Insight: As banks deepen commodity deals, Volcker test likely

Tue Jul 3, 2012 10:36am EDT
 
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By David Sheppard and Alexandra Alper

NEW YORK/WASHINGTON (Reuters) - The subtext of JPMorgan's landmark deal to buy crude and sell gasoline for the largest oil refinery on the U.S. East Coast was barely disguised.

In joining private equity firm Carlyle Group to help rescue Sunoco Inc's Philadelphia plant from likely closure, the Wall Street titan cast its multibillion-dollar physical commodity business as an essential client service, financing inventory and trading on behalf of the new owners.

This was about helping conclude a deal that would preserve jobs and avert a potential fuel price spike during the heat of an election year summer -- not another risky trading venture after the more than $2 billion 'London Whale' loss.

But the deal also highlights a largely overlooked clause in the Volcker rule that threatens to squeeze banks out of physical markets if applied strictly by regulators, one that JPMorgan (JPM.N: Quote) and rivals like Morgan Stanley (MS.N: Quote) have been quietly fighting for months.

While it has long been known the Volcker rule will ban banks' proprietary trading in securities, futures, and other financial tools like swaps, a draft rule released in October cast a net over commercial physical contracts known as ‘commodity forwards', which had previously been all but exempt from financial oversight.

The banks say that physical commodity forwards are a world away from the exotic derivatives blamed for exacerbating the financial crisis. A forward contract in commodities exists somewhere in the gray area between a derivative like a swap - which involves the exchange of money but not any physical assets - and the spot market, where short-term cash deals are cut.

Banks say they are also essential to conclude the kind of deal that JPMorgan lauded on Monday.

"JPMorgan's comprehensive solution, which leverages our physical commodities capabilities... demonstrates how financial institutions with physical capabilities can prudently, yet more effectively, meet our clients' capital needs," the bank said in a press release.   Continued...

 
The JP Morgan (L) and U.S. flags wave outside the JP Morgan headquarters in New York, May 17, 2012. REUTERS/Eduardo Munoz