NEW YORK, Aug 24 (IFR) - As US regulators put together the
final touches to the controversial Volcker Rule, Goldman Sachs'
third-quarter results are likely to reflect the benefits of one
last proprietary trading hurrah from the purchase - and
subsequent sale - of Knight Capital's accidental stock
Knight's trading algorithms suffered a catastrophic
glitch earlier this month, buying stocks worth several billion
dollars. The brokerage turned to Goldman for help and the
investment bank is understood to have bought the portfolio at a
discount. Analysts expect Goldman to pocket profits of between
US$100m and US$230m after unwinding the portfolio.
Analysts have been steadily revising Goldman's third-quarter
earnings estimates higher in part on the expectation of big
profits from the Knight transactions.
According to Rochdale Securities bank analyst Dick Bove, the
deal could be worth 15 cents a share to Goldman this year.
Morgan Stanley has raised its third-quarter estimate for Goldman
by 32 cents - in part on trading the Knight portfolio.
Goldman's third-quarter results will also be enhanced by
trading non-US sovereign debt, the high-yield market and
performance fees from its asset management division. The boost
is a welcome one given the weak trading environment.
Still, the deal between Goldman and Knight Capital is
controversial. The final Volcker Rule comes into effect in
January and will ostensibly limit the ability of big banks to
place market bets with their own money - and the Knight deal
represents such a bet, say some.
"Would Goldman have been able to buy the portfolio if
Volcker were in place? I don't think so," said Bove. "Clearly
they didn't buy this stuff for clients, they bought it for their
own accounts and they are not allowed to do that under Volcker."
Not everyone agrees. "We don't know because the final rule
isn't in place," said one banker. Others insisted that the
Knight trade was essentially Goldman buying and temporarily
holding a large risk position - essentially an equity block
trade, which it sold down.
"It's not proprietary trading," argued Donald Lamson, a bank
attorney with Shearman & Sterling, who believes it would not run
afoul of Volcker.
This is not the type of transaction where a firm buys and
sells securities on the open market with the aim of making a
quick profit, he said. Lamson argues that since the transaction
took place outside of the open market, it was a form of
financing. "No one is going to turn this type of transaction
into a business line," he added.
The varying opinions are indicative of how difficult it is
for the industry to interpret the draft Volcker Rule and why
there have been delays in the implementation of the final rule.
The final rule is expected to be released by year-end, according
to lawmakers and Treasury officials.
The rule was supposed to be published by July 21, but
regulators failed to meet the deadline. JP Morgan's troublesome
trades in its chief investment office slowed progress, as
politicians and regulators debated whether the losses were the
result of hedging or propriety trading.
"JP Morgan's speculative trades were like a turd in the
punch bowl," said Tony Plath, a professor at the University of
North Carolina Charlotte. Until then, it appeared that the final
rule would be softer than the draft rule. "Now, the rules will
be tighter," he said.
However, many are doubtful that a final rule will be
released by year-end. Discussions will not resume until after
Labor Day, which is September 3. The presidential election in
November is likely to slow down progress further.
The most contentious issue deals with proprietary trading,
and how it differs from market-making. The industry and
regulators have yet to see eye-to-eye on what constitutes prop
The 298-page draft rule, which was released in October 2011,
also reduces the ability of banks to invest more than 3% in
either a private equity or hedge fund.
There remain many harsh critics of the Volcker Rule in
Congress. House Financial Services Chair Spencer Bachus said
earlier this month that the Volcker Rule would devastate the US
economy and undermine the country's ability to compete.
The Fed has granted banks a two-year period to comply with
the rule, which began on July 21.