Tito's Blog

Private Equity And Paul Volcker Reform

As banks evolve to become government-regulated utilities, private equity firms and hedge funds will have an even harder time securing financing for their investments.

The specific points at issue are ownership or sponsorship of hedge funds and private equity funds, and proprietary trading — that is, placing bank capital at risk in the search of speculative profit rather than in response to customer needs. Those activities are actively engaged in by only a handful of American mega-commercial banks, perhaps four or five. Only 25 or 30 may be significant internationally. Apart from the risks inherent in these activities, they also present virtually insolvable conflicts of interest with customer relationships, conflicts that simply cannot be escaped by an elaboration of so-called Chinese walls between different divisions of an institution.

If this re-regulation process continues, private equity funds and hedge funds will need to adapt their business model to a “new normal” where debt financing might be scarce. Or the new regulations will open up a space for investment funds focusing on providing debt for “speculative” activities.