News

(Reuters) – Morgan Stanley (MS.N) is considering selling a stake in its commodities unit, according to a news report that, if true, could signal the extent to which regulatory pressures are weighing on the outlook for the business.

The investment bank has been exploring a partial sale since at least last year and has talked to several parties, including private equity firm Blackstone Group LP (BX.N), CNBC television reported Wednesday, citing sources.

Spokespeople for Morgan Stanley and Blackstone declined to comment.

Morgan Stanley’s commodities unit trades in financial contracts, like oil futures, and ships and stores physical assets through subsidiaries TransMontaigne Inc and Heidmar Inc. Sale of a stake could help bolster the bank’s capital base as it faces a potential credit downgrade. Selling a stake also could cut into Morgan Stanley’s income from the profitable commodities unit.

Word of a potential sale of Morgan Stanley’s unit, which has long been one of the most dominant and profitable commodities trading operations on Wall Street, caught some traders by surprise.

“They made a mint at it for a long time,” said Dan Dicker, a longtime oil trader who is president of MercBloc. “The business is changing, they’re not making as much money as they used to, but — holey croley, I know a lot of guys over on that desk and they’re still the best.”

While the business has generated billions of dollars in revenue for Morgan Stanley through the years, it has come under pressure from weaker trading volumes as well as new regulations that will limit U.S. banks’ trading, risk taking and ability to own physical commodity assets.

CNBC cited regulatory reforms as the reason for a possible sale.

There are also signs that Morgan Stanley’s competitive position is slipping.

According to a survey by Greenwich Associates, the bank has fallen to fourth place in the over-the-counter market for commodity derivatives among corporations and investors, behind JPMorgan Chase & Co (JPM.N), Goldman Sachs Group Inc (GS.N) and Barclays Plc’s (BARC.L) Barclays Capital unit.

Morgan Stanley’s commodities trading revenue dropped nearly 60 percent from 2009 to 2011. Based on Reuters’ calculations, revenues peaked at around $3 billion in 2008, declining to about $1.3 billion last year, the lowest since 2005.

Morgan Stanley attributed the decline to “lower levels of client activity.”

JPMorgan had commodity trading revenues of $2.8 billion last year, while Goldman reported $1.6 billion in commodity trading revenue.

Because of the nature of Morgan Stanley’s commodities business, in some ways it faces greater regulatory risks that its peers.

The bank has long run the largest physical oil and energy trading desk on Wall Street, making it one of the biggest distillate importers in the United States. With its purchase six years ago of logistics firm TransMontaigne, it became a major player in the inland market at a time of bumper profits.

The Volcker Rule, part of the Dodd Frank bank regulation law, could limit federally insured banking institutions from trading with their own capital. This in turn could prevent Morgan Stanley from taking risks in the illiquid, opaque cash markets for commodities. Regulators have issued a draft proposal for the Volcker rule, but it has not yet taken effect.

In addition, Federal Reserve regulations restricting non-bank investments could force Morgan Stanley to divest assets.

Meanwhile the client business has suffered. Although Morgan Stanley does not have any major, branded commodity indices, it has one of the biggest operations in selling such indices to investors; however, demand for passive exposure to commodities has dwindled in recent years.

Private equity firms, unencumbered by new capital rules and trading restrictions, have eagerly pushed into the energy industry and trading area in recent years. Stone Point Capital helped fund the start-up merchant Freepoint Commodities last year, while First Reserve has been a major investor in Caribbean oil storage facilities and refineries in Europe and the U.S. East Coast.

(Reporting By Lauren Tara LaCapra, Matthew Robinson, Jonathan Leff and Jeanine Prezioso; editing by Alwyn Scott, Gerald E. McCormick and Jeffrey Benkoe)