Assessing Volcker

It may be a decade before the real impact of the Volcker Rule on private equity can be properly assessed; but for now, GPs have reason to be grateful 

This week, five US regulatory agencies finally issued an approved version of the Volcker Rule, almost four years after it was first publicly endorsed by President Obama. 

It’s worth reflecting on how much difference Volcker has already made to private equity – and the extent to which this has furthered the basic aim of Volcker, i.e. to mitigate the level of risk in the financial system and limit the chances of another financial crisis. 

It’s clear that Volcker has already had a noticeable impact on this asset class. In expectation of the restrictions on their exposure to alternatives, many of the big banks have been offloading their private equity assets. Some have been spinning out or selling off their in-house direct investment arms. Several have been selling their other legacy holdings on the secondary market. And after years of being among the largest investors in private equity funds, most have stopped making new LP commitments. 

Arguably, though, the overall impact has not been as significant as many feared back in 2010. The fundraising market has been tough, but it hasn’t collapsed completely (in fact, this year looks set to be the strongest since the crash). Secondary sales have happened, but we haven’t seen the sort of fire-sale many people were predicting – at least not yet. 

Perhaps the main reason for this is that the financial services lobby has been very effective in dragging out the legislative process, and steadily watering down the initial proposals. Various loopholes, exemptions and clarifications have been inserted; indeed, even this week’s version contained some pleasant surprises for private equity, with the news that bank pension plans and insurance companies are still going to be able to invest in the asset class, and that foreign banks won’t fall within the scope of the new rules (it’s not exactly unheard of for the US to impose new rules on foreign entities, as FATCA shows). 

As such, it’s still not totally clear exactly what banks will be able to get away with, or indeed for how long. The deadline for compliance is now 21 July 2015, more than 18 months from now – and given all the various extensions on offer, banks could end up having some 12 years to liquidate their assets. No wonder that some have remained largely in ‘wait and see’ mode. 

The other big question that hasn’t really received enough attention is: will any of these changes make the US economy less risky? The basic principle behind Volcker – that banks with an implicit taxpayer guarantee shouldn’t be taking incredibly risky bets – is a sound one. But it’s not clear why the world is a safer place now that One Equity Partners is no longer part of JPMorgan, or because new funds are being raised that don’t have any banks as limited partners. In terms of risk in the system, you could argue that regulators would be better served worrying about the huge sums that these big US banks have been doling out in covenant-loose leveraged loans – but that continues apace. 

Some commentators have suggested this week that private equity was one of the big winners of the latest version of Volcker. But as far as we can see, the only real winners will be the lawyers. Sam Batkins, director of regulatory policy at the American Action Forum, estimates that law firms will spend some 2.4 million hours scrutinising the 934-page document (Jones Day apparently had 200 lawyers on the case this week). That adds up to a lot of fee income. 

In fact, chances are that Volcker won’t even turn out to be the most significant legislative agreement this week, at least as far as private equity is concerned. Last night, the US House of Representatives finally passed a budget to resolve the spending rows that have plagued Congress for nearly three years, eliminating the threat of another government shutdown early next year. This might not sound like anything to boast about per se. But when you think back on the extent to which fiscal cliff fears hampered deal-making in the first few months of 2013, it’s easy to see the value to private equity of this (long-overdue) resolution. Unlike 12 months ago, US firms will actually be open for business as we go into a new year.