By Patrick Rucker and Olivia Oran
WASHINGTON/NEW YORK (Reuters) - The Federal Reserve Board recommended that Congress pare back Wall Street's ability to own physical commodities and engage in other aspects of merchant banking because of possible risks to the financial system, according to a report issued on Thursday.
U.S. lawmakers should repeal permission granted in 1999 for Goldman Sachs Group Inc (N:GS) and Morgan Stanley (N:MS) to conduct activities like storing and transporting physical commodities that other banks cannot do, the Fed said jointly with two other regulators.
Fed Governor Daniel Tarullo had already expressed misgivings about the commodities exemption, so the Fed's position was somewhat expected. The Fed's opposition, however, to merchant banking, was something of a surprise.
Merchant banks take direct ownership shares in non-financial businesses.
The report was required under Dodd Frank, the Wall Street reform law, which required the Fed, the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency to report to Congress on the types of banking activities that might pose risks to the financial system.
Existing rules allowing commodity investments raise "safety and soundness concerns as well as competitive issues," the Fed said.
Wall Street firms have been scaling back riskier parts of their commodities businesses in recent years due to public and political scrutiny over the role of banks in raw materials markets.
Morgan Stanley last November completed the sale of its physical oil business to commodity trading firm Castleton Commodities. In 2014, the bank sold its controlling stake in oil storage business TransMontaigne to NGL Energy Partners LP.
In December 2014, Goldman sold its controversial Metro metals warehousing unit to Swiss private equity group Reuben Brothers.
The Fed recommended that Congress repeal the ability of banks to make investments in non-financial companies. This would preclude banks being exposed to legal liability for operations of a portfolio company, the report said.
Spokesmen for Goldman and Morgan Stanley declined to comment on the report.
Wells Fargo & Co (N:WFC), which makes merchant bank investments through its Norwest Equity Partners and Norwest Venture Partners units, said in a 2014 letter to the Fed that its "diverse portfolio of merchant banking investments has increased the safety and soundness of our institution by producing attractive risk-adjusted returns."
A number of banking trade organizations, including the Clearing House, the American Bankers Association, SIFMA, Financial Services Roundtable and the Financial Services Forum, called the recommendations "unfortunate and ill-considered." They said regulators had not provided a cost-benefit analysis or justification for the changes.
(Reporting bPatrick Rucker in Washington D.C. and Olivia Oran in New York; Editing by David Gregorio and Dan Grebler)