Morgan Stanley's Volcker Woes

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According to Reuters, Morgan Stanley’s (MS) plans of raising global infrastructure fund may be severely hit by the proposed Volcker rule. The proposed rule –an element of the Dodd-Frank Act – limits the proprietary trading activities of the banks by curbing the amount that can be invested.

Infrastructure funds invest in assets such as roads, airports, power grids and electricity transmission networks. Along with a long-term investment prospect, these assets provide investors low-risk returns.

However, being private equity-type assets, these are less liquid compared to standard stocks and bonds. With the stringent regulations weighing down further on profitability of such funds, Morgan Stanley Infrastructure Partners will have to be content with a smaller share of profits.

This profit shrinkage has not been taken well by the executives of the Infrastructure Partners. Many of the fund mangers, who were in charge of supervising the infrastructure fund investments, have either left or in the process of leaving the firm.

Moreover, stringent regulations would give the independent asset managers – like The Blackstone Group LP (BX) and The Carlyle Group LP (CG) – a competitive edge over financial institutions such as Morgan Stanley. Moreover, banks face limitations while holding conventionally strong but capital-intensive businesses, chiefly private equity assets, which are generally tied up for a number of years.

As a result, banks have been missing out on earning profits from the infrastructure funds. Similarly, The Goldman Sachs Group, Inc. (GS) was quite unsuccessful in its second infrastructure fund initiative. It had to cut down its target of fund raise by almost 50% to $3.1 billion from nearly $7.5 billion in the middle of the marketing process following the announcement of new regulations.

Whereas Global Infrastructure Partners Ltd –a private equity firm– successfully raised about $7.5 billion for its second infrastructure fund in 2012.  This is the largest infrastructure fund raised globally to date,  overtaking Goldman Sachs’ first infrastructure fund, which raised $6.5 billion in 2006.

The Volcker Rule has been labeled as most divisive and fiercely debated measure of post-financial crisis era of regulatory reforms as it has put a question mark on the future of banks like Morgan Stanley. This rule is sure to dent the top-line growth of U.S. banks.

Moreover, majority of industry partakers opine that market liquidity will be negatively impacted, transaction costs will escalate, trading volumes will be diverted to other jurisdictions and the whole economy may suffer due to the Volcker Rule. However, it should not be forgotten that the primary aim of Volcker Rule is to limit the risky activities of banks to safeguard the taxpayers’ money as well as the health of the economy.

The shares of Morgan Stanley currently retain a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain a long-term Neutral recommendation on the stock.

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