Nuns and analysts alike recognize need for transparency into bank commodity earnings

Reuters ran an article highlighting the need for transparency as "for nuns and analysts alike, bank commodity earnings are a mystery".

The simple fact is that banks are not required to provide transparency.

Remember that under the 1930s Securities Acts, the government is given the responsibility for ensuring that all market participants have access to all useful, relevant information in an appropriate, timely manner so the market participants can independently assess this information and make a fully informed decision.

Commodities is one, but not the only area where the government is not fulfilling its responsibility of ensuring transparency to all market participants.

When the government does not fulfill its responsibility and ensure transparency, the market does not work properly as market participants are not able to assess and properly value risk.

Our current financial crisis is the result of market participants not having access to all the useful, relevant information in an appropriate, timely manner so that they could independently assess and properly value risk.

When the Reverend Seamus Finn got an email from Goldman Sachs last week, the giant Wall Street bank was addressing an issue that was already on his mind. 

"We were getting ready to go back to them and talk to them about commodities anyway," said Finn, who heads up faith-consistent investing for the Missionary Oblates, a Washington DC-based Catholic group that owns Goldman shares.... 

But it left unanswered many of Finn's questions about what the bank is doing in the sector.... 

The statement sent to Finn and later released widely did not address one of his broader concerns: that no one outside the banks themselves knows for sure how big their commodity trading arms are, how much they trade, or how much money they make. 

"We would like more disclosure on that," Finn said.

He is unlikely to get his wish. 

While the country's largest banks are required to disclose their activities in some consumer-facing businesses such as mortgages, there is no similar requirement for them to do so on the commodities side....

Please re-read the highlighted text as this experience not only applies to commodities, but also to all the other opaque areas of the financial system ranging from the banks themselves to Libor to structured finance.

"I don't think you have any banks that are properly disclosing commodities revenue," said George Kuznetsov, head of research and analytics at Coalition, a British consulting firm that employs more than 100 researchers to scrutinize public disclosures and conduct interviews to estimate trading revenues for investment banks. 

The issue is becoming increasingly important as politicians press the banks for more insight into the risks they are taking by owning metals warehouses or chartering oil tankers, and as some seek buyers for their physical commodities holdings. ...

The lack of clarity over trading operations has long been a vexing issue across other desks as well, such as foreign exchange and equities....

In sum, it's big money: the top ten global banks collectively made about $6 billion trading commodities last year, down 24 percent from in 2011, according to Coalition. 

The banks say that they are providing regulators and investors with all the information they are required to give. 

"Our disclosures are in line with all relevant reporting requirements and provide investors with all material information," said a spokesman for Morgan Stanley. He said the bank provides data on the main drivers of results across its three core business lines but does not break down earnings to a "product" level like commodities. 

Critics say the disclosures still leave much to be desired. 

"They really don't tell us much," said Robert McCullough, an energy economist who spent six years litigating an electricity market manipulation case against Morgan Stanley. 

"If you wanted an estimate of what their position was in electricity in 2001, six years of litigation was not sufficient to get it," he said.

To accurately assess the risk of a bank's commodity business, market participants need the bank's current exposure details.

Clearly, there is a significant gap between what market participants need to accurately assess risk and what the government has decided represents all the material information.

In terms of financial system risks, the Federal Reserve, which regulates banks, has the power to make on-staff visits and request data sets from the banks on their commodities activities. 

The agency also keeps on-site staff at the banks who are dedicated to monitoring commodities. 

So the government's solution is to give the Federal Reserve an information monopoly on all the useful, relevant information.

But that is not enough, according to some former examiners. 

"There's a sophistication gap between the regulator and the bank that they regulate," said Mark Williams, a former Federal Reserve bank examiner and energy executive who now teaches finance at Boston University. 

"The commodities are where the more sophisticated transactions take place," he said....

As Mr. Williams observes, the Federal Reserve is not up to the task of accurately assessing this information.  Even if it were, there is another problem: communicating this assessment to the other market participants.

If the Federal Reserve isn't capable of accurately assessing the information and the market participants who are capable of assessing the information don't have access to the information, then the result is that there is no one overseeing and exerting restraint on the banks risk taking.

This is a prescription for banks to take on excessive risk and engage in bad behavior.

As has been shown numerous times since the start of the financial crisis, bankers were and still are only too willing to fill this prescription by taking on excessive risk and engaging in bad behavior.

Goldman Sachs, for instance, reported only $100 million in "commodity and other" trading revenues to the Fed in 2012. In a separate filing with the SEC, the bank said it made $575 million trading commodities. Industry sources actually pegged Goldman's commodity revenues closer to $1.25 billion for the year. 

Asked about the different figures, a spokesman for Goldman Sachs said: "We disclose figures in the way we are required. That may not correspond to the way we actually measure the performance of certain trading businesses." He declined to provide a figure for the bank's commodity trading revenues....

With so much uncertainty around the headline numbers, attempting to separate banks' paper bets on commodities from physical trading - the segment most at risk from regulators - is all but impossible....

That hasn't stopped some influential groups from calling on banks to step up their reporting. 

Last year, the CFA Institute - which confers the Chartered Financial Analyst credential to investment professionals worldwide - endorsed a report calling for banks to improve their risk disclosures to investors. 

Banks' trading books, in particular, remain "very opaque" to investors, said Vincent Papa, the institute's director of financial reporting policy. 

"In many cases, they give you a figure which they deem to be meaningless from an internal management standpoint," Papa said. "They just give it for compliance reasons. That's not beneficial to investors. It's about giving relevant information, rather than just ticking the boxes."...