The US commodities market regulator has put Wall Street banks and other big traders on notice for a possible investigation of their metals warehousing businesses following years of complaints about inflated prices.
The US Commodity Futures Trading Commission last week sent a letter to firms ordering them to preserve emails, documents and instant messages from the past three years.
The notice amounted to a "warning shot" ahead of what is probably a formal CFTC probe, one of the sources said.
If there is an investigation, it would be the first such probe by any regulator into the lucrative and controversial industry, which since 2010 has become dominated by banks including Goldman Sachs Group Inc and JPMorgan Chase & Co and global merchant traders like Glencore Xstrata Plc and Trafigura AG.
The letter from the CFTC's enforcement division did not refer to an investigation, but the do-not-destroy order touched on some of the most sensitive issues in a controversy that has plagued the London Metal Exchange for years.
The CFTC explicitly said that the firms should retain communication related to incentives or premiums given to metal producers in exchange for storing metal; daily loading rates; high load-out requests; delivery policies and procedures and complaints about load out requests.
At least two companies involved in warehousing received the letter, but sources said they believe such notices were sent to all the major players.
While the recipients of the letter say they now expect a wide-ranging probe, it is not clear how or when that could take place. The CFTC opens dozens of investigations a year, yet only a handful ever result in action and some are never made public. It almost never discusses open inquiries.
In the past three years, a mountain of aluminium and other metals has accumulated in the global warehouses that are part of the LME network, clogging the trading system and causing lengthy queues - up to a year - as consumers and dealers of the metal seek to get their hands on it.
The queues have caused the price premium on some metals to surge, prompting accusations that banks and traders are artificially inflating prices and distorting supplies.
After years of complaints from end-users such as Novelis, the world's biggest maker of flat-rolled aluminium, and customers like Coca-Cola Co, which use the metal for aluminium cans, regulators are now taking a deeper look into the industry as political pressure to rein in Wall Street's powers intensify.
In an email to Reuters on Saturday, Bart Chilton, a Democrat on the five-person commission and frequent critic of lax regulation, urged a "full and comprehensive review" of warehouse ownership, but did not comment on the letter itself.
"These markets are too important to allow behind-the-scenes machinations to distort commodity prices," he said.
A possible probe comes amid intensifying scrutiny of Wall Street's role in raw material markets from owning oil tankers, power plants and metals warehousing.
The US Federal Reserve is weighing whether to allow banks to continue owning physical assets.
"The CFTC has a role to play in protecting American manufacturers and consumers from having the price of their gas, canned food and beverages, or electricity driven up by Wall Street speculators," said Senator Sherrod Brown, a Democrat from Ohio.
"The CFTC should use the full force of its power to address this abuse."
The U.S. Senate banking committee will hold its first hearing on the matter tomorrow, asking whether "Too Big to Fail" banks should be allowed to operate freely in loosely regulated physical commodity markets and own physical commodity assets from power plants to oil tankers.
CFTC spokesman Steven Adamske declined to comment.
Goldman Sachs, JPMorgan and Glencore declined to comment. Trafigura declined to make and any immediate comment. The LME declined to comment.
Goldman has consistently said Metro International Trade Services, its warehousing unit, has not broken any laws or rules.
Well before the CFTC's involvement, there has been growing evidence that the period of record high premiums, long queues and rich rewards for owners of the warehouses is drawing to a close.
Earlier this month, the LME's new owner - Hong Kong Exchanges and Clearing Ltd - proposed sweeping reform of its warehousing policy in its third attempt to tackle the wait times and soothe irate industrial clients.
And Goldman Sachs began exploring the possible sale of its warehousing business Metro International earlier this year, Reuters reported in April. JPMorgan has more recently started to look for potential buyers for its Henry Bath unit, people familiar with the process said this month.
The sales efforts precede the change in LME rules, but emerged just ahead of deadlines for the US Federal Reserve to decide whether Wall Street should be allowed to own commodity trading assets. The issue is coming to a head five years after the financial crisis brought Goldman under the Fed's purview.
While it had long been assumed that the banks would likely be allowed to retain many of their investments, even if holding them at arm's length, growing public and political pressure appears to be forcing the Fed to take a deeper look.
Late on Friday, the Fed issued a surprise statement saying that it was rethinking a decade-old decision that allowed banks to trade in physical commodities.
The letter is the latest effort from a newly emboldened CFTC, which has also led the charge on the Libor interest rate manipulation probe and more recently began reviewing millions of energy swap trades for possible violations of new rules.
The enquiry could also raise pressure on the British watchdog, the Financial Conduct Authority, which has regulatory oversight of the LME, to delve into the industry, sources said.
Novelis has complained to the European Commission, the FCA and the CFTC, but has been frustrated by the apparent lack of activity.
"Warehousing has been believed to be outside the scope of the FCA and CFTC because it's not a derivatives market," Novelis vice president and chief procurement officer Nick Madden told Reuters in an interview earlier this month.
"It's an area that's very vulnerable to these players using leverage for their own interest," he said.
The CFTC does not regulate the LME, nor does it have authority over physical commodity trading, but it may still be able to claim some jurisdiction through a no-action letter it granted allowing the LME to operate in the United States or through metal futures traded on CME Group exchanges.
The letter, dated July 19, makes reference to both LME and CME registered warehouses, although the same problems have not afflicted the U.S. exchange's markets.
Warehouse firms in the LME system were traditionally independently owned, but since 2010 four of the six largest players have been bought by investment banks or traders.
Over the same period, storage volumes have surged. Metro now holds 1.4 million tonnes of aluminium at its 29 Detroit warehouses, up from 800,000 tonnes at the end of 2009.