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December 11, 2011 3:21 am
The Volcker rule, as currently constituted, would have a dramatic effect on the European fund landscape.
Yet, with just weeks to go before the January 13 deadline for comments, much of the industry appears to remain in the dark about its possible repercussions.
One of Europe’s largest banks, which with both significant operations in the US and a large asset management arm is in the crosshairs of the legislation, sums up the mood of many, arguing that because it does not engage in proprietary trading or run private equity or hedge funds, it will be unaffected by the Volcker rule.
“In general, this doesn’t strike at the heart of our business. We haven’t done the analysis yet, which gives you an idea of how important it is to us,” it says. Yet, at a minimum, the legislation would appear to force the bank to rebrand its funds and make it harder for it to seed new vehicles. By one interpretation it would simply ban that bank from running Ucits funds full stop.
Awareness is starting to spread, however. Allen & Overy, the law firm, says: “The proposed rules are walking a narrow path between a tough but administrable regime in which banking entities will have sufficient, if tight, space to continue to conduct their asset management businesses, and constraints so tight that, due to a combination of diminished profits, increased compliance burden and employee and investor flight to the more open spaces of funds offered by independent asset managers, these businesses will suffocate.”
Philip Warland, head of public affairs at Fidelity Worldwide Investment, adds: “The Volcker rule was aimed at separating US banks with the benefit of federal support from their proprietary desks and both their own and others’ hedge funds. But the way it has been drafted has caught Ucits and this is likely to cause disruption in the European funds market even for funds that are to all intents and purposes unconnected with banks – let alone US banks.”
HSBC says in a statement: “The provisions of the Volcker rule will require changes to the conduct of certain existing businesses. We will review the final rule and its impact and consider what changes need to be made.”
Industry figures identify two main problems with the rule. Firstly, because legislators seemingly could not agree on the definition of a hedge fund, they have opted for a blanket approach, treating everything bar ‘40 Act US mutual funds as “covered funds”.
“They are paranoiac that evil banks will find a way to evade these rules, that they will run a money market fund or Ucits that is really a hedge fund in disguise,” says a lawyer for the asset management arm of a large US bank.
Secondly, the extraterritorial nature of the legislation appears to capture pretty much every non-US bank of any size.
“You would think there would be an exemption for non-US banks running funds for domestic investors and there is. Unfortunately the definition of ‘solely outside the US’ is completely useless,” says the head of regulation at a major asset manager.
Given that the legislation captures any bank with a single branch, agency, or commercial lending subsidiary in the US, or any US residents as investors in its funds, he adds: “There are European banks who don’t think they are considered a banking entity under the Volcker rule. They might have to reconsider that.”
The upshot is that US bank-owned managers will be able to continue to run US mutual funds without restriction. However, as the legislation stands, both US and non-US banks would have to re-brand their Ucits fund ranges, severely restrict their ownership of such funds and sever many other linkages.
Lending to funds to cover surges in redemptions would be barred, as would a repeat of the widespread bailing out of investors in money market funds during the financial crisis.
“The odd effect of this is that you can have a money market fund in the US and it’s not a covered fund. The same exact fund, run by the same people, managed in exactly the same way by the same guidelines offered the same way in Europe would be a covered fund. That makes no sense,” says the investment house lawyer. “The agencies realise that does not make sense but they are struggling to craft a rule.”
“European [banks] are going to look at this and say this is a bridge too far. I think you are going to get lots of comments about over-reach and unequal treatment,” says Robert Ledig, partner in the Washington office of law firm Dechert.
“In the US banks will be allowed to continue to put as much money as they like in ‘40 Act funds but the law does not apply to Ucits funds although they are exactly the same,” says the head of regulation, who raises the spectre of the rule banning banks from running Ucits funds altogether.
“A European bank can only manage a fund if it is connected to its banking services,” defined as being trust, fiduciary, investment advisory or commodity trading advisory services. “I have no idea whether, if HSBC opened a Ucits fund, it would fall under these rules,” he adds.
He is downbeat about the chances of significant revisions to the legislation, but others remain more hopeful. “From the point of view of public policy, it’s hard to believe this is the intended outcome,” says Dan Waters, managing director of the global trade body, ICIG.
“I remain hopeful that, working with others, we can come up with a more sensible solution.”
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