Volcker, where is thy sting?

The Mother of All Spin-outs is not coming to visit. In fact, her schedule is tied up until 2022.

A key piece of the US financial-overhaul legislation about to be signed into law will not, it turns out, force banks to shed private fund real estate management programmes. Thanks to extension provisions, the new rules won’t even spur much secondary activity in the near future.

Among the closely watched details of the bill was the so-called Volcker rule, designed to get bank holding companies out of private equity, private real estate and hedge funds. Until recently it was unclear how draconian these rules would be – would bank holding companies be forced to part ways with their private fund divisions, or would they be allowed to control such businesses but not be able to invest balance-sheet capital through them?

The uncertainty was particularly stressful for Goldman Sachs, which, through its Principal Investment Area (PIA) and Real Estate Principal Investment Area (REPIA), respectively controls the largest private equity programme in the world, the second largest infrastructure investment programme in the world, and the fourth-largest real estate investment programme in the world, not to mention giant hedge fund, debt and fund of funds platforms.

Now that the final version of the Volcker rule has been revealed, it is clear that Goldman will be allowed to keep those businesses. But it will be restricted from investing meaningful bank capital alongside its limited partners.

Bank holding companies such as Goldman will held to “de minimis” investments in their own funds, representing no more than 3 percent of any one fund’s capital. Banks also may not have more than 3 percent of their Tier 1 capital in these funds.

At first glance, it would appear that Goldman has a problem. According to its most recent financial statement, the firm has $15.5 billion of its own money in its private equity and other private funds, and Tier 1 capital of $68.5 billion. That’s $13.4 billion more than the 3 percent limit.

But before you rush out to raise the $13.4 billion Goldman Sachs Secondaries Fire Sale Fund, be aware that the bank may not truly be forced to comply with the 3 percent rule until as far out as 2022, thanks to multiple federal agency reviews and extensions granted for illiquid assets.

So not only will there likely not be any Goldman REPIA spin-out fireworks to behold, the Mother of All Secondary Deals also seems improbable. In any event, within 12 years, a good percentage of these fund positions may have self-liquidated.

Goldman alternative investment executives aren’t the only ones breathing a sigh of relief. Morgan Stanley, the second largest manager of private real estate funds in the world, has some 9 percent of its Tier 1 capital in its private funds. 

A number of uncertainties around the effects of the Volcker rule still remain, however, including:

•        What happens to the significant undrawn capital that Goldman and other banks have earmarked for private funds? Goldman counts some $12 billion in dry powder that its own funds were counting on eventually drawing down. Will the bank need to default on those commitments, and thus change the dynamic and outlook of its partnerships?

•        Some limited partners found the idea of investing alongside Goldman capital around the world to be highly attractive. Minus that, will the individual Goldman PIA and REPIA general partners need to invest more personal capital in these funds to convince investors of a powerful alignment of interests?

There aren’t many bank-owned private equity and private equity real estate firms left, but Goldman’s dominant position in the private equity business remains more than solid. However, Goldman’s ability to snap its fingers and make balance-sheet investment capital appear has been greatly diminished.

While Goldman PIA and REPIA will need to raise external capital more than ever, this is one of many functions at which it excels.