Goldman Sachs & Co. (GS) has decided to close down its principal strategies desk, a unit that is in proprietary trading, according to a report by Bloomberg News. The decision to spin off the proprietary trading businesses followed the regulatory reform bill that became law in July 2010.
The Dodd-Frank financial reform bill, which was signed into law by President Obama in July, has a number of provisions that would affect the business model of the financial institutions significantly. A provision in the law — the “Volcker Rule,” named after Paul A. Volcker, former Federal Reserve chairman — restricts banks from utilizing their own capital to speculate in order to prevent huge risky bets.
According to the regulatory reform, banks will be restrained from proprietary trading and investing more than 3% of their capital in private equity or hedge fund investments in the long term. Proprietary trading has been a pivotal source of investment bank profits and the step is an attempt to curb speculation by banks, which has been cited as one of the main reasons behind the recent financial crisis.
Around 65 to 70 members of the Goldman Sachs’ unit are exploring new job opportunities. While some may be given new roles within the organization, a team in Asia may commence a new hedge fund business.
Apart from Goldman Sachs, many other U.S. banks including Citigroup Inc. (C), Bank of America Corporation (BAC), JPMorgan Chase & Co. (JPM), Wells Fargo & Company (WFC) and Morgan Stanley (MS) are trying to reduce their investments in hedge funds and private equity. Though the regulation will take several years before its provisions and impacts become clearer, these banks are considering a number of options to comply with it.
The act is not welcome news for Goldman Sachs, which derives a significant amount of its revenues from its proprietary trading activities. Therefore, any measure to curb proprietary trading activities would severely impact the company’s top-line results.
However, Goldman maintains a well managed global franchise with a strong capital base and a leading position in investment banking, capital markets, trading and asset management business. We also believe that with the recovery of the U.S. economy, the company should experience improvements in credit spreads.
Goldman Sachs currently carries a Zacks #3 Rank (Hold), implying no clear directional pressure on the stocks over the next one to three months.
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