New York, 21 January 2010

For commodity markets, President Barack Obama's plan to curtail financial market risk-taking at the biggest U.S. banks has much broader and deeper implications than the position limits proposed last week by the Commodity Futures Trading Commission.

Readying for a fight with the country's investment banks, Obama on Thursday outlined a plan to cut down on proprietary trading at firms that have received government backing over the past 18 months.

By affecting the likes of Morgan Stanley and Goldman Sachs, which wager tens of millions of their own dollars on energy and commodity markets every day the president's plan could overshadow the CFTC's long awaited proposals last week.

While the futures regulator would restrict the amount of contracts that any single entity can own in energy futures markets that it regulates, the caps are so high that it would affect only a handful of the biggest players, more likely to be hedge or investment funds than the banks themselves. Obama's plan would cut across a much larger segment of the market.

"Banks will no longer be allowed to own, invest or sponsor hedge funds, private equity funds or proprietary trading operations for their own profit unrelated to serving their customers," Obama said.

The devil will be in the details, and a White House official later made clear that the proposal would not prevent banks from doing proprietary trading related to client business -- a distinction that is arguably difficult to make at times, and may help offset the impact on the large commodities desks.

But for now, the political risk for market liquidity has clearly shifted from the CFTC to the White House and Congress.

Funds vs Banks

The two proposals, both part of the broader financial overhaul since 2008, differ greatly in approach. The CFTC has authority only to regulate trading on the futures markets like the CME-owned New York Mercantile Exchange and select contracts on the InterContinentalExchange, not the public companies that trade them, nor (as yet) the vast unregulated over-the-counter and physical markets.

Despite reservations from some commissioners, the CFTC voted last week to move forward with a proposal to set allmonth position limits at around 2.5 percent of total market open interest, a practice that's already in place in agricultural markets. It is now open to 90 days of public comment before they decide whether to make it a rule.

But CFTC Chairman Gary Gensler has also campaigned to more explicitly regulate the swaps dealers themselves, the big banks who help corporations manage commodity price risk through hedging, execute trades on behalf of big funds and also bet their own money on global markets, a lucrative proprietary trading business that has expanded together with markets.

Obama's proposal, though lacking details, would appear to do just that, threatening to reduce the high-risk, highreward prop-trade business that's been a valuable profit center while allowing banks to retain the razor-thin- margin risk management desks.

It would also avoid the problem of banks moving into unregulated physical markets or less-restrictive overseas derivatives markets to maintain their trading ways, as some have feared the CFTC regulations would do.

If anything, Obama's boldness could intensify pressure on the CFTC to take tougher action, if lawmakers jump on the bandwagon for a more significant crack-down.

Goldman Most Exposed, JP Morgan next

Depending on the extent of the limits, it's likely to Goldman Sachs -- long the biggest on the block -- that feels the pinch most, as its Value at Risk -- the industry standard measure for how much of a banks' own money is at risk on any given day -- has steadily hovered at around $40 million over the past two years, topping the charts.

JP Morgan has recently moved into second place, with a commodities-market VaR of just over $30 million on average last year, while long-time No. 2 Morgan Stanley pared back its risks to just around $25 million, down from nearer $35 million in 2008.

It remains to be seen whether the unexpectedly tough stance from the administration throws a monkey wrench into JP Morgan's plan to expand its commodities business by buying RBS Sempra, which would add even more proprietary trading to its books. That deal is said to be days away from closing.

If the U.S. plan is approved, it could open the door to overseas rivals who have long snapped at the heels of Goldman and Morgan, especially Barclays Capital, which bought the U.S. operations of failed Lehman Brothers, Deutsche Bank, Credit Suisse and Australia's Macquarie.

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