Federal Reserve indicated it is reviewing its landmark 2003 ruling that allowed regulated banks to trade in physical commodity markets.

Commodity Market

Top global investment banks including Morgan Stanley (NYSE:MS), Goldman Sachs Group Inc (NYSE:GS), JPMorgan Chase & Co. (NYSE:JPM) are set to lose as they derive substantial revenue from commodity trading.

FED statement on commodity trade

On Friday, Reuters reported that the Federal Reserve is going to review the 2003 decision that allowed regulated banks to trade in physical commodity markets: “The one-sentence statement suggests the Fed is taking a much deeper, wide-ranging look at how banks operate in commodity markets than previously believed, amid intensifying scrutiny of everything from electricity trading to metals warehouses.”

In 2003, Citigroup Inc (NYSE:C) got permission from the Federal Reserve to allow the bank’s Phibro unit to continue trading in physical energy markets. Citi acquired the unit in 1998.

Normally, banks are prohibited under the Bank Holding Company Act to engage in non-financial activities such as trading in physical commodities. However, banks are permitted to trade in paper derivatives.

Following Citigroup Inc (NYSE:C) obtaining clearance from the FED, over a dozen other banks sought similar permission. After the financial crisis, top investment banks such as Goldman Sachs Group Inc (NYSE:GS) and Morgan Stanley (NYSE:MS) have also been subjected to the rules under the Bank Holding Company Act.

Senate hearing tomorrow

Last week, news spread that a coalition of beer brewers, automakers such as The Boeing Company (NYSE:BA) and The Coca-Cola Company (NYSE:KO) have accused big banks, including JPMorgan Chase & Co. (NYSE:JPM) and Goldman Sachs Group Inc (NYSE:GS) of involving in anti-competitive behavior in the aluminum market.

The Senate Sub-Committee is set to hear on the issue tomorrow.

The top 10 largest Wall Street banks have derived about $6 billion in revenue from commodities in 2012, including dealings in physical materials and related financial products.

With surging commodity prices at the peak several years ago, a host of global investment banks logged about $15 billion from this segment.

Normally the FED permitted banks to trade in most major commodity markets as long as there is a similar futures contracts for the commodity regulated by Commodity Futures Trading Commission.

With the top four largest U.S. banks having over 11,000 subsidiaries in 2011, the regulators have to confront the difficult task of scrutinizing their complex commodities exposures.