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Investment banks are moving some of the traders known for taking big risks with shareholder cash into their asset management arms, giving them a shot at running their lucrative strategies with outside money to comply with new U.S. rules.
U.S. banks or banks with U.S. branches or subsidiaries will be banned from gambling shareholder capital, known as proprietary trading, from July 21, in a regulatory overhaul to limit some of the risk-taking that contributed to the 2008 financial crisis.
But they will still be allowed to run hedge fund strategies if they replace their own capital with third-party cash over the next two years.
JP Morgan, UBS and Citi are among those looking to let their remaining proprietary traders run client money, including shifting them to asset management.
Other banks including Goldman Sachs and Morgan Stanley - traditionally among the biggest players in prop trading - have already shut their units down.
"You can't be a principal engaged in proprietary trading (But) You can sell strategies to your clients, so if you have people who have certain trading skill sets to keep them active you can have them face clients and sell those strategies," Donald Lamson, a lawyer at Shearman and Sterling, said.
"It's a logical use of talent."
The Volcker rule, part of the Dodd-Frank financial oversight law, is aimed at preventing losses that in 2008 ended in taxpayer bailouts.
Regulators' believe that it is wrong for banks to bet using their own account when many enjoy Federal backstops. Banks say the rule will increase investor costs and undermines U.S. competitiveness.
Named after ex-Fed chairman Paul Volcker, the rule has encouraged a wave of traders to leave banks and launch their own hedge funds since the crisis.
But they face a tough market for capital raising and some banks are encouraging their traders to stay by giving them time to replace bank capital with external funds.
UBS has said it is considering moving its equities proprietary trading desk to its asset management arm, while JP Morgan has tried to shift its emerging market, equity and credit teams to a new unit within its asset management division, sources familiar with the situation said.
Citi, meanwhile, said it will sell part of its hedge fund unit Citi Capital Advisors, headed by the bank's chief operating officer John Havens, to employees, but plans to retain part-ownership as it replaces bank capital with client cash.
"I think on certain desks in banks there are certain people that are highly skilled traders, and the banks don't want to lose those people," Scott Cammarn, Special Counsel at Cadwalader Wickersham & Taft, said.
Banks who keep these traders give themselves the chance to earn lucrative performance-related revenues, even after their capital is replaced with clients'.
UBS, for example, said in February it earned $65 million, primarily from equity prop trading, in the fourth quarter alone.
But the promises of rich rewards outside of banks -- where traders can earn ten or hundreds of million of dollars far from public scrutiny -- makes it tough to hold on to traders.
Even in the turmoil of recent years, traders such as ex-Goldman Pierre-Henri Flamand and Morgan Sze both managed to raise $1 billion-plus US for new fund launches.
Mike Stewart, head of proprietary trading at JP Morgan, rejected a plan to move his team of 9 into the U.S. bank's asset management's arm, and is set to launch his own hedge fund this year instead, a source familiar with their plans said.
JP Morgan wanted Stewart, who runs an emerging markets team, moving into a new alternatives unit along with Fahad Roumani, who runs credit strategies, and Deepak Gulati, who is in charge of equities, the source said.
The move involved around 50 people and would have seen the bank seed it with $2 billion, the source said. Unlike Stewart, Roumani has already moved into the unit, while Gulati is expected to go within the next 12 months, the source added.
JP Morgan, which has already shut other proprietary desks including commodities, declined to comment.
Sutesh Sharma, one of Citi's most senior prop traders, is also set to launch his own fund this year after the bank closed its equity prop desk, sources familiar with his plans said.
Shifting traders into asset management arms give banks time to replace proprietary capital in their funds with money from external investors rather than closing a fund altogether.
"I think some of these (banks) will find if difficult to find third-party money if they suddenly pull out of their own funds (and) so need to do this transition," one person familiar with hedge fund capital raising said.
Under Volcker, bank ownership in a hedge fund is limited to 3 percent of its capital but this does not come into force until the end of a two-year transition period, giving banks breathing space to replace their money with client cash.
Banks are also permitted to provide start-up funds for new hedge fund launches using shareholder capital, so long as they whittle their stake in the fund down to 3 percent by the end of the first year.
As many bank-owned asset managers already run hedge fund strategies, the move could provide proprietary traders who have been unable to go it alone, the time and resources to exploit the rising popularity of alternative investments among the banks' clients.
By keeping the traders, the banks will also be in a good position to hand them back shareholder cash if Volcker is ever watered down and some forms of prop trading permitted.
"With the way that all regulation is unfolding and changing, there are some people who are taking that wait and see attitude (regarding the Volcker rule)...," Nick Roe, Global Head of Prime Finance and Futures at Citi, said.