What was the point of the Volcker Rule?

By Paul Mackintosh - 16/12/13


One of the last lingering effects of the outbreak of the global financial crisis (GFC) in 2008 due to catch up with private equity materialised this week with the approval by US financial regulators including the Federal Deposit Insurance Corp, the Securities and Exchange Commission, and the Commodities Futures Trading Commission, of the so-called Volcker Rule, the section of the Dodd–Frank Act drafted and backed by former Fed Chairman Paul Volcker dealing with the limitation on bank activities in private equity and hedge fund investment, and in proprietary trading. With the rules now approved, the road is clear for their full adoption in April 2014, and as with most US private equity legislation, they are liable to dictate the activity of the industry worldwide.

Forbes has already designated private equity funds as among the winners in the final implementation of the Volcker Rule. After all, they now have fewer competitors in the market, with the private equity arms of major banks either spun out as separate entities or shuttered in anticipation. The rule does also limit the potential role of banks as investors and limited partners in private equity funds, but then there is hardly any shortage of institutional capital available in the current market to back private equity funds anyway, as the attempt by Apollo Global Management to increase its latest buyout fund size to US$17.5 billion attests.  

Then again, there remains the awkward little question of whether the Volcker Rule was ever actually necessary. The Lehman Brothers collapse of 2008 was about holding of subprime mortgage securities, not about hedge fund or private equity investment. The private equity firms have survived 2008 arguably in better shape and with less change to their business models than the banks, certainly if the current rounds of fundraising are anything to go by. And the limited partnership (LP) structure itself rather limits the exposure of any LP investor in a fund, bank or otherwise: after all, commitments are usually only drawn down on request, and if a third-party fund is failing, an investor can always refuse to answer the capital call. A proprietary in-house fund, admittedly, might be a different story, but then the Volcker Rule limits banking LP participation too.

If the more simple, even ethical, purpose of the Volcker Rule is to refocus banks’ attention and efforts on the business of conserving and lending money, rather than playing with other people’s, though, then perhaps it has succeeded, with good reason. After all, the private equity structure exists to soak up large pools of third party capital to play with – on a well-understood, well-regulated and ring-fenced basis. Perhaps that really is the best home for the capital that wants to play in that fashion – rather than within institutions whose watchwords should be prudence and caution at all costs.