Merrill Lynch Pulls Plug on Commodities Business

Faced with shrinking margins and fleeing business, Merrill Lynch (MER) is closing its commodities operations, two people familiar with its plans say.

The move, announced to employees this morning and to be disclosed to the public this afternoon, comes as securities firms aim for businesses in which operating margins are high. Large European banks such as ING Barings, ABN Amro and Societe Generale have come into the business, bringing competition to traditional players.

The people familiar with the plan say Merrill will maintain its energy and financial futures trading operations but exit other commodities businesses such as grain, soybeans, cattle and other hard commodities.

"Commodities is a very small part of their business, and revenue from commodities has gone nowhere in the past five years," says Michael Flanagan, an independent brokerage industry analyst with Financial Services Analytics in Philadelphia. "It's probably 1% or under 1% of their revenue. That's minuscule to Merrill."

Commodities futures represent less than 5% of the total futures market, according to an official at the Chicago Mercantile Exchange, and for brokerage firms like Merrill that now fetch most of their revenue from retail business, "the commodities business requires more capital, risk and management attention than it returns," Flanagan adds. As for other firms shutting down similar futures brokerage operations, "one or two regional firms have either shut them down or outsourced the commodities business."

"Some firms sell what's known as a 'give-up' business, where they give up their seats on the exchange and then sell the business to a smaller operation. Sometimes it's just cutting costs, sometimes it's a prelude to something else," said one fund-of-funds hedge fund manager specializing in futures.

This isn't the first time Merrill has abandoned the futures business; in 1998, it shut down its over-the-counter commodities business. It's not the firm's primary business, and the area in general hasn't been a strong performer for many of the mainstream Wall Street firms, Chicago traders say.

In addition, futures markets have been slower to become electronically enhanced, and the structure of open-outcry markets may be especially cumbersome as fewer players, and especially speculators, participate in the futures markets.

"If you're a gambler, are you going to trade cocoa or Yahoo! (YHOO)? The hot money has all gone into stocks," says one veteran Chicago trader. "The cost structure, too, is onerous. There's a cost consequence to having hundreds of people shouting on an exchange floor."

The commodities-trading business has increasingly consolidated among the big foreign banks, companies such as Cargill and Archer Daniels Midland (ADM), and futures-specific firms.

Just last week, Refco Group, a major futures trading and clearing firm, acquired Lind Waldock, the leading discount futures brokerage. The combined firm will control $2.1 billion in customer funds, according to Securities Week, a securities industry publication.

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