Six months after financial reform legislation was signed into law, some U.S. banks already have closed, moved, sold or lost major investment talents on their proprietary trading teams and hedge fund management subsidiaries.
Officials at bank holding companies The Goldman Sachs Group Inc. and Morgan Stanley & Co. Inc. made it clear they are shedding their prop desks. New York-based Morgan Stanley also has divested its 100% stake in multistrategy hedge fund unit FrontPoint Partners LLC.
Sources said so far, J.P. Morgan Chase & Co., New York, is the only the large U.S. bank that confirmed it is converting its prop trading teams into a hedge fund management unit. That unit will move over to J.P. Morgan Asset Management.
The banks are restructuring to comply with the Volcker Rule provision of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, which prohibits banking entities from conducting proprietary trading and limits investment in hedge funds and private equity funds. Most banks have until 2013 to comply with the new law.
“A lot of big banks have taken the position that they need to divest their prop desks to comply with Dodd-Frank requirements. For some, there's some question about whether they absolutely have to do that,” said attorney Grant Buerstetta, partner with the law firm of Blank Rome LLP, New York.
He noted that “many banks are gearing up to get rid of their hedge funds and prop desks so as not to attract any more negative attention about their assets. They are perhaps being more conservative in their interpretation of Dodd-Frank that they really need to be.”
The swift restructuring by some banks already has pushed a wave of prop traders into the limelight and out of their sheltered existence managing bank assets in internally managed multistrategy hedge fund portfolios.
Because of their behind-the-scenes roles at U.S. banks, the elite traders are not well known to institutional investors, and sources said the majority may remain something of a mystery to institutions until they've built track records that will attract the interest of investors and can convince them they're going to stay in business.
“The vast majority of institutional investors are not interested in being venture partners with some of the new firms that prop traders are setting up. There are too many risks in investing in many startups. Running a business is a lot different than running a prop desk,” said Daniel Celeghin, a partner at Casey Quirk & Associates LLC, Darien, Conn., a consultant to money managers.
“Both institutional investors and hedge fund-of-funds managers have a healthy dose of skepticism about these prop desk startups because many bank prop desks relied on a lot of leverage. Trading strategies tend not to make a lot of money — pennies on a trade — so leverage was routinely used to amplify returns. Prop traders could do this very easily, because they could draw on the bank's balance sheet to put on the leverage. Once you hang out your shingle as a hedge fund manager, there's absolutely no way you could go to 40 times leverage,” Mr. Celeghin said.