Financial reform will have a major impact on how the alternative investment management business will be played and who the players will be.
While specific rules have yet to be set, the reforms called for in the Dodd-Frank Wall Street Reform and Consumer Protection Act could affect everything from investment returns to leverage and risk-taking to innovation and transparency of private equity, real estate and hedge fund managers.
“This will change the way alternative investment businesses are run. They will have to use more capital and less leverage and less risk-taking,” said Henry Kahn, partner in the Baltimore office of law firm Hogan Lovells.
Big financial services firms will have to decide what lines of alternatives businesses they will retain and how they will be structured. Smaller firms might have to deal with Securities and Exchange Commission registration, giving the world — and regulators — a peek at their investment strategies.
“This fundamentally changes what types of businesses financial services firms are in,” Mr. Kahn said.
Institutional investors worry that registration with the SEC could inhibit investment innovation by midsize private equity, real estate and hedge fund managers, Mr. Kahn said. Many larger alternatives firms already are registered and it is yet to be seen whether the real estate investment managers will be exempt from the requirement.
“Some large institutional clients are concerned that regulations will put additional costs on medium-size advisers and inhibit beneficial innovation in investing,” Mr. Kahn said.
Investors also worry that more transparency and heightened inspection by the SEC will make managers less willing to innovate because their proprietary strategy will be open to review by the SEC and competitors.
Most institutions and managers contacted for this story declined to comment on the record.
Martin Cohen, co-chairman and CEO of New York-based real estate investment firm Cohen & Steers Inc., agrees that financial reform is having a major impact, with financial institutions divesting themselves of private equity and real estate businesses.
For example, Bank of America Merrill Lynch effectively departed the business when it outsourced management of its Asian real estate fund to Blackstone Group in July, said Steven Coyle, chief investment officer of Cohen & Steers' fund-of-funds management arm, Global Realty Partners, New York.
Anticipating that financial reform would likely make the businesses obsolete was one reason leading to the decision to sell, Mr. Coyle noted. The other was “realizing that recent hits to real estate made these businesses less attractive on an ongoing basis,” he said.
Bank of America executives could not be reached by deadline for comment.
“If they remain as banks, I don't think they will stay in business,” Mr. Coyle said. “Most investors invested because the house (bank parent to the investment management firm) had a major investment.”