Forget the already corrosive gulf between Wall and Main Streets. We now have a new divide. Last week, President Obama indicated that lower Manhattan itself could be rent apart by a Glass-Steagall Act 2.0. Legislation that would scythe commercial banking in two; banning owning or investing in hedge funds and making free-wheeling prop desks a thing of the past.

As panicked memos, ordering complete media silence, filtered down from penthouse offices to trading floors, the hedge fund community was a little more communicative. Many told HFMWeek that they were concerned about loss of investment, but others exuded a calmly entrepreneurial zen – relishing potential M&A opportunities, the arrival of new talent and a market free of ‘crowded’ prop desk trades.  

In the grand scheme of things, US banks are actually relatively small direct investors in hedge funds, representing 0.9% (approximately $10bn) of total capital. However, data provider Preqin also suggests that bank-owned funds of hedge funds (FoHFs) account for $180bn in assets, or approximately 16% of all US capital flowing into the sector. Enough of a stake to create tremors, if proposed mass divestiture becomes a reality.

In addition to this, HFMWeek’s own research also shows that shares in a number of brand-name hedge funds – including, Winton, Landsdowne and Avenue – are held by US commercial banks. It’s a selection box of coveted names that could result in an explosion of asset management M&A, if Obama and the octogenarian former Fed chair Paul Volcker are true to their word.

The “incredibly complex logistics of all this are mind boggling,” says Kinetic’s Julian Korek. “You can’t just unpick these relationships overnight,” he muses, worrying that the “regulatory arbitrage” created by the US response will have unintended consequences globally. The banks themselves are equally confused. “We are still trying to ascertain what is likely to happen – at the moment it reads just like one big sweeping statement,” said a source from one large US institution.

Like the potential vagaries of the European Union’s AIFM – proposed legislation that also unfairly aligns hedge funds with the failures of prop desks – this will not just be felt by the nation that spawned it. Many US institutions invest in European and Asian funds, while it would also affect the European investors in funds managed by US banking institutions.

"Pension funds that have invested significant amounts in these funds will be particularly concerned about the implications of any changes to their ownership structure going forward," believes Andrew Bradshaw, partner at specialist pension solicitors Sacker & Partners.

There is even speculation that such a move would make the likes of Goldman Sachs and Morgan Stanley reconsider their recently found positions as commercial banks – potentially returning to the investment bank fold as they try to preserve operational freedom. It’s a decision that Watson Wyatt’s David Gold thinks is unlikely, just yet, saying it is too early to really understand the likely impact of the proposals.  

Gold – whose own investors have yet to break a sweat over the issue – believes that even if banks are forced to divest, it wouldn’t necessarily affect the product, as teams take part in a flurry of management buy-outs or units simply move wholesale to other owners. Although the widespread divesting of in-house funds, believes HFMWeek’s banker, could worry investors, “because of the lack of surrounding infrastructure,” he also doubts there will be a panicked exodus in the intervening period.  

When the dust settles, these cooler heads may still prevail. A press statement from Aima, the hedge fund trade body, has already gnomically pointed to “opportunities”. Beyond M&A, this could translate as the best bank traders fleeing to hedge funds, or even setting up their own shops. Without prop desks, the arbitrage is also “back on”, one small US manager told HFMWeek. It is this chance to access alpha without fighting against the monetary might of the banks that some believe holds a real opportunity for the average management firm.

With lobbying juggernauts already mobilised on Capitol Hill, change has yet to be guaranteed. The prop desks could stay, it could still be argued that banks are ‘serving their own customers’, and would therefore be exempt from having to give up their hedge funds. Yet, while the current unease on Wall Street has already served to halt a year’s worth of banking stock rises, and worry stalks the trading floors, Obama’s highly politicised reform package could still hold opportunities for many within the hedge fund space