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By Anna Louie Sussman and Emily Stephenson
NEW YORK/WASHINGTON, Jan 13 (Reuters) - The U.S. FederalReserve is set to take its first formal step toward limiting therole of Wall Street banks in physical commodities markets thisweek by issuing a notice to seek public comment on the topic,sources familiar with the matter said on Monday.
The Fed will publish an "advance notice of proposedrulemaking" on Tuesday, laying out the issues it is considering,one day before a second Senate banking committee hearing on thematter, the sources said.
The notice and Wednesday's hearing come after months ofpublic and political outcry over the risks of allowing banks totrade physical commodities such as tankers of crude oil andpallets of copper.
At a Senate hearing in July, witnesses testified that theactivities pose a risk to the financial system in the event of acatastrophic accident. Metals consumers complained that banks'ownership of physical storage assets enabled them to inflateprices for commodities such as aluminum.
In 2013, banks including JPMorgan Chase and Barclays have paid hundreds of millions of dollars in fines formanipulating energy markets.
The U.S. Federal Energy Regulatory Commission (FERC), whichregulates energy markets, will be represented at Wednesday'shearing by Norman Bay, a former New Mexico district attorney whohas led a series of high-profile market manipulation casesagainst big traders in the U.S. power and gas markets, includinga record $410 million penalty agreed with JPMorgan.
The other two witnesses are the CFTC's market oversightchief, Vince McGonagle, and Michael Gibson, the Fed's directorof banking supervision and regulation.
WHAT ARE THEY THINKING?
It is not clear what measures the Fed may propose. Thepublic is expected to have 60 to 90 days to submit commentletters, which the Fed can use to formulate its rules.
A Federal Reserve spokeswoman declined to comment.
An ANPR can range from being a simple list of questionsdesigned to elicit information to something more like a conceptpaper, said Hugh Conroy, Jr., a banking lawyer at ClearyGottlieb Steen & Hamilton. In any case, Tuesday's document willprovide the first glimpse into the Fed's thinking sincelawmakers and the public have put the issue in the spotlight.
"Usually an ANPR would be done in a context where they'retrying to get people to give them more ideas, versus a proposedrule text where they just want people to comment on what theyhave already put in writing," he said.
Over the past year, lawmakers have pressed the Fed toexamine whether Wall Street's biggest banks, including JPMorganChase & Co and Goldman Sachs Group Inc, should be allowedto own assets such as metals warehouses and oil tankers, and totrade physical commodities alongside commodity derivatives.
The notice by the Fed may touch on the issue of capitalsurcharges for certain activities, an issue that arose in mediareports but was never clarified by the Fed.
SOME BANKS EXITING COMMODITIES
In July, the Fed said it would be reviewing the role ofbanks in physical commodities trading, something that it hasallowed a range of banks to engage in since 2003.
Karen Shaw Petrou of Federal Financial Analytics inWashington said the notice would likely seek comment on how therisk varies by commodity, and would consider the systemic impactof various physical trading activities.
"This is hard, and the Fed is busy," Petrou said. "It isreally complicated. If you want to have a simple capital rule,then you would have an across-the-board charge for certaincommodities activities, but it's true that some of them are alot riskier than others."
It is unclear whether the Fed will also address a relatedbut distinct question: whether former investment banks Goldmanand Morgan Stanley should be allowed to carry on owningcommodity-related assets, such as metals warehouses and oilpipeline, due to a "grandfathering" clause in a 1999 law.
Regardless of the scope of the Fed's statements, they arecertain to be scrutinized by industry executives and theirlawyers, who have been frustrated by the lack of clarity over apossible crack-down that could further roil Wall Street'smultibillion-dollar trading operations.
Some banks have not waited for a final word. JPMorgan is inthe final stage of a months-long process to sell its entirephysical commodity desk, and Morgan Stanley agreed last month tosell its physical oil trading operation to Rosneft.
"One thing I'd want to look at is their justifications forsuch a proposal. I think for it to be an appropriately reasonedrule-making, it should address how the charges address therisks," said a banking lawyer who declined to be named.
"I would also want to see what they said about theirsupervisory experience over the time they have allowed financialcompanies to do this."
ANPRs are a preliminary step on the rulemaking path, saidConroy, adding that even more advanced documents, like draftrules or interpretive statements, can fall by the wayside.
"Generally, even notices of proposed rulemaking andinterpretive statements sometimes don't end up becoming rules,so an ANPR may not end up becoming a rule," he said.
"But it indicates they are moving towards that."
