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November 16, 2016  

Trump's Stance on Volcker Rule Poses Threat

While the election of Donald Trump has industry professionals buzzing about the prospect of less regulation and more deal-making, some also are pointing to a potentially negative consequence for hedge funds: a repeal of the Volcker Rule.

Trump’s campaign platform called for rolling back the Dodd-Frank Act, of which Volcker is among the most controversial provisions. The rule, which took effect in July 2015, imposes strict limits on the amount of proprietary capital banks can put at risk via their own trading desks or investments in hedge funds.

Volcker effectively removed banks as competitors to stand-alone fund operations and sent legions of talented bank prop traders into the job market — many of whom were snapped up by hedge funds. The concern now is that if Volcker gets repealed as part of a broader push by a Trump administration to dismantle the post-financial-crisis regulatory apparatus, hedge funds once again would face competition from banks — both for trading talent and for investor capital.

For banks, of course, repealing Volcker would be a boon — hence the rally in financial-institution stocks since the Nov. 8 election. A former bank executive said banks would welcome an opportunity to re-establish once-profitable prop-trading operations. “If they can do it, they will,” he said. There’s a “great deal of money to be made.”

Eliminating Volcker is a key provision of a Republican-sponsored bill known as the Financial Choice Act, which is expected to serve as something of a roadmap as the Trump administration and GOP-controlled Congress tackle regulatory reform next year.

Trump’s campaign also called for re-establishing the Glass-Steagall Act, which prohibited commercial banks from pursuing investment-banking activities prior to its appeal in 1999. The thinking is that reinstating Glass-Steagall would be a further incentive for investment banks to resume proprietary trading at a time when hedge fund managers already are under pressure to improve performance and lower their fees.

Volcker has been blamed in part for diminishing market liquidity, as banks have pulled back from their traditional market-making roles. In this respect, repealing Volcker could have a positive effect on hedge funds and other traders. On the other hand, banks would continue to be constrained by new regulatory-capital requirements that have made it more expensive to hold risky assets on their books — unless a Trump Administration seeks to ease those mandates as well.

One investor suggested renewed competition from banks could benefit the hedge fund industry in the long run. “I think it is the best thing that could happen to them as it would indirectly force them to stay smaller and nimbler,” he said.

In the short term, a Trump White House could deliver regulatory relief on a number of fronts, from installing industry-friendly officials at the SEC and CFTC to staying the rule-making process for several Dodd-Frank mandates that have yet to be finalized — including additional rules for derivatives trading. “Basically, we are totally uncertain as to what Trump’s administration will be doing with derivatives or Dodd-Frank,” said Seward & Kissel lawyer Lauri Goodwyn.

SEC chair Mary Jo White, who has taken an aggressive approach to policing securities violations, plans to step down when President Obama leaves office in January, the SEC said this week. Because the commission already has two vacancies, White’s exit would leave just two of five commissioners in place — a Republican and a Democrat — opening the door for Trump to remake the agency. Industry lobbyists also are counting on Trump to reverse new Labor Department regulations expanding fiduciary-duty responsibilities for retirement accounts — rules that would prohibit financial advisors from earning commissions on hedge fund investments they recommend to clients.

Among Trump’s advisors and transition-team members are a number of people with ties to the hedge fund industry, including Paulson & Co. founder John Paulson; SkyBridge Capital founder Anthony Scaramucci; and Rebekah Mercer, daughter of Renaissance Technologies co-chief executive Robert Mercer. Bloomberg reported this week that Trump’s transition team favors Steven Mnuchin, a former Goldman Sachs banker and founder of fund shop Dune Capital, to head the Department of the Treasury.

Still, it will likely be months, at least, before the Trump team’s regulatory priorities become clear.

“Trump talks about rolling back regulations, and that may be right, but it depends on whether he’s angry at, say, the hedge fund industry at any given point in time because someone said something unkind about him, or because they were mean to him,” said Jeffrey Berman, a partner at law firm Clifford Chance and an expert on Volcker. “It’s not as if he has any consistent ideology.”