JPMorgan Chase & Co. (NYSE: JPM) became the first investment bank to take steps to comply with the so-called "Volcker Rule" by shutting down its proprietary trading unit.
JPM, the second-biggest U.S. bank by assets, told about 20 traders who work on its commodities trading desk that the company will close the unit, Bloomberg News reported, citing an anonymous source.
The bank eventually will close all in-house trading to comply with new U.S. curbs on investment banks, said the person, who asked not to be identified because New York-based JPM's decision hasn't been made public.
The closure may cost JPM as much as $1.4 billion in annual profit, Barclays Capital analysts led by Jason Goldberg estimated in a June 28 research report.
"This revenue and the risk it carries with it now goes away," Christopher Whalen, a Federal Reserve Bank of New York analyst in the 1980s and co-founder of Institutional Risk Analytics, told Bloomberg. "This will put more pressure on JPM to look for growth outside the U.S. market."
The move marks the first definitive step by Wall Street banks to deal with regulatory reform passed by Congress this summer. Bank of America Corp. (NYSE: BAC), Goldman Sachs Group Inc. (NYSE: GS), and Morgan Stanley (NYSE: MS) executives are wrestling with how to comply with the rules without dismantling their proprietary trading and private-equity activities.
Congress earlier this year passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, placing on financial firms restrictions designed to prevent a recurrence of the 2008 credit crisis, which almost caused the banking system to collapse.
The bill promises sweeping reform for the U.S. financial system and requires new and existing regulatory agencies to undertake more than 50 studies of the financial system.
The Dodd-Frank law also contains curbs known as the Volcker Rule, named after former Federal Reserve Chairman Paul Volcker, restricting firms from trading exclusively for their own accounts.
The rule banned banks from using their own taxpayer-backed cash to speculate in the financial markets, while limiting their investments in private equity or hedge funds to 3% of Tier 1 capital.
But the precise definition of what constitutes proprietary trading remains an open issue and is likely to be the source of contention among banks, regulators, and politicians for some time.
Despite reports of banks spinning off units in response to the rule, banks continue to look for creative ways to continue doing business as usual – especially for their more profitable activities.
Citigroup Inc. (NYSE: C) is looking at three options to meet the new rule, including moving a team of proprietary traders into its hedge-fund unit, people briefed on the matter told Bloomberg. The bank would bankroll the unit and set up the traders as hedge-fund managers, then raise money from outside investors to reclaim the seed money, the people said.
Goldman reportedly has been moving some of its proprietary traders to its asset management teams. But according to The Wall Street Journal, the traders come from Goldman Sachs Principal Strategies, the smaller of Goldman's two prop trading operations with about $1 billion to $2 billion in assets.
Keith Horowitz, an analyst at Citigroup, told The Journal Goldman is more protective of a much larger prop-trading operation called the Special Situations Group, a debt-securities specialist. Horowitz estimates the unit has about $10 billion in assets.
Goldman has no plans to unwind or unload the Special Situations Group, a person familiar with the matter told The Journal. Goldman maintains the unit won't be affected by the so-called Volcker rules because it is involved in lending, not trading.
"Goldman Sachs is a money-making machine, and if there is a component to the machine that is making money, they'll find a way to keep it alive," Michael Driscoll, a former Bear Stearns Cos. executive told The Journal.
Morgan Stanley's trading unit might be spun off over several years, while Bank of America might sell its main $3 billion proprietary-trading desk to a private-equity firm or hedge fund, people familiar with the situation told The Journal.
"This is a fairly painless way to show a proactive embracing of the new rules, but it's not a sea change," said Roger Freeman, an analyst at Barclays.
The bigger question is how regulators will define other types of proprietary trading and how hard a line to take on investing that blurs the line between trading and lending.
The debate is likely to be intense.
"We do not expect Wall Street to give up its risky and conflict-ridden trading operations without a fight," Sen. Jeff Merkley, D-OR and Sen. Carl Levin D-MI, wrote in a letter to regulators urging them to get tough on Wall Street banks.
The law is "intended to give you strong tools to protect our nation's families and small businesses from the vagaries of the Wall Street casino," they wrote.
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