be FERC--nor the SEC is actually able to
regulate because something is not a future, for example.
So it could be that you have also uncovered a third agenda,
which is addressing some of those gaps, whether or not it is
bank holding companies.
Senator Levin. Well, one of our recommendations I think
fits very closely to what you have just been talking about.
This is a bipartisan recommendation, No. 8 of our Report:
Financial regulators should ensure that large traders,
including financial holding companies, are legally precluded
from using material non-public information gained from physical
commodities activities to benefit their trading activities in
financial markets.
Now, I think that fits very closely with what you just
said.
Mr. Tarullo. I think it does, Senator.
Senator Levin. And Recommendation No. 11 would be or is
that the Office of Financial Research should study and produce
recommendations on the broader issue of how to detect, prevent,
and take enforcement action against all entities that use
physical commodities or related businesses to manipulate
commodity prices in the physical and financial markets.
Will you take a look also at that recommendation and give
us a reaction to that, if you would?
Mr. Tarullo. Sure, absolutely.
Senator Levin. Because as you have just pointed out, it
just seems like every day there is another example of market
manipulation, and you mentioned, I believe, interest rates and
foreign exchange rates and energy prices. Now you can add
aluminum. And these too-big-to-fail banks that have access to
the Fed's discount window and near-zero borrowing costs are
engaging in the manipulation of numerous markets, and each one
of these falls under the oversight of a different regulator,
technically. But you are the only constant regulator we have,
the Federal Reserve, and your willingness to get in to make
sure that regulations are abided by, even if those regulations
are regulations of your, as you put it, sibling agencies, could
be a very important step, because if banks do not do that, then
their safety and their soundness could be impacted if either
there is no regulation, which may be the case, as you have just
referred to, or if the regulations of other agencies either
have gaps or are not lived up to. So that commitment on your
part to look at this and to think about that possibility is
very important.
We have a situation which is totally unacceptable to me,
and that is that in the area of commodities, which do not have
the same regulation as stock, and are not subject to the same
rules about inside information, for instance, as is true in the
stock market, with the SEC looking at misuse of inside
information, that does not exist in the same way, at least, in
the commodities area. The information used in the commodities
area was not regulated because that information started a
hundred years ago with a farmer trying to calculate how big a
crop he was going to have. That world is totally upside down
now. Now 70 percent of the transactions are speculative. They
are not by the end users. It used to be 70 percent of the
transactions and future contracts were by people who actually
were going to use something. Now it is 30 percent. So the
speculators have taken over, which is their right, but it is
also our right as a government to make sure that information
which they gain is not misused, just the way we take steps to
make sure inside information is not misused. And it is very
important that the Fed become much more aggressive and
interested in making sure that the possibilities here do not
become real and that the real abuses are not accepted so that
the safety and soundness of our banks, for instance, is not
ultimately at risk, nor is the consumer taken advantage of.
Mr. Tarullo. Senator, do you want a quick reaction to that?
Senator Levin. Sure.
Mr. Tarullo. One of the things that Congress did in the
Dodd-Frank Act was to substantially both change and give a
message to agencies for further change on interagency
cooperation and interagency coordination. The systemic risk and
financial stability mandates of the Dodd-Frank Act are already
occasioning the kinds of discussions between the market
regulators on the one hand and the banking regulators on the
other that did not take place very often prior to the financial
crisis. We now have a formal interagency group of regulators
that can look at gaps in the regulatory structure.
So my immediate reaction is that it would be a good idea
for the relevant agencies, including the Fed and OCC because of
our involvement with banks, but also the market regulators, to
take a look at exactly this issue of how regulations are
expected to be complied with throughout an organization and
whether there are any lacunae in the regulatory structure that
might bear a recommendation for action.
Senator Levin. I think it was your study which pointed out
some numbers as follows, the Fed study: That financial holding
companies typically have a capital ratio of 8 to 10 percent,
where oil and gas companies, for instance, have capital ratios
exceeding 40 percent. The end result of that is that due to
cheaper financing costs and lower capital ratios, which I have
just mentioned, financial holding companies can nearly always
undercut any non-bank competitor.
Now, we saw examples of that type of unfair competition in
our investigation. Morgan Stanley used shell companies called
Wentworth to construct a compressed natural gas plant in direct
competition with a company called Emera; and where Emera had
proposed building a compressed natural gas plant to export
9,000 billion cubic feet of gas per year, Morgan Stanley
proposed a plant to export 60 billion.
Senator Levin. I misspoke there. The private company had
proposed building a plant to export 9,000 cubic feet of gas;
Morgan Stanley proposed a plant to export 60 billion cubic
feet.
Now, I am guessing that Morgan Stanley had a whole lot more
money than Emera to invest and could do it with less capital
and less financing costs, and Emera just simply could not
compete with that, and I am wondering if that is a concern of
yours, Governor Tarullo.
Mr. Tarullo. Well, I think what may lie behind some of
those capital numbers you cite is, again, the concern about
catastrophic risk and potential risks associated with some of
these activities.
A centerpiece of the analytic work that the Fed staff has
been doing over the past year and a half or so has been on
precisely that point. And, of course, what that translates into
is questions about the appropriate risk weights that should be
assigned to certain kinds of activities. So as you know, in
Basel III and some of the other changes we have made in capital
requirements, part of it has just been upping the ratio; part
of it has been saying, wait a second, there are a lot of asset
classes that were riskier than existing risk weights would have
suggested.
So a key part of our review has been precisely around this
issue of are risk weights appropriate, reflecting in particular
the potential for catastrophic loss. And I expect that that is
the kind of work which will come to fruition in the not too
distant future.
Senator Levin. Mr. Gasteiger, let me turn to you for a few
moments, and then we will have a few more questions as well,
for Governor Tarullo.
You have described in your testimony electricity
manipulation cases involving three financial holding companies:
Barclays, Deutsche Bank, and JPMorgan. And in each of these
cases, very different types of manipulative schemes were
employed.
Now, one of the messages, I would think, from those cases
is that there are lots of ways to abuse the system, and
regulators have to police a lot of different aspects of the
electricity markets to catch wrongdoing. Would you agree with
that?
Mr. Gasteiger. Yes, I would, Mr. Chairman.
Senator Levin. And where does the manipulation case that
FERC brought against JPMorgan stack up in terms of significance
and size of manipulation compared to other cases that FERC has
brought?
Mr. Gasteiger. Mr. Chairman, the JPMorgan case would be the
largest settlement to date that the Commission has gotten under
its EPAct authority.
Senator Levin. And it is my understanding that independent
system operators in California and Michigan had never before
witnessed the degree of blatant manipulation and gaming
strategies that JPMorgan used to try to profit from its power
plants. Is that correct?
Mr. Gasteiger. I think it is safe to say that the schemes
particularly in California were more numerous than anything
that I am aware of having seen before.
Senator Levin. Is it also true that because of JPMorgan's
manipulative bidding strategies, the independent system
operators in California and Michigan had to revise the way they
allow companies to bid on electricity in California and
Michigan?
Mr. Gasteiger. Yes, it is true; several tariff filings had
to be made to make changes to the markets.
Senator Levin. And with regard to the JPMorgan
manipulations that resulted in a $410 million settlement, it
began with the hiring of one new employee, is that correct, a
man named John Bartholomew, who advertised in his resume that
he had identified a ``flaw'' in the market mechanism, make-
whole payments, that is causing CAISO to--is that the way it is
pronounced, CAISO?
Mr. Gasteiger. We say CAISO.
Senator Levin [continuing]. To misallocate millions of
dollars. In other words, he in essence believed that you could
profit by gaming the system rather than from selling
electricity at market rates, and in a matter of hours of
sending in his resume, the head of JPMorgan's Houston office,
Mr. Dunleavy, instructed others to get him in ASAP. Is that
what your investigation found?
Mr. Gasteiger. Yes, Mr. Chairman, that is correct.
Senator Levin. And there are two things that I find
incredible about this: The first is that anyone would advertise
in a resume that they know about a flaw in the system,
signaling that they are ready and willing to exploit that flaw;
and, second, that somebody would hire the person sending that
signal. The enforcement staff of FERC found that between 2010
and 2012, JPMorgan engaged in 12 types of improper bidding
strategies. Is that correct?
Mr. Gasteiger. That is correct, Mr. Chairman.
Senator Levin. Is it also true that the FERC staff
discovered some of these schemes during its investigation and
brought them to the attention of JPMorgan and that JPMorgan did
not stop the manipulative activity but instead developed new
schemes?
Mr. Gasteiger. That is correct.
Senator Levin. And in one of these manipulative schemes,
JPMorgan traders submitted bids that offered to sell
electricity at rates well below JPMorgan's cost to generate
electricity, which meant that the offers usually lost money
when accepted, and JPMorgan was willing to make those
artificially low offers, sort of like a loss leader, so that it
could then participate in certain ``make-whole'' payment
mechanisms that could end up generating payments well in excess
of the expected losses. Do I have that right so far?
Mr. Gasteiger. Yes, Mr. Chairman.
Senator Levin. And those make-whole payments allowed
generators to be compensated at above-market electricity prices
to provide an incentive for plant owners to participate in the
bidding auctions and ensure grid reliability. Is that correct?
Mr. Gasteiger. Yes.
Senator Levin. And so JPMorgan used its bidding strategies
to more than make up for the money it lost at market rates,
frequently receiving in the end more than twice its costs
because of the make-whole mechanism.
Mr. Gasteiger. That is correct.
Senator Levin. And in the end, JPMorgan's bidding schemes
caused California and Michigan electricity authorities to pay
approximately $124 million in excessive payments to JPMorgan.
Mr. Gasteiger. That is correct.
Senator Levin. Now, we have an exhibit, which is a copy of
an email--and we will get you the number of that exhibit in a
minute. It is a copy of an email that JPMorgan sent to several
colleagues in the midst of abusive bidding schemes. It contains
an image of Oliver Twist extending a bowl, and the subject
line: ``Please, sir, more BCR.'' Now, the BCR refers to the
make-whole payments that JPMorgan was using to unfairly profit
from the system. And I got to tell you, it is mighty offensive
to me that JPMorgan portrays its actions as a joke, comparing
itself to a poor orphan needing charity when it was ripping off
consumers. Did that email offend you?
Mr. Gasteiger. I agree it is a striking image.
Senator Levin. Is it an offensive use?
Mr. Gasteiger. I would agree with that characterization.
Senator Levin. Now, I understand that in connection with
the CAISO and FERC investigations into JPMorgan's manipulative
bidding schemes, JPMorgan refused to hand over a number of
documents, claiming attorney-client privilege, but it later
turned out they were not privileged at all. Can you describe
what happened in that regard? And what was the penalty that
FERC imposed in a response?
Mr. Gasteiger. There were disagreements between us and
JPMorgan throughout the course of the investigation over access
to documents. Ultimately there was a proceeding--this really
actually dealt more with disagreements that JPMorgan was having
with the California ISO market monitor with respect to access
to information as part of its investigation. In a separate
proceeding that was not directly part of the enforcement
investigation, the Commission ultimately suspended JPMorgan's
market-based rate authority for a period of 6 months.
Senator Levin. Now, all three of the financial holding
companies that we looked at--JPMorgan, Goldman, and Morgan
Stanley--were active in power plant activities, using the Fed's
complementary merchant banking or grandfather authority. Did
you get a sense, Mr. Gasteiger, that these financial holding
companies really want to own or operate electric power plants,
or is it more likely that they are in the business for
financial gains, for the financial trades end of their
business, to get non-public information that can assist them in
their trading operations?
Mr. Gasteiger. In the limited number of cases that we
worked on, particularly JPMorgan, clearly they were using the
ownership in order to engage in the type of market activities
that we were investigating. And in that particular instance,
because the units were not themselves profitable, they were
looking for ways to try and do that, that is what led them to
develop the schemes that they wound up implementing in CAISO.
Senator Levin. And what would be the relationship then to
the financial trading end of their businesses?
Mr. Gasteiger. Well, because of the ownership of the
plants, that led them to engage in those financial trading
activities within those markets.
Senator Levin. From what you have seen in enforcement cases
brought by FERC, the financial holding companies have the same
commitment to understanding and following electricity-related
regulatory regimes as, say, utility companies that are focused
on the electricity business, or are they more prone to try to
game the rules?
Mr. Gasteiger. Well, Mr. Chairman, we have not undertaken
any type of a real study, but on the limited sampling that we
have, certainly as you indicated earlier, as my testimony
indicates, financial institutions have, in fact, been involved
in the most significant cases that the Commission has brought
through its enforcement authority.
Senator Levin. And would that seem then to fairly imply
that they do not have the same commitment from that experience
to following the regulatory regimes that are supposed to govern
electric utilities as those electric utility companies that are
focused on the electricity business have? From that limited
experience, is that a fair statement?
Mr. Gasteiger. I think one could perhaps draw that
conclusion.
Senator Levin. Now, FERC has been active in going after
manipulation in the electricity markets, and we have not seen
the same level of activity in other markets, such as for crude
oil, aluminum, or copper. Now, part of that is that no Federal
regulatory agency has been assigned explicitly the
responsibility to prevent price manipulation in the same way as
FERC, especially in the purely physical markets. But it seems
to me that FERC's experience in uncovering manipulative schemes
as well as other enforcement cases that we have seen suggests
that too many Wall Street financial holding companies are ready
and willing to engage in market manipulations and will do so
until they are caught.
Governor, does the Federal Reserve have authority to bring
a market manipulation case? Or is that basically for other
agencies?
Mr. Tarullo. Market manipulation as such would not be
within our ambit, Senator, although when one of the other
regulators with authority is able to bring an enforcement
action, we are often able to cooperate with them to require
certain remediation measures in compliance within the firm and,
where appropriate, to impose penalties on the firm for
violation of safety and soundness and other compliance
activities.
Senator Levin. And if other agencies do not bring
enforcement action where there is clear evidence that
enforcement action is appropriate, are you in a position, as
someone having overall responsibility, to talk to other
agencies about why enforcement actions against manipulation are
not taken?
Mr. Tarullo. Yes, that is right. There are two distinct
issues. One is if we uncover activity which is arguably--it
does not even have to be definitely, but arguably a violation
of law or the regulations of a sibling agency, we absolutely
will initiate contacts with them. If it is a circumstance in
which nobody has--people conclude that nobody has authority,
then it is a somewhat different situation and one that I was
alluding to earlier where it may be that there need to be some
recommendations to Congress as to how to fill in some of those
gaps.
Senator Levin. We would ask you, Governor, to take a look
at our recommendations. I do not think we want banks that are
under your authority and have advantages because of their
connection to the Fed to engage in manipulative activities. I
do not think that you want it. I do not think anybody should
want it. And if there are gaps--and there are--in the way
manipulative activities are taken out or stopped because there
is an absence of regulation or a failure of regulation, we
believe it is essential that those gaps be filled. We cannot
tolerate what we saw with the Goldman warehouses in Detroit,
for instance. It is totally intolerable.
And so if you would take a look at our recommendations in
the Report and tell us--not now but for the record--in addition
to what you have just told us, what the Fed might do to help go
after the manipulation in these banks that have advantages from
the Fed, we would appreciate it.
Mr. Tarullo. Of course.
Senator Levin. Now, one of the most significant things that
we saw, Governor, in our Report and investigation is that there
is no overall size limit on the amount of physical commodity
activities for banks and their holding companies. For instance,
JPMorgan used loopholes, exclusions, and valuation techniques
to stay under the Fed's limit. And as a result, in September
2012, JPMorgan had physical commodity holdings of $17.4
billion, which was equal to 12 percent of its Tier 1 capital,
at the same time it told the Fed that it had $6.6 billion, or
4.5 percent of its Tier 1 capital. The discrepancy between
those two numbers is stark, and it shows just how ineffective
the current limits are.
Physical commodities, as you know by heart, may be held
under complementary authority, in which case they are subject
to the 5-percent Tier 1 capital limit; under grandfather
authority, in which case they are subject to a limit of 5
percent of total consolidated assets; and under merchant
banking authority, they have no limit at all, but they are
governed by the other criteria in that authority. None of this
counts anything against what is held by the banks under the
authority of the OCC.
Now, this would look to me like a problem that seems ready
for rulemaking. In Section 5(b) of the Bank Holding Company
Act, the Federal Reserve has broad authority ``to issue such
regulations and orders as may be necessary to enable it to
administer and carry out the purposes of this chapter and to
prevent evasions thereof.'' And the Federal Reserve has used
its broad powers in the past. It previously had a limit on
merchant banking activities, which it removed via a rulemaking
in 2002. It also imposed the 5-percent complementary authority
limit without statutory direction. So the authority would see
to be there for the Fed to impose an overarching limit pursuant
to its broad authority under the Bank Holding Company Act.
Given the significant differences in the risks posed by a
4.5-percent interest in commodities versus a 12-percent
interest, do you believe that the Bank Holding Company Act
gives the Fed sufficient legal authority should it choose to
enact it or use it, do you have the authority, should you
choose to enact an overarching limit on the physical commodity
holdings of a financial holding company?
Mr. Tarullo. Let me put aside subsection (o) for a second,
authority under subsection (o). I think with respect to--and I
want to give my own current understanding, not having consulted
with our Legal Division on this, but I would suspect that we do
have authority to put an overall limit, certainly as we already
have on complementary, and quite possibly on merchant banking
activities as well.
With respect to the broader issue, when you have a Section
4(o), my initial reaction would be that we probably would not
have authority to bring down below the congressional 5-percent
level the amount of activity--and that is 5 percent of assets,
too--the amount of activity in a Section 4(o)-eligible firm.
But we could certainly say that we would not allow any more
than that.
So, once again the Section 4(o) provision creates a
different circumstance for those two firms really than for
anybody else, but more broadly, I think we do have pretty good
authority.
Senator Levin. Can you get back to us on the question of
whether or not you have the authority to put an overall limit
that would then be the combination of those sub-limits and
those sub-authorities?
Mr. Tarullo. Right.
Senator Levin. Can you check with your Legal Division and
get back to us?
Mr. Tarullo. I would be happy to. And as you know, and I
think it was in the Report. You probably know it even if it is
not in the Report. The difference between 5 percent of capital
and 5 percent of assets is huge.
Senator Levin. And would you also let us know for the
record whether or not the Fed believes that the Bank Holding
Company Act provides sufficient authority to place a reasonable
size limit on a financial holding company's physical commodity
activities overall to limit the commingling of banking and
commerce?
Mr. Tarullo. Sure, we can do that, too.
Senator Levin. In 1997, the Federal Reserve issued a
regulation which said in part that bank holding companies can
treat copper as bullion, treating it the same way as gold and
silver. But for more than 100 years, commodity markets
throughout the world have treated copper as a base metal, not a
precious metal, valued for its uses in industry rather than as
a medium of exchange like gold or silver. The only thing that
changed was its regulatory status. Designating copper as
bullion has made it exempt from size limits that would
otherwise apply and from reports that are required of financial
holding companies to be made to the Federal Reserve about the
dollar value of their physical commodity holdings.
At the same time, our investigation has shown that JPMorgan
and Goldman engage in massive copper transactions and actively
build and reduce their massive copper inventories, which at
JPMorgan peaked at $2.7 billion and at Goldman reached $2.3
billion. Now, what is the rationale for exempting copper from
size limits and commodity holding reporting requirements? How
is it risk-free?
Mr. Tarullo. Well, Senator, that was an interesting
decision, and my understanding--because I asked about it,
because that was long before I got to the Fed, and what I was
basically told was it followed on an OCC decision that made a
similar determination for holdings of copper within national
banks, and so what it appears to me as is the Fed proceeded to
say, if they are going to be doing this stuff, we do not want
to force it into the banks, so permit it in the holding company
more generally.
Having said that, I think I cannot offer, again, a Board
position on this, but I just would observe that I think a
pretty good case could be made for the proposition that copper
is different from palladium and copper does seem to be
basically an industrial metal. And so it is something that
would bear revisiting, I think.
Senator Levin. Will you talk to the OCC about the
possibilities of making a change in that regard?
Mr. Tarullo. I will.
Senator Levin. Really, there is huge risk with this kind of
ownership and inventory at billions and billions of dollars,
particularly since it has no business in that category. So if
you will talk to the OCC, we would appreciate it. Will you do
that?
Mr. Tarullo. Sure.
Senator Levin. Now, in 1997, that is covered. A question
about merchant banking. Gramm-Leach-Bliley indicated that it
intended to allow merchant banking investments only if they
were financial in nature. That is where the bank acts as a
passive investor, does not try to run the company it buys, and
holds it for resale to make money off the equity investment.
And I think you have talked about that this morning. That is
its purpose.
From what we have seen, it looks like some of these big
banks are not always following the rules. First, there is a
lack of information. The merchant banking reports that the Fed
gets now and makes public has such high level aggregate data
that they are ineffective as an oversight tool. They do not
even contain a list of the merchant banking investments at a
bank, so it is nearly impossible to tell if all the merchant
banking investments are included.
So I have two questions. How can a regulator police an
activity without that kind of basic information? Let me start
with that one.
Mr. Tarullo. You cannot do it as it should be done, and I
think, Senator, that is one of the reasons why the reporting
issue, again, has been another principal topic of internal
discussion about the kind of changes we may make.
Senator Levin. And it is not enough that the additional
information about these activities just be required. It has got
to also be made public.
Mr. Tarullo. As with all reporting, in any changes we make,
we will look to see what the maximum transparency we can
provide without encroaching on genuinely business proprietary
information.
Senator Levin. That would be helpful. Another issue is the
issue of whether financial holding companies are getting
involved in the routine management of the companies that they
buy. We saw Goldman designate its commodities arm, J. Aron &
Company, as the exclusive marketing agent for its coal mines,
selling 100 percent of the coal on a day-to-day basis. It also
appears Goldman was approving coal mining plans and key
infrastructure investments. Goldman's ownership of its
warehouse company, Metro, raises similar concerns.
So they are exercising a whole lot of management control
over Metro, as we saw yesterday, and Metro's board is composed
exclusively of Goldman's employees, and they were approving
freight incentives and this merry-go-round shenanigans and
policies related to queue length. So that is a second set of
issues.
How do you get at that issue as to whether or not they are
getting too deeply involved in the day-to-day management of the
companies that they buy, which is inconsistent with the rules
of merchant banking?
Mr. Tarullo. So I think probably two things, Senator. One
is compliance with current rules and guidance, which is part of
this overall issue I was referring to earlier. And second is
the question as to whether we should revisit the actual rules
and guidance that have been put out. I do not want to get too
biographical here or autobiographical here, but as you know, I
was teaching law, teaching banking regulation after Gramm-
Leach-Bliley came out. And as you know from law school, the way
you teach these things is you give the kids a hypothetical and
you say, ``OK, where is the line here? And how do you draw the
line?'' And, not surprisingly, good law students can make the
arguments on both sides, which suggested to me at the time, and
I think I have been reminded of this by some of the work that
your Subcommittee has done, that it may be worthwhile taking a
look at those merchant banking guidelines, not just for
commodities but for all activities, actually.
Senator Levin. We are going to ask you and the Fed to take
a look at the activities of Goldman and the others that we have
in our Report, in this merchant banking area. And I cannot
speak for Senator McCain yet because I have not talked to him
about this, but I will ask him if he would like to join in a
letter to you specifically on this issue, which is on top of
the recommendations which are in our Report.
Mr. Tarullo. OK.
Senator Levin. The third set of concerns involves
enforcement. JPMorgan claims to be holding three power plants
as merchant banking investments, but only after striking out
efforts to hold them as complementary activities. So first it
was supposed to be a complementary activity. Then they shifted
over to merchant banking as the justification and the
rationalization for the authority.
Documents from the Fed indicate that JPMorgan promised in
2011 to sell all three power plants. Three years later,
JPMorgan still has all three.
So, first question, what is your view of how banks have
been using the merchant banking authority with respect to
physical commodities?
Second, what plans, if any, does the Fed have with respect
to the problems of inadequate information, bank involvement
with routine management, bank failure to sell merchant banking
assets, after promising to do so?
Mr. Tarullo. That, I think, gets at two of the issues that
you have raised. It sort of combines two things you have
already raised, Senator. One is the information and reporting,
and second is the set of expectations around merchant banking
and the understanding and compliance with the understanding of
what it means to have a passive investment.
As you know, there can be legitimate questions with what is
a passive investment when one is talking about a major action
that affects the whole value of the investment. But when you
are talking about information flows back and forth on a routine
basis, that does not seem to go to the heart of the protection
of an investment for its own sake, which is supposed to be held
as sort of a profit-making proposition over time.
Senator Levin. Finally, Goldman has not allocated any
capital to cover potential losses from a catastrophic event.
Their argument is that it does not have capital allocated to
these physical commodity activities of theirs because it cannot
be held liable. Goldman says its policies and procedures are
adequate and that it will always follow them and that no court
anywhere in the world would find otherwise. Earlier today, we
had a catastrophic loss expert express grave concerns over
their assumptions. Should Goldman be allocating capital to
cover potential losses from a catastrophic event?
Mr. Tarullo. Actually, Senator, we will look with interest
at that testimony that you heard this morning, but, again, as I
mentioned earlier, that issue of the potential exposure is
really quite central to what we are doing now. And to be
honest, that is one of the things that has occasioned the most
analysis and continues to occasion the analysis. And I know the
Board of Governors, will want some good answers on that as we
proceed to think about exactly what is going to be in the
Notice of Proposed Rulemaking next spring.
Senator Levin. Will you take a look then at the testimony
of Goldman in that regard in this hearing yesterday?
Mr. Tarullo. Sure.
Senator Levin. Because it goes right to what you call a
central issue.
Gentlemen, we thank you for your service, for your
regulatory work, for your appearance here today. We have some
idea as to what your schedules are, and your appearance, your
cooperation with the Subcommittee is very much appreciated. So
go get them.
Mr. Tarullo. Thank you, Mr. Chairman. And, again,
congratulations.
Senator Levin. Thank you.
[Whereupon, at 12:21 p.m., the Subcommittee was adjourned.]
A P P E N D I X
[GRAPHIC] [TIFF OMITTED]