Goldman Sachs in spotlight over 'aluminium price-hike' scandal

Financial giant is accused of exploiting rules over metal warehousing in order to manipulate commodity prices

Goldman Sachs is at the centre of another potential London-linked scandal after US watchdogs kicked off investigations into practices that could have hiked the price of aluminium and damaged the world’s economy.

America’s Commodity Futures Trading Commission has ordered firms involved in the market to preserve emails, documents and other messages from the past two years. 

It is the first step in what could lead to a formal investigation into an increasingly controversial market that has become dominated by Wall Street banks.

Over the last couple of years, vast backlogs of aluminium have been built up, particularly at various warehouses in Detroit. In some cases queues have stretched for more than 100 days, and the London Metal Exchange (LME) – which sets the rules of the global market – is now considering new requirements that could force them to deliver metal to customers more quickly.

Wall Street banks now dominate the metal warehousing market, and the New York Times has claimed that Goldman Sachs has effectively exploiting rules by the LME that force firms to move at least 3,000 tonnes of metal a day, but do not say where it has to go – meaning it can simply, and legally, be shipped between its warehouses.

Holding the metal at a warehouse generates substantial rental income. This serves to boost the so-called “spot” price of the metal on global markets, and means that consumers can end up paying a tiny amount more per can of soft drink. This then translates into potentially huge profits for the banks, but a vast number of other industries are also affected.

While suppliers can and do source the metal from other suppliers, the practice still means they pay more because of the impact on the “spot” price.

Goldman Sachs said in a statement: “The warehouse companies, which store both LME and non-LME metals, do not own metal in their facilities, but merely store it on behalf of the ultimate owners. In fact, LME warehouses are actually prohibited from trading all LME products.”

However, the Financial Conduct Authority (FCA) is understood to be looking at the situation, and the LME’s consultation into changing its rules could force warehouses with queues that are longer than 100 calendar days to deliver out more metal than they take in.

Goldman Sachs faced sharp criticism for the role it played in the run-up to and during the financial crisis, and it agreed to pay $550m (£360m) to settle civil fraud charges of misleading investors. The charges related to its marketing of mortgage investments as the US housing market faltered.

However, it has bounced back strongly, wowing Wall Street with its recent results, as attention has shifted to rivals.

The involvement of banks in commodity markets has become increasingly controversial in the wake of the financial crisis. Barclays is one of a number of banks accused by US watchdogs of manipulating electricity markets, although the company is disputing attempts to fine it a record $453m and the case is headed for court.

Barclays also pulled out of its “soft commodities” business, which includes foodstuffs such as wheat, amid controversy over it making profits from rising food prices.

Yesterday the FCA fined US-based High Frequency Trader, Michael Coscia, $903,176 (£597,993) for “deliberate manipulation of commodities markets”. The regulator accused him of placing “thousands of false orders for Brent Crude, Gas Oil and Western Texas Intermediate (WTI) futures from the US on the ICE Futures Europe exchange (ICE) in the UK, which generated price movements and enabled him to reap a profit of US $279,920 in six weeks”.

Commodities have been classified as among the City’s “dark corners” which are either unregulated or imperfectly regulated.

While derivatives, such as futures and options, are overseen by watchdogs, the physical market for metals themselves is not. That could prevent regulators penalising institutions even if they believe wrongdoing has occurred.

The situation is similar to that which occurred with the Libor interest rate scandal. It was unregulated, although the Financial Services Authority (FSA), which was the precursor to the FCA, was able to deploy its “principles of business” rules to impose fines upon banks including Barclays, UBS and the Royal Bank of Scotland.

The LME is the City’s last major “open outcry” exchange which has yet to fully convert to screen-based trading. Traders still shout orders at each other across its “ring”.

The exchange used to be owned by its member banks and traders, until its sale last year to the Hong Kong based HKEx Group. More than 80 per cent of all non-ferrous metal futures business is transacted on UK platforms, equating to a notional $14.5tn last year and 3.7bn tonnes of metal.

Q&A: The lucrative business of metal warehousing

Q What on earth are banks doing warehousing metals?

A In a word, it makes money. Metal warehousing generates a considerable income for them from rental fees.

Q So, what’s the problem?

A Companies ranging from soft drinks manufacturers such as Coca-Cola to car makers like General Motors, who depend on access to metals, complain that long queues to remove metals including aluminium, copper and zinc drive prices up by creating bottlenecks.

Q Who own the warehouses?

A Ownership is concentrated in the hands of a small number of companies. In addition to Goldman Sachs they include JP Morgan and the FTSE 100 commodities trader Glencore.

Q What action is being taken?

A The London Metal Exchange (LME) is considering forcing warehouses with queues of more than 100 days to deliver more metal than they are allowed to take in. At the moment they have to deliver 3,000 tons a day, but warehouse owners can shift metal between warehouses.

Q Will that solve it?

A It may. It will certainly cut the profits from warehousing. Critics have noted that the LME is not entirely disinterested in this debate. It gets a small cut (about 1 per cent) of any rental income.

Q Is what has been going on illegal? What can regulators do about it?

A Nothing illegal about it, at least on the surface. America’s CFTC has sent letters to market players ordering them not to delete emails and other communication, but it would have to prove an impact on the futures markets. The market for physical metals is not regulated but because the warehouses are linked to the London Metal Exchange and its traders, there may be an opening for it there. However, just because the CFTC has sent letters doesn’t mean it will be able to launch a formal investigation or secure a “settlement” from the banks that are allegedly involved.

JAMES MOORE

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