Could the "Volcker rule" be having an influence already?

In the weeks since President Obama unveiled a proposal to keep commercial banks out of hedge funds, private equity and proprietary trading, a flurry of reports has emerged about planned divestitures and business reevaluations by some of the largest diversified financial companies.

But those decisions may have more to do with the spirit of the Volcker rule than the letter. Though the proposal's enactment is in doubt, a strong consensus exists in Washington and on Wall Street that the activities targeted by the rule will soon be saddled with higher risk weightings and capital requirements.

With such expectations, some banking companies already have curbed their appetite for private equity, hedge funds and proprietary trading and may continue to do so even if the Volcker proposal fails. Such moves would free up capital from assets that otherwise would probably become a lot more expensive.

Citigroup Inc. [C] is reportedly is in talks to dispose of a $10 billion private-equity unit, and Morgan Stanley [MS] is reviewing its stakes in several hedge funds. Press reports also indicate that JPMorgan Chase & Co. [JPM] is reconsidering plans to buy the North American operations of Sempra Commodities LLP and will focus on the metals and energy trader's European division.

"Behind the Volcker rule has been a reconsideration of what the capital requirements are going to look like," said Brian Gardner, a Washington analyst at KBW Inc., "and as businesses try to figure out what those rules are going to be, they've probably come to their own decision that they're going to take this on and try to figure out how to best deploy their capital."

Recent comments by Sens. Christopher Dodd and Richard Shelby, the ranking members of the banking committee, indicated that congressional support for the Volcker rule is shaky. With Dodd eager to make progress on financial reform before leaving the Senate, policymakers may feel too rushed to consider all the implications of a proposal that could trigger tectonic shifts in a financial system that has proven vulnerable to unsteadiness.

"It's something that's going to require a lot of thought and study, and as Dodd said, given where we are on the [legislative] calendar, I don't know that we have time for that," said Sandy Brown, a lawyer in the banking practice at Bracewell & Giuliani in Dallas. "I'm a bit skeptical as to whether [the rule] will become part of the financial restructuring bill, but I wouldn't be the least bit surprised to see it land somewhere in policy, which most likely would be in the risk-based capital rules."

Brown, who helped write rules on risk-based capital as a regulator in the l980s with the Office of the Comptroller of the Currency, said private equity, hedge funds and proprietary trading, perhaps along with commercial real estate investments, would be ripe for higher weightings coming out of the financial crisis.

"There's a precedent for cranking up the capital requirements for activities that present greater risk," he said, mentioning the 200% risk weighting assigned since 2002 to certain mortgage-related investments rated below investment grade.

Of course, the higher weighting did little to prevent a crisis triggered by the implosion of the subprime mortgage market, and this raises questions about the effectiveness of putting higher risk weightings on hedge funds and private equity — areas no doubt involved in the crisis but generally not considered the cause of it.

To be sure, even before the Volcker rule was unveiled, some banks showed a waning interest in more speculative endeavors that, in the wake of the crisis, no longer seemed as attractive or as central to their missions.

Citi Private Equity, for example, was grouped last year with the assets that Citigroup plans to sell or unwind. However, the company, which also shut down Chief Executive Vikram Pandit's former Old Lane Partners hedge fund, still plans to hold on to divisions Volcker might not approve of such as the Metalmark Capital buyout group and Citi Venture Capital International.

Morgan Stanley hired former Merrill Lynch & Co. executive Gregory Fleming in December and announced, a day before Obama unveiled the Volcker rule, that one of Fleming's first duties when he officially joined the firm in February would be to review its ownership of FrontPoint Partners LLP and stakes in other hedge funds, including Landsdowne Partners LLP, Avenue Capital Group and Traxis Partners LLC.

"When you get into a difficult environment and into the part of the credit cycle that we're in, people redefine what is core," said Brian Sterling, a co-head of investment banking at Sandler O'Neill & Partners. "Some of [these moves] I would argue are just part of the cycle, like getting out of businesses that aren't as core or selling businesses that chew up a lot of capital to generate capital.

"But the Volcker rule would be less cyclical and much more a longer view in saying we really want to change the business model."

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