December 18, 2013

Goldman to Feel Biggest Hit From Volcker Rule

Five of the top 30 banks got at least 24% of their revenue from proprietary trading as of Sept. 30

Goldman CEO Lloyd Blankfein, right, in front of the NYSE. (Photo: AP) Goldman CEO Lloyd Blankfein, right, in front of the NYSE. (Photo: AP)

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  • Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
  • Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isn’t just a recommended best practice— it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firm’s strategy is proprietary.

According to SNL Financial, five of the top 30 banks will feel the greatest regulatory effects of the recently released Volcker Rule, which governs proprietary trading at depository institutions.

Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan Chase (JPM) and First Horizon National (FHN) each derive more than 24% of their total revenues from trading sales, the research firm says, as of Sept. 30. Goldman Sachs tops the list at 62%, followed by Morgan Stanley at 36.5%.

In terms of the quantity of trading assets, Goldman, Morgan Stanley, JPMorgan, Bank of America (BAC) and Citigroup (C) have more than $260 billion each in total trading assets. First Horizon has about $1.5 billion.

Charles Schwab (SCHW) has $3.1 billion of total trading assets and gets just 0.02% of its total revenues for trading sales. Wells Fargo (WFC), which has $60 billion of trading assets, derives 3.4% of total sales from trading.

The Volcker Rule goes into full effect on July 21, 2015.

“The final version of the rule spans nearly 800 pages and introduces a vast new compliance regime for documenting market-making and other activities allowed under the rule,” said SNL analysts Robb Soukup and Sam Carrin their report. “Among the prohibitions under the rule is broad portfolio hedging, and regulators across the board acknowledged the broader rulemaking process as among the most complex in which they had ever taken part.”

In terms of exemptions to the Volcker Rule, proprietary trading of certain U.S. government-related instruments — including U.S. Treasury securities and other government agency and entity related debt — is allowed.

Analysts with Keefe Bruyette & Woods point out that it’s not only the biggest banks that will be affected by the new regulatory regime, since the rules also govern those with assets of $10 billion to $50 billion.

KBW foresees the compliance burden as being more important financially than any loss of revenue. "We believe the largest hurdle for regional banks will be related to hedging compliance and showing that the hedges reduce risk properly," the firm wrote in its report.

Overall, all banks may be unable to keep holdings of collateralized loan obligations on their books, according to Dave Preston of Wells Fargo Securities.

Although the Volcker rule exempts loan securitizations, it doesn’t seem to exempt them if the CLO owns bonds or other securities. This possible impact, however, could be affected by the precise ownership clauses for the CLOs.

More important, Preston points out, banks may not be able to make a market in the assets or liabilities of non-exempt CLOs for which it acted as the underwriter, since this would be a covered transaction.

Analysts with SNL say we’ll have to stay tuned for at least two to three years.

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