One unintended consequence of the long-awaited Volcker rule, which was mandated by Dodd-Frank and finally issued by U.S. regulators last week, may be increased pressure on the retail-wealth-management businesses of wirehouses to contribute more to overall profitability.
Focused on reducing risk in the banking system, the 298-page rule would prohibit federally insured banks from principal trading in securities, derivatives and other financial instruments and would ban them from “owning, sponsoring or having certain relationships with a hedge fund or private-equity fund,” according to a fact sheet from the Securities and Exchange Commission.
“The rule could affect the range of products that they have to sell to their clients, including hedge funds and private-equity investments,” said Chip MacDonald, a lawyer with Jones Day, who specializes in the financial services industry. “It could also put more pressure on wealth management operations to make up for lost revenues and profits in the rest of the business.”
The rule, named after former Federal Reserve Board Chairman Paul Volcker, who recommended risk restrictions on banks in the wake of the 2008-09 financial crisis, provides exemptions for trading in government and government agency bonds, as well as activities relating to “market making, underwriting and risk-mitigating hedging.”
Last week, the American Bankers Association called the proposed rule “unworkable,” while the Securities Industry and Financial Markets Association said that the restrictions “will discourage investment, limit credit availability and increase the cost of capital for companies.”
Although all parties affected by the rules seem to be gearing up for a fight over what constitutes “risk-mitigating hedging” and other kinds of trading that involves bank capital, the nation's largest banks already have started to pare their trading and hedge-related operations.
Last month, The Goldman Sachs Group Inc. closed its Global Alpha Hedge Fund.
Morgan Stanley also has been selling and closing prop desks since taking huge losses in the business in 2007.
After it completes the spinoff of its Process Driven Trading operation to employees by the end of next year, the firm will have no stand-alone proprietary trading operations, said company spokesman Mark Lake, who declined to comment on the Volcker rule proposal.
Bank of America Merrill Lynch and UBS AG also are likely to face significant changes from the new restrictions. But Wells Fargo & Co., due largely to its huge retail-banking business and its smaller capital markets activities, likely would be the least affected by the rule changes.
Representatives of those three firms didn't return calls for comment.
“The big question is to what extent the banks will continue to engage in trading activities. I think a lot of that activity will move out of the banks and out of the United States,” said Bert Ely, a longtime banking consultant and analyst who runs his own firm.
“The regulators are trying to lean on the "got a hunch, bet a bunch' with bank capital practices,” said Jeffery Harte, an analyst who covers banks and brokerage firms for Sandler O'Neill & Partners LP. “But the concern is, how this will impact market-making activities, particularly in illiquid markets.”
Under the rule, banks will be required to establish compliance and reporting programs to help regulators sort things out.
Based on man hour requirements estimated by the rule makers, Citigroup Global Markets Inc. analyst Keith Horowitz estimated in a recent report that startup costs for such programs could total $500 million for the industry, with continuing costs hitting $130 million a year.
Email Andrew Osterland at [email protected]
