UPDATE 2-JPMorgan sells physical commodities unit to Mercuria for $3.5 bln

* All-cash transaction to be completed by third quarter of this year

* Metals brokerage business to stay with JPMorgan, source says

* Mercuria is first trade house to absorb entire physical division from a bank

(updates throughout with quotes, background)

By Dmitry Zhdannikov and Chris Peters

NEW YORK, March 19 (Reuters) - JPMorgan JPM.N is selling its physical commodities business to Mercuria for $3.5 billion, the U.S. investment bank said on Wednesday, sweeping the fast-growing Swiss trading house into the top league of commodities traders.

The all-cash transaction for one of the most powerful oil and metals desks on Wall Street is expected to close in the third quarter, JPMorgan said in a statement.

In documents circulated to potential buyers last year, JPMorgan had valued its physical commodity business at $3.3 billion, with an annual income of $750 million. JPMorgan paid nearly $2 billion to buy the largest part of the business from RBS in 2010.

JPMorgan decided to sell its multi-billion dollar physical commodities division last year due to rising regulatory and political pressure and so it could concentrate on the bank's core business of lending.

"Our goal from the outset was to find a buyer that was interested in preserving the value of J.P. Morgan's physical business," said Blythe Masters, head of JPMorgan's global commodities business.

JPMorgan said it would still provide traditional banking activities in commodities markets, including financial products and the vaulting and trading of precious metals.

It gave no further details of what exactly would be included in the transaction, but a source close to the matter said the bank's metal brokerage business including its London Metal Exchange (LME) ring dealing team would remain with JPMorgan.

However its Henry Bath metals warehousing unit was included in the deal, the source added.

JPMorgan also has sizeable power, natural gas and carbon trading desks, largely operating from London, as well as owning power plants. News Search ID:nL6N0MG28H

MASTERS

The fate of JPM's Masters was too early to tell, the source said, adding that she and her management team had been primarily focused on achieving the sale.

Others in the commodities units were waiting to hear about their future.

"It will be interesting to see whether Mercuria will want to keep us on or not, and whether they will attempt to move our desks to Geneva," one trader with the bank said.

"Most of us want to stay here (in London), so I suspect a drive to move us to Geneva would equate to a reduction of our power and gas trading desks," the trader added.

Many other banks, including Deutsche Bank, Bank of America Merrill Lynch and Barclays, have recently scaled back or shut down their power, gas and carbon trading desks, citing unfavourable banking regulation as the main reason News Search ID:nL6N0JQ3PC

In February, Reuters reported that Mercuria, led by two former Goldman Sachs GS.N executives Marco Dunand and Daniel Jaeggi, became the front-runner to buy the physical commodities unit, one of the most powerful oil and metals desks on Wall Street. News Search ID:nL5N0LA4IS

EXCLUSIVE TALKS

The bank went into exclusive talks with Mercuria in February. In the weeks before that, the trade house had been competing with Australian bank Macquarie Group MQG.AX and private equity manager Blackstone Group LP BX.N to buy JPMorgan's unit, sources had said.

Private and lightly regulated trading houses have benefited most from a major retreat by banks from commodities trading over the past two years.

Companies such as Glencore GLEN.L and Russian oil major Rosneft hired whole teams of traders from banks such as Morgan Stanley but Mercuria will become the first trading house to absorb an entire physical division from a bank.

(Reporting By Chris Peters, Dmitry Zhdannikov and Ron Bousso; Additional reporting by Susan Thomas, Veronica Brown and Henning Gloystein; Editing by Anna Willard)

((dmitry.zhdannikov@thomsonreuters.com))

Keywords: JPMORGAN/MECURIA