If US president Donald Trump achieves his stated aim of dismantling the Dodd-Frank Act, a repeal of the Volcker Rule would likely follow, which would help drive banks’ capital back into Asian alternative assets – though to a lesser degree than in the past, say industry experts.
Under the Volcker Rule, banks are prohibited from proprietary trading, or having any interest in third-party private equity funds or hedge funds. They are entitled to seed funds but their stake must be less than 3% of a strategy’s total assets one year after it starts trading.
Support for Asian assets?
So repealing the rule should provide some stimulus for the private equity and hedge fund sectors in Asia as money flows back from US banks and global banks with US subsidiaries, said Effie Vasilopoulus, co-head of investment funds practice at law firm Sidley Austin in Hong Kong.
It could also make bank co-investors more secure and Asian asset markets more stable, she told AsianInvestor. That’s because financial or economic turbulence often results in capital flight from the region, including large redemptions from hedge and private equity funds, which can trigger ownership limits, in turn forcing bank investors to withdraw capital.
Asian funds are particularly vulnerable to this negative feedback loop, Vasilopoulus said, because they tend to have fewer investors and the underlying assets they hold tend to be more volatile anyway.
If a repeal of the Volcker Rule brings back US and global banks, institutional investors already active in Asia are likely to face greater competition for the best investment opportunities.
As it is, some such as US college endowments have been able to drive hard bargains on fees and terms – such as around liquidity – with Asian hedge and private equity fund managers, Vasilopoulus said.
For asset managers with bank investors, a repeal would probably also reduce compliance costs, she noted. “These require long side letters dealing with [the] Volcker [Rule], covering the disclosure of information, reporting around thresholds, and rights to redeem if thresholds are hit.”
Bank risk appetite questioned
But other participants AsianInvestor spoke to questioned the extent to which and how quickly Volcker would be repealed, and whether banks would subsequently return to Asian markets in large numbers.
Kevin McPartlend of the market structure and technology practice of research firm Greenwich Associates in New York, said: “A full repeal of the rule seems unlikely. It is more likely that the rule will be softened in areas, reopening some opportunities for banks to invest.”
A partial repeal might raise the 3% threshold for investments where the bank is the investment manager, enabling some degree of bank investment in third-party funds, or allow proprietary trading to resume in some capacity.
An executive order in early February committed the US administration to a review of the Dodd-Frank Act. But changing the legislation requires an Act of Congress, which could be blocked by Democrats. The Republican majority in the Senate does not extend to the 60 votes required to pass legislation.
“The additional capital injected could provide a boost to [private equity and hedge fund] assets under management, although we don’t expect any such move to be quick,” McPartlend said.
The total amount invested, meanwhile, is likely to be less than before the global financial crisis of 2007-8, even if the Volcker Rule were rolled back, he said. Bank risk appetite will remain well below its pre-2008 levels, he noted, with shareholders and management preferring less volatile revenue and profit.
An alternatives specialist at a large bank agreed. Andrew Lee, CIO of alternatives at UBS in New York, said: “If the Volcker Rule goes, you won’t get the level of proprietary investing you had before.
“More balance sheet capital is likely to be reinvested in the underlying bank business,” he added. “The banks don’t have the same risk appetite [for alternatives] these days.”