‘I think it got overblown’

Named after former Federal Reserve Bank chairman Paul Volcker, the Volcker rule aimed to separate investment banking, proprietary hedge fund trading and private equity from retail banking. Ushered in as part of the Dodd–Frank Wall Street Reform and Consumer Protection Act in the wake of the global financial crisis (GFC) in 2010, the rule was derided and feared on Wall Street, not to mention misunderstood. The rule also put a 3 percent cap on how much of its own capital a bank could invest in its own fund.

But in 2013, with full implantation of the Volcker rule looming, Wall Street firms have continued to roll out infrastructure funds, even while divesting in-house hedge funds and, to a lesser extent, private equity. To Allen & Overy partner Kent Rowey, the initial hullabaloo over the rule was just that, as far as the infrastructure asset class is concerned.

Has regulation introduced in the aftermath of the global financial crisis (GFC), specifically the Volcker rule, had an impact on Wall Street-sponsored infrastructure funds?

KR: I would have thought so back in 2010, when the Dodd–Frank Wall Street Reform and Consumer Protection Act was first proposed and the Volcker rule was first promulgated.

Now I think, in a strange way, Dodd-Frank might be a benefit for a lot of the bank-sponsored funds in the sense there is a sort of legislative – or legal – reason to not have to put a lot of their own capital to work. Instead what the bank-sponsored funds will be doing is managing money on behalf of other people – limited partners (LPs). Based on the fundraising metrics, LPs want to see a certain amount of capital by the bank. Well here, with the Volcker rule, because a bank can only invest up to the maximum, 3 percent amount, a bank can respond, “Well, look, we can’t put that much of our own capital in – but we still want to be in the asset management business”.

The return on capital could actually be better without having a big general partner (GP) stake or captive bank LP stake in the fund. The bank will manage more LP money and take a fee from that. I think that’s been borne out in the fact that we haven’t seen much divestiture of bank-sponsored funds.

[The Credit Suisse sale of its 50 percent stake in] Global Infrastructure Partners (GIP) in March was a notable exception, but I wonder how much of that had to do with the Volcker rule and how much it had to do with how Credit Suisse was positioning itself in asset management as well as whatever economic consideration it had as the GP. I wonder if that had as much to do with it as a rule.

What prompted the speculation early on that the Dodd-Frank Act and Volcker rule might touch on bank-sponsored infrastructure funds?

KR: Dodd-Frank is a financial reform statute and it was designed to reduce the amount of risk that banks can undertake with depositor money. The Volcker rule put a cap on the amount a bank can have of its own capital invested at risk. That is the reason people thought there would be an exit.   

But we haven’t seen that. With the exception of what happened with Credit Suisse and GIP, captive funds are out raising capital for follow-on funds. I think it got overblown. 

We have seen the independent asset management business talk up a competitive advantage over captive funds based on not being subject to Dodd-Frank: is it a legitimate claim?  

KR: I don’t think it is. I won’t call it a non-issue. With a bank, the attractiveness of its fund for LPs is accessing an investment banking network and its deal flow. 

That part – access to deal flow – is unaffected by the Volcker rule. That attractiveness is still there. I think again what the rule will is limit the amount of bank money that can be put in the funds to 3 percent. An LP is can consider that 3 percent figure a big issue, but look at what 3 percent is of what a bank can put in. It’s a sizeable amount of capital.   

The non-bank funds are looking for an advantage, but that’s wishful thinking. I think on the face of it, the LP community would be wondering if the banks will put a lot at risk because they like to see skin in the game.

Can the 3 percent cap have an impact on manager compensation?

KR: I can’t speak to any particular bank, but I think the compensation issue is a broader issue than just the Dodd-Frank Act or Volcker rule. I think the banks are naturally giving less compensation, and that might create the opportunity for unregulated asset managers to pick up investment talent. But I think that’s something apart from the Volcker rule.   

You have to look at what’s happened after the GFC, and how banks are forced to compensate. There’s a smaller bonus pool now. There’s also a lot more scrutiny on banks. Then there are the shareholders. To appease shareholders, a publicly traded bank has to keep its share price high. For them to see a professional highly compensated when the bank is having a bad year is problematic.   

Banks in general are cutting cash compensation in favour of handing out bonuses in the form of stock options to align interest.

While infrastructure funds haven’t been divested, hedge funds and private equity have.  

KR: There was a lot of talk of divestment in general. There hasn’t been a big stampede. As far as infrastructure funds, I can’t tell whether it is a function of the Volcker rule or a function of the change in compensation structure, but there has seemed to be a move for the banks toward real assets.

You see a lot of banks emphasising infrastructure and real estate, as opposed to financial assets. Hedge funds are essentially that.

Where do you stand on the Volcker rule?

KR: Some form of regulation was needed after the GFC and I think a need for prudential regulation to limit bank funds. There’s a risk always that there’s an overreaction. There might be material in Dodd-Frank leaning in that direction. I think there was a need for reform.

As for the Volcker rule in and of itself, I think the philosophy is sound. There are a lot of exceptions to the 3 percent rule and banks can structure around it. But some form of Dodd-Frank was needed – and inevitable.