Will the Volcker Rule be a boon for hedge funds?

Just how controversial is the Volcker Rule? Outside groups have now sent at least 170,000 words of feedback to regulators, the Wall Street Journal notes, most of which are critical of the rule-in-progress. One of the biggest complaints is that the regulation — which is intended to curb speculative trading by banks for their own benefit, rather than their customers’ — is that it will hurt consumers by reducing liquidity in the market and strangle banks’ ability to hold large quantities of assets for investors to buy and sell.

Paul Volcker, former chairman of the U.S. Federal Reserve. (Bloomberg) Supporters of the regulation counter that the fears about liquidity are overwrought. What’s more, they add, hedge funds and other non-banks will still be allowed to conduct so-called proprietary trading and could move into that market when banks exit. “In any event, there are and should be thousands of hedge funds and other non-bank institutions ready, willing and able to undertake proprietary trading in unrestricted securities in large volumes,” writes Paul Volcker on his eponymous rule. “The point is that those traders should not have access to the taxpayer support implicit in the safety net of commercial banks.”

It’s still unclear, however, whether hedge funds and other non-investors will be willing or able to fill in the gap if trading contracts significantly. The Volcker Rule, moreover, also reduces the ability of banks to invest in both private equity and hedge funds by capping such investments at 3 percent, which could also reduce their own capital. More criticism of Volcker from the Securities Industry and Financial Market Association is here. You can read Paul Volcker’s full comment letter here and his most recent op-ed on it here.