In late April, banks and other select financial institutions received a bit of a reprieve from the regulatory onslaught, when the Federal Reserve announced that they would be granted a two-year conformance period for the Volcker rule. Originally scheduled to take effect next month, when the broader Dodd-Frank Wall Street Reform and Consumer Protection Act comes online, these banks will now have until 21 July 2014 to get their affairs in order with regards to Volcker.
The news likely came as some relief to banks that feared they may have had to comply with the Volcker rule as early as this summer. Much of that relief likely was focused on the rule’s proprietary trading aspects, which the Federal Reserve now probably wishes it hadn’t postponed in light of last month’s revelation of more than $2 billion in trading losses at JPMorgan Chase. However, as important as the proprietary trading portion of the rule is to mitigating systemic risk in the overall financial system, it is not very relevant to PERE.
The part of the Volcker rule that PERE does care about is the portion that deals with banks’ involvement and investment in private equity. That part of the rule originally called for banks to choose between running private equity operations and taking deposits, but that approach was seen as too harsh. The rule was revised to limit banks’ investment in private equity to no more than 3 percent of their Tier 1 capital, with an additional restriction from acquiring no more than a 3 percent ownership stake in any fund. There also are some murky restrictions regarding the branding of bank-sponsored funds.
Given those parameters, the private equity portion of the Volcker rule seems like much hoopla over nothing. Indeed, many in the industry say that 3 percent co-investment for private equity real estate funds is pretty much in-line with the market norm, if not above it.
Furthermore, given all the phase-in provisions and possible extensions of which a bank-sponsored real estate platform could take advantage, the 3 percent rule may not need to be met until as far out as 2022 – a full 10 years from now. Given that most commingled real estate funds have a life of eight to 10 years, that means almost every fund in existence today will liquidate before it needs to comply with Volcker. In addition, the Federal Reserve left to door open for a further reprieve on the front end with the phrase “unless the [Federal Reserve] extends the conformance period.”
Meanwhile, the banks themselves have begun to mitigate the impact of Volcker by spinning off or selling their private equity and real estate platforms. In late 2010, Bank of America Merrill Lynch sold its Asia real estate platform to The Blackstone Group and spun out its European unit to management, which was renamed Peakside Capital. Last year, ING Group completed its sale of ING Real Estate Investment Management to CBRE Global Investors, and Deutsche Bank is trying to do the same this year with its RREEF platform.
That just leaves three banks with private equity real estate businesses – Morgan Stanley, JPMorgan and Goldman Sachs. Interestingly, each bank has a different take on how Volcker will affect their real estate platform, as well as different degrees of urgency.
Take, for example, Morgan Stanley. Its private equity real estate arm, Morgan Stanley Real Estate Investing, has taken the view that Volcker will be implemented eventually and that it will be subject to the 3 percent cap on co-investments in its funds. Although most of its existing real estate funds are likely to get into compliance naturally over the course of the rule’s implementation and phase-in periods and any new funds will be structured to comply straight off the bat, the firm has taken steps to get into compliance in any rare instances where that will not be the case.
JPMorgan also recognises the need to comply with the 3 percent restriction set out by the Volcker rule, but it has been going about informing its investors in a low-key manner. “For the clients we have spoken to so far, they understand it’s because we are regulated,” Joseph Azelby, head of global real assets, told PERE in this month’s Blueprint (see page 30).
Goldman Sachs, meanwhile, believes the Volcker rule will be a non-issue for its real estate funds. Apparently, the firm has been told by its council and some regulators in Washington DC that the rule doesn’t actually reach its real estate funds because of an exemption under Section 3(c)(5)(c) of the Investment Company Act, which requires that at least 55 percent of the fund’s assets be fee interests in real estate, mortgages fully secured by real estate and certain mezzanine loans and B notes. Since Goldman appears to be shift its real estate platform more towards debt funds and debt investing, problem solved it seems.
In the final analysis, it would appear that those remaining banks with real estate platforms are not too overly concerned about complying with Volcker’s 3 percent rule. After all, a lot can happen in 10 years.
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