Now that they have had some time to absorb regulators’ proposals on the Volcker Rule, experts are voicing growing concerns that the rule could have effects far beyond the banks whose activities it was intended to curb.
Instead, the broad brush that the Securities and Exchange Commission and banking agencies have used could affect a wide swath of financial companies, including insurance companies and broker-dealers, preventing them from sponsoring buyout funds or participating in funds sponsored by others. Meantime, limits on proprietary trading could permanently reshape markets.
But the tentative nature of the proposed rule also reflects uncertainty on how to implement the rule, part of the Dodd-Frank financial reform law, meaning that banks and other potential fund sponsors could face a lengthy transition period before the final rule is set.
A chief concern is the impact of the rule on non-bank financial companies that are affiliates of banks, “even if the affiliate is the dog and the bank is the tail,” said Michael Harrell, co-chair of the private equity funds and investment management groups at the New York law firm Debevoise & Plimpton LLP.
For instance, an insurance company that has a subsidiary with a banking charter is likely to find that the Volcker Rule affects not only the bank unit’s activities, but those of other business units that might sponsor buyout funds, Harrell said. “The Volcker Rule doesn’t impact just what the bank piece can do. It affects the entire organization.”
Debevoise & Plimpton is working with several insurance industry clients and others in related fields, such as brokers and dealers in stocks and bonds, to weigh their alternatives, Harrell said. For instance, an insurer might drop federal savings bank charter in favor of forming a state-chartered trust company, which could provide similar services without falling under the provisions of the Volcker Rule.
The Volcker Rule limits banking companies to investing 3 percent of their core, Tier 1, capital in buyout or hedge funds, and it bans proprietary trading activities. It also limits banks to holding a 3 percent ownership interest in any such fund they sponsor as of a year after launch. A number of fund managers have already spun out from banks;
For most existing buyout shops, the main impact is likely to come in the area of fundraising. “They will need to evaluate whether they should be spending time with financial institutions, bringing them in as limited partners,” said Edwin S. del Hierro, a partner at the Chicago law firm Kirkland & Ellis LLP.
If the wealth management unit of a bank wants to offer clients a buyout oriented investment, the rule appears reasonably clear that it can, del Hierro said, but in a proprietary investment environment, where the banking company would be making investments from its own balance sheet, “then you have a lot of uncertainty whether that’s a worthwhile focus.”
The proposed rule is out for comment until Jan. 13, and regulators have said they hope to have a final version of the rule by early in the second quarter, so companies can prepare for it to take effect next July 21.
“There is a massive number of questions for commentators. This is extraordinary,” said Chester Spatt, a professor of finance at Carnegie Mellon University’s Tepper School of Business. “It does kind of come across as a fishing expedition, a way to get feedback.”
The Volcker Rule is proving to be one of the most contentious provisions of Dodd-Frank, along with a requirement for derivative contracts to be cleared through centralized clearinghouses, said Spatt, who was chief economist at the Securities and Exchange Commission from 2004 to 2007. And given the market-changing potential of those provisions, industry pushback through the comment period is likely to be intense, he said. As a result, “it’s very hard to know what the final form of the rule is going to be.”