Expect Slow Trickle Not Flood of Prop Desk Spin-offs in Asia

"You may not realize it when it happens, but a kick in the teeth may be the best thing in the world for you."

Walt Disney, entrepreneur & film producer (1901-1966)

Obama's recent Volcker Rule that aims to restrict risk-taking by banks will face challenges as the legislative process gets underway. The actual rule in its initial form may force banks to drop out of prop trading, running hedge funds or HFoF and even private equity operations for their own account. It might also extend to shops like MS and Goldman, Sachs - traditional prop shop power houses.

But one thing is sure - if U.S. banks and a large number of European ones do follow through on the Volcker Rule then it might spur a large number of spin-offs of current prop trading (equity/fixed income and derivative-related) operations in Hong Kong, Singapore and Tokyo currently attached to these banks.

While the balance sheets of these entities certainly helped to scale up these prop trading operations, a clear implication will be to expect and to see a fall-off in overall volumes of instruments traded either off balance sheet or even on exchanges.

Exactly what the scale of this potential prop trader migration will take is unknown. It will certainly differ from country to country and from firm to firm. Clearly, it will lead to some movement to large multi-strategy multi-national firms like the Och Ziffs and Citadels of the world, although they may already have a stranglehold on the best trading talent in the region. It may also open up a whole new talent pool to the large Japanese banks and brokers looking to build up their presence in these once profitable areas. It might also look a little "bad" if there is a flood of talent given how some of these teams were brought on board at considerable cost in the wake of the Lehman Brothers demise.

Another area where there could be action is likely to be among the HFoF community. A small number of these U.S. banks may still have on-the-ground analysts and marketers in Asia as they look to build globally diversified portfolios along the lines of the JP Morgan Asset Managements of the world.

If there is value out there these FoHFs may become subject to MBOs, M&A activity or they may simply dissolve as key talent runs to other firms. As an idea at to the size of this opportunity, consider that a consultant (Prequin) recently estimated that the 19 FoHF units of U.S. banks account for around $180 billion in AUM. In my opinion, these bank operated HFoFs tend to have been the worse performing vehicles relying for too long on their name brands and distribution channels to move product. The days of the mediocre HFoF in Asia may really be over.

Whatever the result, The Volcker Rule may have implications as far away as Tokyo as the boards of major banks crank out business plans and reports to try and prepare for how they too will try to take advantage of the current opportunities. Expect many implications for current business practices and new ones too that will impact other associated industries like insurers. There is no doubt that consultants and headhunters will be working the phones actively and profitably in 2010! Mahalo.