Regulators make new push, and Goldman could take the brunt

Goldman Sachs headquarters: Wall Street bank and large peers could be hit by proposed new commodities limits

The moves on September 8 amounted to a signal that regulators aren’t done scrutinising businesses beyond basic loans and deposit taking.

The most significant and, to many, surprising announcement was a recommendation by the Federal Reserve that Congress repeal banks’ authority to engage in merchant banking, a business in which banks own stakes in non-financial companies as a way of providing them capital but also with the goal of making a profit when they exit.

The recommendation is sure to raise concerns on Wall Street about exactly how far the Fed will go in attempting to limit banks’ investment portfolios. The Fed doesn’t have the authority on its own to ban commodities or merchant-banking businesses outright.

Merchant banking essentially gives big Wall Street firms a do-it-yourself option when they can’t find the right investor to fund a corporate client in need of financing. It also can provide an opportunity to reap investment gains.

Done right, the business can be lucrative. But it can also bring risks of heavy losses.

Even if Congress doesn’t act, regulators have other tools to put pressure on businesses that they believe are risky. Those include increasing capital requirements or penalising such investments in annual regulatory “stress tests” that evaluate a bank’s dividend and share-buyback plans.

The firm hardest hit by the proposals could be Goldman, which has a long history in merchant banking and often invests in non-financial businesses. The bank is also a bigger player in commodities trading, another activity that came under attack on September 8 when regulators proposed limiting bank activities in that area.

Goldman had about $ 22 billion of equity investments as of late 2015. The firm has put money into everything from ride-hailing service Uber Technologies to less-well-known trading technologies. The firm marks these holdings to market prices, often Goldman’s best guess of their worth, meaning they are reflected in its quarterly earnings.

Some investments are simply opportunistic bets; Goldman stands to make billions on Uber, for example. Some also help cement banking relationships, such as future merger or IPO work. Goldman invested early in Square and helped take the payments company public.

It isn’t clear how broadly the Fed or Congress would seek to define the investments they are seeking to discourage. Many financial-technology startups straddle the two sectors. If the Fed were to view them as outside of finance, many current investments held by Goldman and others could be at risk.

Goldman declined to comment. But a group of financial-industry trade groups issued a joint statement saying the merchant-banking proposal and others “are unfortunate and ill-considered….The regulators have made these recommendations without pointing to any evidence that these activities have ever posed any problem, and have made no attempt to assess the costs to businesses and jobs.”

At the end of 2015, 21 bank holding companies held merchant banking investments of $ 26.78 billion, down from $ 49.3 billion in 2012, according to a report on September 8 from the Fed and other banking regulators. Of those 21 banks, five were foreign-owned.

Merchant banking investments left banks “exposed to the risk of legal liability for the operations of a portfolio company”, the Fed said in the report, a response to a requirement of the 2010 Dodd-Frank financial-overhaul law. “A repeal of merchant banking authority would help address potential safety and soundness concerns and maintain the basic tenet of separation of banking and commerce.”

The Fed also said Congress should repeal a provision of a 1999 law that effectively allows Goldman and Morgan Stanley to store, extract and transport commodities even though other banks are barred from doing so. Fed Governor Daniel Tarullo, the central bank’s regulatory point person, has previously endorsed that policy. The new recommendation was approved unanimously by the Fed’s five-member governing board in Washington.

Many large banks have already significantly scaled back their commodities businesses as the result of regulatory and political pressure, including Deutsche Bank, Credit Suisse, Morgan Stanley and JP Morgan.

Separately, the Office of the Comptroller of the Currency, which regulates federally-chartered national banks, proposed to prevent national banks from dealing or investing in metals such as copper, which would reverse a previous regulatory policy.

Congress likely won’t act on the Fed’s recommendations this year.

In January 2014, the central bank asked for public input about, among other things, its capital policies regarding merchant banking. Officials have said they are working on a formal rule proposal, but haven’t published a draft.

—Justin Baer and Tatyana Shumsky contributed to this article

Write to Ryan Tracy at and Liz Hoffman at

This story was first published by The Wall Street Journal

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