WASHINGTON - It is too early to tell whether the Federal Reserve Board's decision to let Citigroup Inc. stay in the physical commodities business was a watershed, but it will certainly renew speculation about the divide between banking and commercial activities.
The Fed issued an order Thursday that allows Citi to continue trading commodities through its Phibro Inc. subsidiary, which deals in crude oil, natural gas, and metals, among other things. Phibro had been part of Travelers Group before it merged with Citicorp in 1998.
Physical commodities were not on the list of activities in the Gramm-Leach-Bliley Act of 1999 that are permissible for financial holding companies, and Citigroup's grandfathered rights to the business were set to expire this week unless the Fed took action. (In 1998 the Fed had granted Citi similar permission to keep its insurance underwriting businesses; Gramm-Leach-Bliley later allowed banks to offer insurance.)
Last week's order broke legal ground that may invite applications by other companies. Using a prerogative in Gramm-Leach-Bliley, the Fed classified the physical commodities business as "complementary" to financial services.
The act gave federal banking regulators the flexibility to let financial holding companies into new businesses that its framers could not envision. The Fed and the Treasury Department, for instance, may deem new activities to be "financial in nature" or "incidental" to financial services, while the Fed alone has the power to deem something complementary - a vaguely defined term referring to activities a bit more tangential to banking than incidental ones.
Critics of letting financial holding companies stray into nonfinancial businesses are always on guard about such decisions. One of the legal issues with physical commodities is that sometimes a trader must temporarily own them to complete the transaction.
"I would expect the other group of trading banks to take advantage of this order at some point," said Oliver Ireland, a former associate general counsel at the Federal Reserve Board who is now a partner at the law firm Morrison & Foerster LLP. "I think this is a logical extension" of decisions by banking regulators to expand the powers of banking companies.
Time will tell whether the Fed's decision was a limited one inspired by the Phibro deadline or part of the central bank's implementation of a larger plan.
"Whether it's a wide-door or a rifle-shot approach, it's unclear at this point," said Gil Schwartz, a Washington banking lawyer at Schwartz & Ballen LLP. "Given the Federal Reserve's track record, it's probably a rifle shot."
Still, some companies may seek to seize on it as a precedent.
"The fact is, it does send a message," Mr. Schwartz said. "People were saying, 'They are just not going to use [the power to allow banks into new businesses] at all.' This is a clear signal that they can use their authority - but you have to build an appropriate case."
Getting approval for new types of activities has not been easy since Gramm-Leach-Bliley was enacted.
Industry efforts to define real estate brokerage and management as financial in nature have been routinely quashed. The Treasury and the Fed proposed making such a definition, but strong opposition from the real estate industry has pushed the issue to Capitol Hill.
Fed officials did not comment Friday on the order, so it is unclear if other applications for complementary powers are pending or have been rejected in the past.
There are conditions to the order. For example, Citi is not allowed to hold commodities with a market value of more than 5% of its consolidated Tier 1 capital, and can trade only commodities that have been approved for the U.S. futures exchange.
"Permitting Citigroup to engage in the limited amount and types of commodity-trading activities described above does not appear to pose a substantial risk to Citigroup," the order said.
A Citi spokeswoman would not comment on Friday.
