Last week, President Obama and former Federal Reserve chairman Paul Volcker announced intentions to scythe the US banking industry in two, separating risk-taking elements, like proprietary trading desks, from retail banking divisions. The move could lead to the forced divesting of banks’ stakes in hedge funds, the sale of bank-owned funds and funds of hedge funds (FoHFs), and impact prime brokerage businesses.

According to data provider Preqin, US banks are actually relatively small direct investors in hedge funds, representing 0.9% (approximately $10bn) of the total capital. However, bank-owned FoHFs – including firms like Bank of New York Mellon’s $2.7bn Ivy Asset Management – account for a further $180bn in assets, or approximately 16% of all US capital flowing into the sector.

In addition to this, HFMWeek has also identified a number of brand-name hedge funds partially owned by US commercial banks.

These include Morgan Stanley’s 19% stake in Lansdowne Partners, as well as its shares in Avenue, Traxis Partners and Abax Global Capital. Goldman Sachs, via its Petershill private equity vehicle, is thought to own significant portions of Claren Road, Winton Capital Management, Trafalgar Asset Managers and Capula Investment Management.    

Although investors could be spooked if a proposed mass divestiture becomes a reality, one US banker doubted if there would be a mass exodus, instead predicting a flurry of management buy-outs or units simply moving wholesale to other owners. “Investors won’t necessarily notice,” he said. Executives at the $7bn Morgan Stanley-owned Frontpoint are already thought to be mulling over a management buy-out.

Independently owned hedge funds, although concerned about the drying up of bank investment, have also said that the proposals will offer a less crowded trading environment and access to a rich pool of talent, if banks’ traders choose to find new homes.

Without prop desks, the arbitrage is “back on”, one small US manager told HFMWeek. “It takes away one of the clear advantages of being associated with a large bank,” said Patrick Morris, CEO, Hagin Investment Management.
Any hedge fund hiring boom has yet to begin in earnest, but Lansdowne’s – the UK-based hedge fund partially owned by Morgan Stanley – unusual hiring of former UK prime minister Tony Blair has already been flagged as an interesting move.
 
Although the announcement has nothing to do with Obama’s regulatory thrust, with US banks already mobilising their lobbying machines against the plans, the influence of the former premier could provide leverage in the likely wrangles to come.