Banks Poised to Win on Venture Capital in Volcker Rollback

(Bloomberg) -- Venture capital funds could be poised to see bigger cash infusions from Wall Street banks as U.S. regulators move closer to easing post-crisis restrictions on such investments.

The Federal Reserve’s board voted 4-1 Thursday to propose a multi-agency plan for walking back investment limits imposed in 2013 as part of the Volcker Rule’s trading curbs. The Commodity Futures Trading Commission, Federal Deposit Insurance Corp., Securities and Exchange Commission and Office of the Comptroller of the Currency also signed off on the proposal, which loosens several investment restrictions banks have faced for years.

Venture capital funds were lumped in with constraints on investing in private equity and hedge funds that reined in banks’ risk-taking after the 2008 financial crisis. The new proposal marks the final push by regulators appointed by President Donald Trump to roll back the rule named for former Fed Chairman Paul Volcker. Softening the regulation, included in the 2010 Dodd Frank Act, has been a top priority for banks and the Trump administration.

Smoother Path

In addition to the elimination of the venture-capital restrictions -- including allowing banks to sponsor funds -- the agencies are also proposing letting lenders get back into funds that “make loans, invest in debt securities or otherwise extend credit.” They also would set up a smoother path for banks to do business with family offices that handle investments for wealthy clients and fix what they see as unintended restrictions on banks’ involvement with foreign funds.

“We have learned that a simpler, clearer approach to implementing the rule makes it easier for both banks and regulators to carry out the intent of the rule,” Fed Chairman Jerome Powell said in a statement. The regulators say they’re changing parts of the original Volcker Rule that don’t raise concerns it was meant to address.

The proposal -- which will be open for public comment -- would also let Wall Street put more types of assets into loan securitizations to give banks “greater flexibility to sell and securitize loans.” And it would permit banks to set up funds “designed to facilitate transactions between a banking entity and a single customer.”

Easing venture-capital rules could help banks seize on the desire from institutions and wealthy individuals to take early stakes in future unicorns. Keeping more of their own money in venture capital funds can show clients that banks have skin in the game. That approach does come with risks, however, as was shown in the dot-com crash that saw banks’ investments in tech firms plummet in 2001.

Capital Constraints

Also, banks will still be subject to existing capital constraints, which could dissuade them from directing a lot of their own money into new venture capital funds.

“Congress put in place strong protections around these types of funds to mitigate the risks posed by hedge funds and private equity funds,” Fed Governor Lael Brainard said in a statement announcing she won’t support the proposed Volcker revisions. “I see no change in the statute or in the nature of these activities that would call for weakening those protections.” FDIC board member Martin Gruenberg also opposed the proposal.

Even with the restrictions imposed by the Volcker Rule, banks have found ways to invest in startups over the past decade, mostly because the law didn’t curtail direct investment. Goldman Sachs Group Inc. saw a $5 million wager on Uber Technologies Inc. in 2011 grow into a stake worth hundreds of millions of dollars when the ride-sharing company went public last year.

Too Aggressive

Wall Street lobbyists have long complained that the rule was too aggressive, and Trump’s regulators have worked to address those concerns. But the language of Dodd-Frank is still the law, so the agencies were limited in what they could throw out or redefine.

In addition to the law’s well-known ban on banks speculating in the markets with their own capital, it also restricted the lenders’ stakes in private equity and hedge funds to 3% of any one fund, and said no more than 3% of its overall capital. Those numbers can’t be moved.

But even former Senator Chris Dodd, whose name is on the law, said before its passage that venture capital investments shouldn’t get the same restrictions as stakes in other funds.

Also Thursday, the Fed finalized a new rule to define what it means to control a banking organization. The rule -- formalizing how the agency figures out whether it needs to oversee an entity as a bank holding company -- is largely similar to what was proposed last year.

“It is no accident that the Fed is finalizing the revised control proposal at
the same time it is proposing revisions to the fund restrictions in Volcker,”
said Douglas Landy, a banking lawyer at Milbank. “Each relates to controlling
risk through limiting investments, and once adopted banking entities should be
able to attract additional capital from fund investors while at the same time
putting that capital to work structuring new bank-led client funds.”

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net

To contact the editors responsible for this story: Jesse Westbrook at jwestbrook1@bloomberg.net, Gregory Mott

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