SEC’s Volcker Rule plan paves banks’ return to PE

The Securities and Exchange Commission has called for comment on proposals to ease restrictions under the Volcker Rule that prohibit banks from investing in private equity funds – a move that could pave the way for the return of bank-sponsored private equity funds.

In a nearly 700-page document, the SEC has primed potential respondents in the sections pertaining to private equity by listing numerous questions concerning a “covered fund” – the definition of which is at the heart of the private fund investment prohibitions under the Volcker Rule.

The document asks: “Instead of retaining a unified definition of ‘covered fund,’ should the agencies separately define ‘hedge fund’ and ‘private equity fund’ or define ‘covered fund’ as a ‘hedge fund’ or ‘private equity fund’? Would such an approach more effectively implement the statute? If so, how should the agencies define these terms and why?”

A question further in the report suggests that the agency is open to the idea of scrapping any restrictions on banks backing private funds, asking: “Are there funds that are included in the definition of ‘covered fund’ that do not engage in these (prohibited) investment activities? If so, what types of funds, and should the agencies modify the definition to exclude them?”

The agency is asking for submissions by 18 September.

Compliance with Volcker, a part of the Dodd-Frank Act that restricted banks’ private equity investments to 3 percent of tier one capital, has previously resulted in a sell-off of private equity assets by banks, including private markets fund stakes.

Critics of the Volcker Rule say it restricts legitimate banking activities, including illiquid private equity investment, that would be beneficial for clients. Proponents argue that private equity funds fall into the category of “speculative” investments that can cause systemic risk and should be restricted.

Research in 2010 by Lily Fang of INSEAD and Victoria Ivashina and Josh Lerner of Harvard University, while not considering the issue of systemic risk arising from bank-backed funds, found that companies owned by bank-sponsored private equity funds perform worse than their independent peers. Of the sample studied, only 63 percent recorded a profitable exit, compared with 73 percent of the non-bank backed companies. A larger percentage also went bankrupt. The parent bank was also 22 percent more likely to be chosen as a future lender to the company than other banks, raising questions of cronyism.

The SEC’s effort is the latest to water down the Volcker Rule after the Crapo Bill, signed into law in May, exempted small banks from the Obama-era law and loosened restrictions for medium-sized banks.