The first glimmers are emerging of a new financial landscape of lower profits and reduced risks, even before Congress completes a major overhaul of financial regulation.
Some big financial firms are moving out of the private equity business. Some are padding their capital cushions. Other players are already making the giant over-the-counter derivatives market more transparent.
Just last week, British bank HSBC Holding said it is in talks to spin off its private equity arms and ICAP Energy, a top broker for over-the-counter energy trading, said it would start delivering prices on an electronic platform.
Changes are happening — sporadically for now but perhaps more uniformly soon — in response to legislation that aims to limit risky trading by banks, boost their capital cushions, and shed light on shadowy markets. President Barack Obama wants a final bill on his desk for signature by July 4.
While financial companies are still lobbying furiously on Capitol Hill to weaken new rules and protect their profits and business models, some are moving ahead with changes in anticipation of the biggest regulatory revamp since the 1930s.
"It wouldn't surprise me that if the handwriting is on the wall, people would want to get a running start rather than wait for the inevitable," said Michael Greenberger, a former Commodities Futures Trading Commission official now at the University of Maryland.
Firms are making these moves ahead of discussions by U.S. lawmakers this week to compromise on the final version of the financial reform bill.
Tougher banking industry regulation is leading firms globally to scale back non-core functions, such as private equity investing.
Some form of a proposal to ban banks' risky trading, known as the Volcker rule for its original champion, White House economic adviser Paul Volcker, is seen remaining part of the U.S. reform plans.
The news of HSBC's private equity spinoff follows Barclays' plans to shed its mid-market buyouts arm this summer. Royal Bank of Scotland is also in talks to sell its European and U.S. private equity funds portfolios.
"It's hard to decipher if these guys are spinning things off because of the new rules or because they are trying to get smaller—it's probably a combination of both," said Paul Miller, an analyst at FBR Capital Markets in Washington.
Both House and Senate bills call for boosting capital requirements on firms as they grow and take on more risk.
Even while future capital mandates remain uncertain, some regional banks are raising capital now, because they expect it to be harder when the capital rules are final, said Chip MacDonald, a partner at Jones Day in Atlanta.
"There is some fear among some banks that if capital standards rise too much too quickly, there's not enough capital out there to fill the hole," he said.
Credit rating agencies, whose credibility dove after products they rated triple A became junk, have said they are already changing their ways ahead of legislation.
For example, Moody's Chief Executive Ray McDaniel told a hearing earlier this month that the company has begun using flexible metrics for when financial assumptions change.
In anticipation of proposed rules to move some the $615 trillion derivatives market into the sunlight, exchanges and other platforms have been bringing the light themselves. The over-the-counter (OTC) market is vastly bigger than exchange-based trading, with its opacity attracting hedgers and investors seeking higher returns.
Traders are already easing into the reforms that could crimp those profits.
The managing director of ICAP Energy, a unit of the biggest interdealer energy swaps broker, ICAP PLC said last week it would start delivering OTC oil prices on a new electronic trading platform using technology provided by IntercontinentalExchange.
Banks are taking a wait-and-see approach, though, to some of most dramatic—and still in flux—proposals.
One provision mandates banks to spin off their derivatives units, though it faces an uphill fight to stay in the bill.
"Everyone is waiting to see what (the law) is finally going to look like," said Ernie Patrikis, banking partner at White & Case in New York. "No one is going to move this early," on that one, he said.
The reform bills in Congress force securitizers to keep a baseline 5 percent of credit risk on securitized assets—an attempt to have issuers keep "skin in the game," so that they shoulder more risk.
"It's clear given that both House and Senate have passed 5 percent risk retention requirement that there will be some mandated risk retention broadly," said Tom Deutsch, executive director of the American Securitization Forum. "Risk retention will certainly lower the overall securitization issuance volumes."
But other issuers are testing out offerings with the reforms.
Redwood Trust retained 5 percent of the bonds offered to investors in a $222.4 million bond in April, which was the first private residential mortgage-backed securities deal in about two years. It cited forthcoming regulations in its closing sheet.
These early adaptions to the new regulatory climate may soften the impact on the financial industry, but the assumption remains that profits will suffer, whatever final form of the law emerges.
"There will be more transparency coming into the market with whatever bill we get," Miller said. "It will be a less profitable endeavor over the next decade."
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