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Spec commodity trading seen surviving rule changes

09/07/2010 @ 7:25am

DJ Speculative Commodity Trading Seen Surviving Law Limiting Banks Role

NEW YORK (Dow Jones)-Speculative investors are likely to remain a force in commodities markets despite signs that the big banks are bowing out.

The exit by JPMorgan Chase & Co's (JPM) and Goldman Sachs Group Inc. (GS) from proprietary trading sent a message that Wall Street banks are moving quickly to comply with tough new market regulations.

The recently passed financial overhaul requires commercial banks to jettison any derivatives trading they undertake with their own capital, including bets on commodities. Some large financial firms are already moving to close down proprietary trading operations after more than five years of rapid expansion.

The bill gives banks nearly a decade to end speculative derivatives trading to comply with the so-called Volcker Rule, named after former Federal Reserve Chairman Paul Volcker who first proposed it. However, JPMorgan already informed roughly 20 commodities traders on the bank's "prop desk" that their jobs are being eliminated, according to a person familiar with the matter. Goldman Sachs has decided to close its principal strategies unit, which does its proprietary trading, according to someone familiar with the matter.

Some markets could see a temporary lull if other banks follow the lead of these large firms, and there are worries about the loss of liquidity in some sparsely traded products. But a permanent reduction in speculative activity isn't in the cards. Hedge funds and other investment groups are expected to fill some of the void, and analysts are hopeful rules will still allow for banks to serve their clients.

Regulators haven't comprehensively defined what constitutes "proprietary" trading, which is often intertwined with deals done on behalf of clients, transactions still allowed under the Volcker Rule. The new regulations also won't stop banks from spinning off their proprietary trading desks.

Demand for commodity derivatives hasn't diminished this year, even as Congress moved toward limiting the role of some large traders. Markets for commodities such as oil, copper, grains and gold have seen strong trading volume as investors look for ways to further diversify their portfolios and gain exposure to additional asset classes tied to the health of the global economy. Someone--whether it's banks, hedge funds or companies that produce and consume commodities--will still need to take the other end of those trades.

"The line between providing liquidity and proprietary trading is very thin," said Jeffrey Harris, a professor and former chief economist at the Commodity Futures Trading Commission. "If people want to trade on prop accounts, they are going to find a way to do it," he added.

The hunt for top trading talent has already begun. First New York Securities, a private proprietary-trading partnership, said it is looking to expand in light of the changes to large banks. "We're looking at this as an enormous opportunity for us," said Donald Motschwiller, managing partner at First New York, which currently has 230 traders working in numerous asset classes, including commodities.

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