The Federal Reserve said mid-December that banks could apply for an extension of up to five years to conform with the Volcker Rule, provided they demonstrate a “good-faith effort” to divest their private equity holdings and comply with the official July 2017 deadline.
This marks the fourth grace period the Fed has granted since the Dodd-Frank Act – of which the rule is a part – became law in 2010.
The rule is intended to keep banks from speculating with their customers’ money and limits the amount of capital they can invest in private equity and hedge funds. Since it passed, financial institutions have been divesting their private equity divisions, or spinning them off.
One Equity Partners spun out from JPMorgan in January 2015, while over the past few years Credit Suisse has sold off its Customized Fund Investment Group, Strategic Partners secondaries business and Global Infrastructure Partners division. Citigroup offloaded Citi Venture Capital International in September 2013.
But some banks still have a significant amount of disallowed private capital investment on their books. Morgan Stanley’s non-Volcker compliant portfolio is valued at around $2.2 billion, most of which is held in private equity and real estate funds, securities filings show. Goldman Sachs’s private equity and real estate portfolio is worth over three times more, $7 billion, even though it has cut its exposure to non-Volcker-compliant investments by 60 percent over the past five years.
Ahead of a second-quarter results filing, the investment bank said it expected “some flexibility” from the regulators on compliance.
Others are said to be exploiting loopholes in the legislation, or creating more complex structures to mask their holdings in products they technically shouldn’t hold, while the many exemptions the rule allows mean that some banks are able to retain significant private equity and hedge fund holdings.
“There are a number of ways in which it can be circumvented,” one London-based private equity lawyer told pfm.
The repeated extensions, the unsealed loopholes and the number of bills passing through the system aimed at either dampening down the regulation, or eliminating it in its entirety, seem to point to two things: a lack of conviction in the rule, and a questionable commitment to seeing it implemented. Add to this the absence of specific penalties for non-compliance, and it looks like Volcker may just have run out of steam.