Insight: Wall Street uses 'merchant' workaround to cling to commodity assets
By Jonathan Leff and David Sheppard
NEW YORK/LONDON (Reuters) - Wall Street's commodity trading giants are using a 14-year-old law to hold on to their oil storage terminals and metals warehouses a little bit longer, even as the Federal Reserve considers cracking down on such investments.
Under the so-called "merchant" authority, U.S. financial holding companies are allowed to invest their own capital in just about any type of business - so long as they do so at arm's length, for purely passive financial purposes, and for no more than 10 years. Banks have been allowed to take small equity stakes for decades, but a controversial 1999 banking law vastly expanded the scope of such investments.
Morgan Stanley (MS.N: Quote) gave approval to TransMontaigne LP (TLP.N: Quote) to re-purchase a major stake in a new oil terminal in Houston, Texas late last year after the investment was restructured as a "merchant" deal that would comply with the law, according to a person familiar with the project.
The legal maneuver, which hasn't been previously reported, is likely only a temporary measure for Morgan Stanley, which has been looking at ways to spin off or sell the whole commodities business since last year. The bank's oil trading desk is too deeply intertwined with the wider TransMontaigne oil terminal and pipeline business to separate the two.
It is unclear whether the arrangement offers a longer-term solution for Goldman Sachs (GS.N: Quote), which has said publicly that its Metro International Services metals warehousing unit - the target of political and regulatory scrutiny due to allegations that it has inflated the cost of aluminum - is structured as a merchant business. The same goes for a Colombian coal mine.
Executives at Goldman have been the most outspoken on Wall Street about the importance of commodity trading, saying its J. Aron commodities arm is "core" to the bank and stressing that it is allowed to hold onto Metro for another six years. However, the bank is informally resuming efforts to sell the warehouses after drawing interest in recent months, a source said.
The merchant deal tag has allowed the banks to press ahead with certain investments or stave off an immediate forced sale. However, it also means the assets they purchased during the height of the commodity boom are of little use to their trading desks, as the Fed enforces strict Chinese walls.
If the banks can show that they are not involved in the "routine management or operation" of the firm, as required under the merchant clause, the bank would be largely protected from liability, lawyers say - in theory satisfying the Fed's primary objective of keeping the banks and financial system safe from potentially devastating disasters. Continued...