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In an unprecedented move, JPMorgan Chase & Co. (JPM - Analyst Report) announced its plan to exit the physical commodity business, including stakes of commodities assets and physical trading operations. This step comes amid heightened regulatory and political scrutiny of banks’ ownership in such assets.

JPMorgan will be exploring a whole lot of options ranging from a sale, spin-off or strategic partnership of its physical commodity business. As of Mar 31, 2013, the company’s physical commodities were valued at nearly $14.3 billion.

Nevertheless, JPMorgan will be committed to traditional banking activities in the commodity markets and continue to make markets as well as offer advice and liquidity to clients across the globe.

JPMorgan received the Federal Reserve’s approval to trade in physical commodities in 2005. With the acquisition of Bear Stearns Cos. in 2008, which included an energy trading platform, the company began building its physical commodity business. Moreover, in 2010, the company purchased Royal Bank of Scotland Group plc's (RBS - Snapshot Report) non-U.S. commodities joint venture with Sempra Energy – RBS-Sempra Commodities LLP.

However, over the last few years, the physical commodity business witnessed a decline in revenues across the industry.  Further, JPMorgan’s internal review of the operation concluded that profits from the business were not worth the risks posed from multiple fronts. Moreover, the company is negotiating a settlement with the Federal Energy Regulatory Commission for alleged manipulation of the California and Michigan power markets.

Earlier this month, the Fed stated that it was reviewing its 2003 decision of allowing banks to pursue trading in the physical commodity market. Further, following complaints of banks and traders manipulating supplies and prices, the Commodities Futures and Trading Commission has initiated an inquiry on the banks’ role in the metals warehousing operation.

In deciding to exit the physical commodity business, JPMorgan follows Morgan Stanley (MS - Analyst Report) and The Goldman Sachs Group, Inc. (GS - Analyst Report). Since Mar 2013, Goldman has been trying to sell its warehousing business Metro International Trade Services LLC, while Morgan Stanley has been trying to find a buyer for its oil pipeline and terminals business – TransMontaigne – for more than a year now.

Further, new stringent regulations and low volatility have dampened interest in commodity trading. Hence, we believe that finding a buyer for JPMorgan’s vast and diverse physical commodity business will be quite challenging. Moreover, the company might have to split the business, in case it does not find a single buyer for the whole unit.

Currently, JPMorgan carries a Zacks Rank #2 (Buy).

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