When the Volcker rule was first unveiled in January by President Barack Obama and Paul Volcker, the former chairman of the Federal Reserve after whom it is named, there were widespread fears it could fundamentally reshape the US financial system.
The policy called for significant restrictions on banks’ proprietary trading activities and sponsorship of hedge funds and private equity firms. In its original format, the Volcker rule could have resulted in a mass spin-off of bank-sponsored private equity and private equity real estate platforms.
In the end, the Volcker rule stumbled out of Congress in a much watered-down state than when it first entered thanks to an erratic process of reconciling two different versions of a financial reform bill passed by the Senate and House and intense lobbying from the financial industry.
Tom Pax, head of US banking regulatory practice at law firm Clifford Chance
The result – unveiled last Friday and which restricts banks from investing more than 3 percent of a fund’s equity commitments, and caps total co-investment in alternative vehicles to 3 percent of a bank’s tier 1 capital ratio – was deemed a win for Wall Street, with little need for captive platforms to be divested. 
We are going to be dealing with the unintended consequences of this legislation for years and years to come.
A weekend spent digesting the small print, however, has left some legal professionals wondering whether that will ultimately prove the case.
Under the bill – which still needs to pass a final vote in the Senate before it can be signed into law – banks could be given up to 12 years to implement the changes, especially in relation to illiquid funds such as private equity real estate. The sheer scale of the lead time being offered by the government means existing closed-ended funds, which have a typical life of seven to 10 years, will escape the co-investment crackdown.
But as Tom Pax, head of US banking regulatory practice at law firm Clifford Chance, told PERE this week: “We are going to be dealing with the unintended consequences of this legislation for years and years to come.”
Aside from affecting the level of bank co-investment, Pax argues that the regulations – once introduced – could alter the way banks look at their involvement in the industry.
Most bank-sponsored private equity real estate platforms have benefitted from significant co-investment from their parent organisations, often to the tune of 15 percent to 20 percent of a fund’s equity. By limiting Goldman Sachs’ – and other banks – co-investment capability, will Congress be capping future appetite for captive private equity real estate funds?
Goldman Sachs and bank employees, for instance, invested almost $2 billion of the equity raised for the $4.8 billion Whitehall Street Global Real Estate 2007 fund – 41 percent of the total raised. According to the 2007 fund PPM, seen by PERE, since 1991 Goldman Sachs’ co-invested roughly 27 percent of its real estate vehicles’ equity haul. The bank currently has 22 percent of its tier 1 capital ratio invested in its private equity, real estate and hedge funds, according to sources familiar with the matter.
By limiting Goldman Sachs’ – and other banks – co-investment capability, will Congress be capping future appetite for captive private equity real estate funds? After all, will it make sense to fund an in-house platform when a parent bank can only invest up to 3 percent of a vehicle’s fundraise? Crucially, banks will be asking themselves whether it’s worth the effort of maintaining the status quo or whether the opportunity cost is just too high.
Congress has at least given banks plenty of time to digest the changes and make plans for the future. But after living through one of the most painful real estate recessions for a generation, some institutions may feel the Volcker rule is the straw that broke the camel’s back.
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