(Adds Sherrod Brown comment in paragraphs 16-17)
By Josephine Mason
NEW YORK, July 21 The U.S. commodities market
regulator has put Wall Street banks and other big traders on
notice for a possible investigation of their metals warehousing
businesses following years of complaints about inflated prices.
The U.S. Commodity Futures Trading Commission (CFTC) last
week sent a letter to firms ordering them to preserve emails,
documents and instant messages from the past three years, two
sources who received the letters told Reuters.
The notice amounted to a "warning shot" ahead of what is
probably a formal CFTC probe, one of the sources said.
If there is an investigation, it would be the first such
probe by any regulator into the lucrative and controversial
industry, which since 2010 has become dominated by banks
including Goldman Sachs Group Inc and JPMorgan Chase & Co
and global merchant traders like Glencore Xstrata Plc
and Trafigura AG.
The letter from the CFTC's enforcement division did not
refer to an investigation, but the do-not-destroy order touched
on some of the most sensitive issues in a controversy that has
plagued the London Metal Exchange for years.
The CFTC explicitly said that the firms should retain
communication related to incentives or premiums given to metal
producers in exchange for storing metal; daily loading rates;
high load-out requests; delivery policies and procedures and
complaints about load out requests.
At least two companies involved in warehousing received the
letter, but sources said they believe such notices were sent to
all the major players.
While the recipients of the letter say they now expect a
wide-ranging probe, it is not clear how or when that could take
place. The CFTC opens dozens of investigations a year, yet only
a handful ever result in action and some are never made public.
It almost never discusses open inquiries.
In the past three years, a mountain of aluminum and other
metals has accumulated in the global warehouses that are part of
the LME network, clogging the trading system and causing lengthy
queues - up to a year - as consumers and dealers of the metal
seek to get their hands on it.
The queues have caused the price premium on some metals to
surge, prompting accusations that banks and traders are
artificially inflating prices and distorting supplies.
After years of complaints from end-users such as Novelis
, the world's biggest maker of flat-rolled aluminum,
and customers like Coca-Cola Co, which use the metal for
aluminum cans, regulators are now taking a deeper look into the
industry as political pressure to rein in Wall Street's powers
In an email to Reuters on Saturday, Bart Chilton, a Democrat
on the five-person commission and frequent critic of lax
regulation, urged a "full and comprehensive review" of warehouse
ownership, but did not comment on the letter itself.
"These markets are too important to allow behind-the-scenes
machinations to distort commodity prices," he said.
A possible probe comes amid intensifying scrutiny of Wall
Street's role in raw material markets from owning oil tankers,
power plants and metals warehousing.
The Federal Reserve is weighing whether to allow banks to
continue owning physical assets.
"The CFTC has a role to play in protecting American
manufacturers and consumers from having the price of their gas,
canned food and beverages, or electricity driven up by Wall
Street speculators," said Senator Sherrod Brown, a Democrat from
"The CFTC should use the full force of its power to address
The U.S. Senate banking committee will hold its first
hearing on the matter on Tuesday, asking whether "Too Big to
Fail" banks should be allowed to operate freely in loosely
regulated physical commodity markets and own physical commodity
assets from power plants to oil tankers.
CFTC spokesman Steven Adamske declined to comment.
Goldman Sachs, JPMorgan and Glencore declined to comment.
Trafigura declined to make and any immediate comment.
Goldman has consistently said Metro International Trade
Services, its warehousing unit, has not broken any laws or
(Reuters in-depth report on warehouses:
SEEKING AN EXIT
Well before the CFTC's involvement, there has been growing
evidence that the period of record high premiums, long queues
and rich rewards for owners of the warehouses is drawing to a
Earlier this month, the LME's new owner - Hong Kong
Exchanges and Clearing Ltd - proposed sweeping reform
of its warehousing policy in its third attempt to tackle the
wait times and soothe irate industrial clients.
And Goldman Sachs began exploring the possible sale of its
warehousing business Metro International earlier this year,
Reuters reported in April. JPMorgan has more
recently started to look for potential buyers for its Henry Bath
unit, people familiar with the process said this month.
The sales efforts precede the change in LME rules, but
emerged just ahead of deadlines for the U.S. Federal Reserve to
decide whether Wall Street should be allowed to own commodity
trading assets. The issue is coming to a head five years after
the financial crisis brought Goldman under the Fed's purview.
While it had long been assumed that the banks would likely
be allowed to retain many of their investments, even if holding
them at arm's length, growing public and political pressure
appears to be forcing the Fed to take a deeper look.
Late on Friday, the Fed issued a surprise statement saying
that it was rethinking a decade-old decision that allowed banks
to trade in physical commodities.
CFTC GETS TOUGH
The letter is the latest effort from a newly emboldened
CFTC, which has also led the charge on the Libor interest rate
manipulation probe and more recently began reviewing millions of
energy swap trades for possible violations of new rules.
The enquiry could also raise pressure on the UK watchdog,
the Financial Conduct Authority (FCA), which has regulatory
oversight of the LME, to delve into the industry, sources said.
Novelis has complained to the European Commission, the FCA
and the CFTC, but has been frustrated by the apparent lack of
"Warehousing has been believed to be outside the scope of
the FCA and CFTC because it's not a derivatives market," Novelis
vice president and chief procurement officer Nick Madden told
Reuters in an interview earlier this month.
"It's an area that's very vulnerable to these players using
leverage for their own interest," he said.
The CFTC does not regulate the LME, nor does it have
authority over physical commodity trading, but it may still be
able to claim some jurisdiction through a no-action letter it
granted allowing the LME to operate in the United States or
through metal futures traded on CME Group exchanges.
The letter, dated July 19, makes reference to both LME and
CME registered warehouses, although the same problems have not
afflicted the U.S. exchange's markets.
A PREMIUM METAL
Warehouse firms in the LME system were traditionally
independently owned, but since 2010 four of the six largest
players have been bought by investment banks or traders.
Over the same period, storage volumes have surged. Metro now
holds 1.4 million tonnes of aluminum at its 29 Detroit
warehouses, up from 800,000 tonnes at the end of 2009. That is
almost a quarter of the aluminum in registered LME warehouses
around the world and almost 1 million tonnes of it is waiting to
be delivered out.
The warehouse firms collect rent on the metal, and are only
required to deliver it out at a limited rate set by the LME.
Warehouses with 900,000 tonnes or more are required to load
out metal at a minimum rate of 3,000 tonnes per day, regardless
of how much metal was delivered into the warehouse.
The firms pay big incentives to traders to use their
warehouses. End-users then fork out high rates in order to get
their hands on metal.
Aluminum premiums in the United States AL-PREM are at
record highs even though the market is in chronic surplus.
The LME's vast global storage network is currently holding
over 5 million tonnes of aluminum, with analysts estimating
another 5 million tonnes stored outside of the exchange.
That combined 10 million tonnes is about 10 percent of
annual global demand.
The CFTC letter says warehousing firms, parent companies,
staff and anyone acting on their behalf must "retain, preserve
and safeguard against destruction" all documents and
communications since January 2010, according to a copy of the
letter read to Reuters.
"This is the 'we're going to be coming for you so we're
putting you on notice that you can't tell us when we come to you
that you had some destruction policy in place,'" according to
one of the sources who received the letter.
(Reporting by Josephine Mason; Additional reporting by Douwe
Miedema in DC and David Sheppard in New York; Editing by
Jonathan Leff, Martin Howell and Nick Zieminski)