14/07/2010 Author: Tony Griffiths

Volcker: time to adapt

The announcement of the US Financial Reform Bill last week confirmed what many feared, that the Volcker Rule will limit banks' hedge fund holdings. But, with lighter restrictions on prop desks than expected, banks can now get on with the process of adapting to meet the new rules

When the Volcker Rule was first mooted back in January, it prompted pandemonium in the US banking sector. US banks, the rule proposed, would be banned from owning or sponsoring hedge funds and private equity vehicles. Those institutions with sizable hedge fund investments would have to spin out or sell up. Lawyers and executives scrambled for the boardroom, putting the kibosh on preparations and quickly establishing contingency plans.

The passage through the House last week of the US Financial Reform Bill has since granted a certain amount of closure and a sizable amount of relief, not least because of the inclusion of an exemption permitting sponsorship of up to 3% of a bank’s tier one capital. What this rule has also done is allow banks to reconsider their plans for present and future hedge fund investments, which, since January, have been up in the air.  

“Everyone is using the newly defined rule as the lens to judge their proposed activity by, and, if using that new lens they think it’s acceptable, then a lot of banks will feel comfortable moving forward,” says Joseph Vitale, a partner in Schulte, Roth & Zabel’s New York office.

“There’s no question about it. Everyone now knows what the ground rules are and it’s not as bad as expected,” adds Andrew Rubio, CEO at consultancy firm Throgmorton. “So whereas some of the banks may have been looking wholesale to get out of certain areas, they’re now realigning so that they can move forward with a little bit more certainty.”

The practical implications of the new provisions are now beginning to take shape. “We’re seeing that some of the banks are realigning their internal trading positions and spinning off more hedge fund and other boutique-style businesses, potentially on the back of the Volcker rule, to make sure they don’t fall foul of it,” Rubio says.
Morgan Stanley this week announced that it has spun off Copia Capital, its $520m Chicago-based hedge fund, while sources at Credit Suisse said the bank has similar plans for two of its credit funds, Candlewood Special Situations and Candlewood Credit Value. HFMWeek knows of at least one sizable prop desk team at an unidentified institution moving out and establishing its own fund.

The issue is “too sensitive” for most banks to discuss, one investment bank executive admitted to HFMWeek, but a recent report by Citigroup analyst Keith Horowitz has given a good indication of where the most fervent activity is likely to be taking place (see insight, p4). With more than 40% of its $68.5bn tier one capital in hedge funds, private equity and other related investments, Goldman Sachs is under pressure to re-house over $27bn in order to comply with the Bill’s 3% upper limit. The rule’s second biggest victim, Bank of America Merrill Lynch according to Horowitz, only needs to redistribute $9bn. When approached by HFMWeek, Goldman Sachs declined to comment.  

The Horowitz study also puts JP Morgan’s plans to buy a Brazilian hedge fund unit into perspective. Although seemingly incongruous with the Volcker rule, the bank’s current percentage, 6.76%, is markedly lower than most of its rivals, though still double the Volcker maximum.

Citigroup’s announcement that it is to expand its hedge fund and private equity holdings is the real misnomer – not only would the new funds come from outside investors, but, a source said, would likely increase the bank’s percentage of its own funds and thus reduce its Volcker risk.   

“Bank holding companies are taking a close look at what they’ve got in the pipeline and vetting those plans against the revised Volcker rule,” Vitale concludes. “However, even those banks that are moving ahead with deals are probably going to wait until the bill is passed by the Senate, and possibly even signed by Obama, before they go public.”