In an effort to comply with the financial regulations, Goldman Sachs Group Inc. (GS) is said to be shutting down its Global Macro Proprietary Trading desk, according to a Wall Street Journal report. The trading desk deals with foreign-exchange markets, interest-rate markets, stocks, commodities and other fixed-income markets.
The Dodd-Frank financial reform bill, which was signed into law by President Obama in July 2010, has a number of provisions that would affect the business model of financial institutions significantly. A provision in the law – the “Volcker Rule,” named after Paul A. Volcker, former Federal Reserve chairman – restricts banks from utilizing their own capital to speculate in order to prevent huge risky bets.
According to the regulatory reform, banks will be restrained from proprietary trading and investing more than 3% of their capital in private equity or hedge fund investments over the long term. Proprietary trading has been a pivotal source of investment bank profits and the step is an attempt to curb speculation by banks, which has been cited as one of the major culprits of the recent financial crisis.
The particular trading desk that Goldman is winding down has been in operation for the past several years and has significantly contributed to its revenue. Last year, the company also shut down Goldman Sachs Principal Strategies to abide by the Volcker rule.
Besides Goldman, the other Wall Street biggies such as JPMorgan Chase & Co. (JPM), Morgan Stanley (MS) and Citigroup Inc. (C) are closing down or selling off their proprietary trading businesses to observe the new rule.
We believe that this act to curb proprietary trading activities is not a favorable one for Goldman in the near term, as it has derived a significant amount of its revenues from such activities in the past. It is in fact a lucrative revenue generating source for financial institutions and banks. However, over the long term this will reduce their dependence on risky revenue sources.
However, we expect Goldman to benefit from its well managed global franchise, strong capital base and industry leading position in trading and asset management. Though the company recorded lower equity trading revenue along with decreased overall revenue in the quarter, its prudent business model and strong fundamentals are likely to deliver better earnings in the upcoming quarters.
Yet, higher competition is expected to prevail both within the investment banking business and sales and trading, as the economy recovers. Continued weakness in the commercial real estate market, where Goldman has significant exposure, also remains a concern.
Goldman shares are maintaining a Zacks #3 Rank, which translates into a short-term “Hold” recommendation. We also have a Neutral recommendation on the stock.