http://dealbook.blogs.nytimes.com/2010/05/24/behi…
Great article in deal book about current PE, LBO and M&A markets.
It will be interesting to see how PE's adapt to the the new carried interest reform and buyout arm carve outs. Although I saw another article about how Barclays is one of the few banks which still has a PE arm in -house. Am I missing something?
What about GS PIA? Morgan Stanley PE? What about BAML Capital Partners? JPMorgan's OneEquity Partners? DB still has their Global PE unit.
From what I gather none have shed their PE operations. Any comments on how you think this is going to impact IBD going forward?
I suppose there will be a meaningful pull back in compensation since a lot of the over head will redundant, won't be able leverage in-house contact/intel in the same fashion (questionable) and most significant IMO, you won't have the alternative investment divisions of BB banks with outsized profits padding the firms traditional bottom line. I don't know if its necessarily a bad thing. Who knows, banks may actually have to figure out ways to make money doing what they were made to do... make markets and provide advisory services.
Lets face it... research reports are informative of what the issues/drivers are for a company but seldom get much else right. M&A advisory services are extremely overrated... its not at all what it used to be as far as establishing a real relationship with a firms executive office and being a trusted adviser. I can't comment much on S&T, but it seems like these days one of the primary role of the desk in a BB bank is to make markets for the positions the bank's prop desk wants to take. And where did I read that 8 or 9 out of 10 of Goldman's TOP TRADES that they send out to clients lost money in Q1-2010... a period of time when Goldman did not have a single losing trading day.
We tend to be overly sympathetic to Wall Street. I think its partially because much of the people on this forum romanticize what IBD/S&T is all about. Its partially because a slight at Wall Street is a slight at us. But if you really look at what an investment bank does nowadays, I think its not a bad time to shake things up and force them to step up their game.
That was a great article, thanks man
Amen, brother. Great article. +1 to you.
Interesting article.
Will banks necessarily spin out their PE arms though? As I understood it, banks are prohibited from investing in PE/HF, but I don't see why that would prohibit them from managing a fund that none of the bank's money was invested in. Of course, selling could well still be the more profitable course.
Though the bank's 'money' may not be invested in their PE/HF arm, simply having one creates a conflict of interest. They become competitors to their PE/HF clients, which may or may not create problems.
Agreed. I haven't read the law, but as I understood it, it wasn't the conflict of interest that is making them spin out the arms, but the provision that they can't engage in proprietary investments. If you use your definition, then all investment arms would have to spun out - ie, AM goes, PWM goes, etc...
Great article and comment as well!
That's a good point. But I would say the "Chinese wall" is a little known and even less trusted mechanism by Main Street and Washington. Banks will be open to the same criticism Goldman is dealing with now. A shit load of people are going to lose money by being sheep, and talented people at banks will make a shit load of money by going by their gut... and it will turn into a GS PIA made a 28% return while the overall stock market lost 11%. They sold their shitty deals to unsuspecting naive Harvard MBA's and Rhode Scholars and exploited the simple folks who lost so much money at little unknown mom and pop shops like Dreyfus Investments and Vanguard.
This whole thing is fucking stupid. Why do they want to prohibit investment banks from prop trading and PE? So they don't take risky positions that could lose them lots of money... needing them to be bailed out? As if they're not going to bail out Bridgewater, Paulson, GS PIA or TPG or KKR if their entire portfolio goes under. Non-investment banks will never be bailed out right? Was Long Term Capital Management not bailed out? It may have been funded by the private sector but it was spearheaded by the Fed and the only reason they didn't pump US Treasury dollars into LTCM is because it was only a few billion dollars and was palatable by the financial institutions. Its the same capital thats invested. It can be invested in public vehicles or private, it doesn't matter. If the bottom falls out and hundreds of billions or trillions of dollars of wealth are on the line, the US Treasury/FED will intervene.
As is typically the case in Washington, its a lot of noise and outrage primarily for effect. The issues/problems, if there are any, are not even understood much less dealt with. The ineptitude isn't the result of ignorance -- well not in the sense that law makers think they are fixing things -- its the result of a callous disregard for actual results. Everyone wants to be the one to say "I CHAMPIONED FOR GREEDY BANKERS TO SHED THEIR RISKY AND IRRESPONSIBLE OPERATIONS" come election year.
Just saw a headline that Barclays and RBS are selling their PE businesses
Aren't the aforementioned PE arms essentially just funds of funds?
I thought most BBs operated "hedge fund hotels" for unaffiliated funds that want to tap into the bank's infrastructure (ie they pay rent to use their back office and even office space). Chinese walls should prevent most of the info sharing...and as for leveraging contacts, that is something which is inevitable whether or not funds are allowed to stay within i-banks . And I wasn't aware that alt investments/HF/PE contributed anything major to the bottom line for banks. Last I read it amounts to around 5% of revenue for most of the big guys (correct me if I'm wrong).
Yea I don't know about the wall. At UBS the prop traders sit right next to people in the brokerage, although they did isolate the FI floor.
lol. i remember the ny office had 6 foot plexiglass walls up that didn't come near the ceiling. lots of guys could just poke their heads over them.
All good points. My interpretation of the compensation disparity between BB PE arms vs. stand alone shops is higher costs of doing business as a PE arm of a BB. I'm generalizing when I say HF/PE and that includes the prop desk which contributes faaar more than 5% of the firms profits. Also... I said padding the bottom line, not top line.
In a political context where risk management and curtailment of excessive risk appetites of the banks are in issue, the decision to separate the PE and prop trading arms of the banks actually comes as no surprise.
And honestly, wouldn't you say that these decisions are geared to prevent massive financial crises in the long-term? Agreed that they might pull back on banks' profitability during a few years but they would also reduce the possibility of a second credit-crisis-like fiasco right?
That said, I'm guessing that banks will only have to spin-off their PE and prop trading business. Does this mean that they can then incorporate these businesses as separate companies (like a Cayman Islands type incorporated firm)? Because that would really defeat the purpose of the legislation.
What is the rationale behind the supposition that spinning off these businesses somehow contains contagion when markets start moving against prevailing thought. It doesn't matter whether DE Shaw writes $10 billion of CDS protection on GM bonds or if the GS Alpha Fund writes $10 billion of CDS protection on GM bonds. When GM goes bankrupt the implications to that position are the same and the impact it has on the overall economy is the same... someone lost $10 billion dollars, CDS spread widen, DE or GS Alpha gets hits with margin calls, likely ends up in a death spiral, their assets are liquidated at uneconomic levels to pay counterparts... and a shit load of wealth is destroyed. Who's wealth? A bunch of institutional investors. The same institutional investors that commit capital to GS PIA, GS Alpha Fund, etc... are committing capital to DE Shaw and Bridgewater and Soros and Paulson.
Is the implication that if any of these entities were stand alone and they faltered they would be allowed to fail because there wouldn't be a domino effect? Thats a bunch of bullshit. If all you had to do was have a free standing alternative investment entity to prevent financial market contagion than LTCM would have been allowed to fail and the investors would have been out all of their money.
Totally agreed. Or have we forgotten who owned Chrysler?
I don't claim to be an expert on this but 2 points:
(i) If the PE or prop trading arm of a bank incurs huge losses, doesn't that show up on the bank's overall balance sheet and raise all sorts of capital adequacy requirements which wouldn't arise if such a division was not a part of the bank? (And therefore having more of an impact on the overall financial system than if these divisions were divested).
(ii) Aren't issues of conflicts of interest arising out of the bank's position vis-a-vis their clients (like the recent Goldman case) also potentially reduced if you don't give banks the chance to take speculative proprietary positions in the first place?
“little unknown mom and pop shops like Dreyfus Investments and Vanguard” Sarcasm? Or doe $1 Trillion AUM count as mom and pop these days?
“What is the rationale behind the supposition that spinning off these businesses somehow contains contagion?”
Largely populism and politics, as you pointed out. The idea behind the Volker rule is that you prevent banks that accept retail deposits from taking speculative positions. The rule is meant to prevent banks from taking Joe the Plumber’s FDIC insured deposit to the casino. I don’t know if the rule was initially meant to prevent contagion.
I actually have no idea how this rule will stop GS or MS from closing up their prop arms– they may be classified as depository institutions but I don’t think they take any retail bank deposits. They could easily go back to being pure investment banks.
Perhaps there are some valid arguments for the split – there may be less cross selling of risky assets to customers; credit may get tighter. I don’t know how much of a difference it makes.
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