THE ANNUAL REVIEW 2010 - PEI Media

page 12 private equity annual review 2010
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Volcker lays down the law
Former Federal Reserve chairman Paul Volcker turned the spotlight on bank-owned
private equity operations and got the ball rolling on industry-changing new rules
Volcker: points out the dangers of bank-backed private equity
Proposals to limit bank involvement with
private equity outfits took a decisive tone in
February when former Federal Reserve chairman
Paul Volcker appeared before the Senate
Banking Committee. The chairman testified on
the behalf of the eponymous “Volcker Rule” –
endorsed by President Obama just weeks earlier
– which would restrict banks from owning,
sponsoring and investing in hedge and private
equity funds. Volcker argued such operations
should live or die by their activities – without
the unfair advantage of taxpayer support.
During his testimony, Volcker stressed
that commercial banks were covered by
federal deposit insurance and have access
to the Fed’s discount window for emergency
loans due to the public’s interest in providing
a “safety net”. However, Volcker insisted if
bank holding companies wanted to invest
in riskier activities, such as private equity
funds, these operations should “stand alone”.
“They are, and should be, free to trade,
to innovate, to invest – and to fail,” he said.
“[They should be] able to profit handsomely
or fail entirely as appropriate in a free
enterprise system.”
In full agreement, the White House urged
lawmakers to back the Volcker Rule, saying
bank holding companies should choose
between taking deposits and being a “financial
company that can do other activities”.
After months of negotiations and
compromise, the Volcker Rule eventually
cemented its place in history as part of the
broader “Dodd-Frank Wall Street Reform
and Consumer Protection Act”, signed
into law on 21 July 2010. The rule’s final
language was watered down to prohibit
banks from investing more than 3 percent
of their Tier 1 capital in private equity and
hedge funds, with an additional restriction
from acquiring more than a 3 percent
ownership stake in any private equity group
or hedge fund.
The signed bill, which provided only a
framework around which the rules would be
implemented, would not prove to be the end
of the reform process, however. In October
the newly formed Financial Stability Oversight
Council began a public consultation period
over the rule as mandated by the Dodd-Frank
Act, which requires the council to complete
a study of the rule no later than six months
after the bill’s enactment.
Upon completion of the study, which
will help guide regulators in cementing the
final details of the Volcker Rule, financial
supervisory agencies will have nine months
to implement the rule’s final language.
The rule will ultimately become effective
either one year following that, or on July
21, 2012 (two years after Dodd-Frank was
first enacted), whichever date comes first.
Banks may be slightly comforted by
provisions which allow for a comfortable
lapse-time to sell or unwind assets should
the 3 percent threshold be breached. Up
to five years could be provided to banks
to reach full compliance with the rule
following its implementation, with the
Federal Reserve Board authorized to grant
further extensions in select circumstances.
A number of banks have already started to
unwind their private equity activities either
by spinning out captive teams or selling off
portfolios of fund interests. Most notably, in
August a group of Bank of America private
equity professionals spun out to launch
independent firm Ridgemont Equity
Partners; and in December the management
buyout of HSBC Private Equity (Asia) was
completed, reemerging as Headland Capital
Partners.
Better news for banks may come in 2011.
With Republicans taking over the House of
Representatives in 2011, they will wield
increasing influence as details of the rule are
drafted in the months to come. ■