'Volcker rule' looms over exchange IPOs

An American law could limit the universe of institutional investors that may invest in the coming Initial Public Offers (IPOs) of India's two major bourses, the BSE and National Stock Exchange (NSE).

The law in question is called the 'Volcker Rule', as it was enacted on the recommendation of Paul Volcker, a respected central banker. This US federal regulation prohibits banks from conducting certain investment activities with their own accounts, and limits their ownership and relationship with hedge funds and private equity funds, also called 'covered funds'.

It appears both BSE and NSE could be deemed 'covered funds' as defined in the Volcker Rule. Both exchanges are relying on an analysis that they do not come under the definition of an 'investment company' under the US Investment Company Act because of an exception provided under it. However, this means they may be considered a covered fund as defined in the Volcker Rule.

A covered fund faces greater restrictions while marketing an IPO to institutional investors compared to an 'investment company'. "The exchanges might have to market the offering to a smaller set of institutional clients and adhere to a longer list of procedures," said an expert at a law firm.

Banking entities under the relevant law include any US-insured depository institution or any company that controls a US-insured depository institution. Any company, including non-US ones, that are treated as a bank holding company for purposes of Section 8 of the International Banking Act of 1978 are also treated as a bank. This means even a non-US company that maintains a branch, agency or commercial lending office in the US will be categorised as a banking entity.

"There may be limitations on the ability of banking entities to purchase or retain our equity shares in the absence of an applicable Volcker Rule exemption. Consequently, depending on market conditions and the banking entity status of potential purchasers of our equity shares from time to time, the Volcker Rule restrictions could negatively affect the liquidity and market value of our equity shares," says the NSE draft offer.

There is, however, lack of clarity among experts on which banks come under this restriction or if the restriction will apply at all. "After the Lehman crisis (late 2008), several investment firms like Goldman Sachs and Morgan Stanley became bank holding companies and all of them have asset management arms. However, I'm not sure how they will classify themselves; it's a matter of interpretation," said an investment banker, on condition of anonymity.

After Donald Trump won the US presidential election, some of the big US banks have reportedly stepped up lobbying efforts to dilute or eliminate the Volcker Rule. Large US banks include the likes of JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley.

Investment bankers managing the exchange offerings believe the impact, if any, is likely to be minuscule. An e-mail sent to NSE and BSE on the potential impact of the Volcker Rule on investment from foreign institutional entities went unanswered.

The Volcker Rule is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (popularly termed 'Dodd-Frank after its sponsors). As explained earlier, it aims to restrict US banks from making speculative investments that do not benefit their customers.

Since the Act was passed six years earlier, banks have been forced to scale back high-risk/high-reward proprietary trading desks.