Volcker Rule Is Giving Big Banks Headaches

Curiosity is growing about which Wall Street banks will be the first to get out of proprietary trading or the private equity business as they restructure to come into compliance with new financial regulatory reform legislation. The Volcker Rule – named for former Federal Reserve chairman Paul Volcker – limits banks from these practices and sets new levels on the size of private equity or hedge fund investments.  In other words, the banks are not allowed to hold more than three percent of their Tier 1 capital – a measure of their financial strength — in private equity or hedge fund investments.

Bank of America is almost in compliance, though Goldman Sachs must act more aggressively and is reported to be weighing several options to comply with the increased regulation.  The good news for the Wall Street banks is that they have several years in which they can reduce their holdings.  “They have time to adjust,” said Mark Nuccio, partner at Boston-based Ropes & Gray.  “I don’t think there’s any intention on behalf of the regulators to create economic dislocation at financial institutions.”

The new rules are driving certain banks to rethink their business, while others see the new law as a welcome excuse to distance themselves from unwanted hedge or private-equity funds.  “If you were leaning toward a strategic change anyway then now is a good time to re-evaluate the business because you have a regulator saying you shouldn’t be in this business anyway,” said Thomas Whelan, chief executive of Greenwich Alternative Investments.  This is particularly true for banks that quickly acquired hedge fund operations during the boom years.  At that time, having a hedge fund was essential to the strategic mix.  Since 2008, however, when hedge funds posted their worst-ever returns and clients tried to cash in assets, the math changed for many banks.