Liquidity to Keep Flowing on Wall Street

Liquidity from private equity firms has been credited with fueling the recent rise in global markets. But a regulation enacted by the Securities and Exchange Commission in 2004 could provide the next boost, and in the process add an additional $4 billion annually to the bottom line of big banks and brokers..

Sure, $4 billion is chump change, but the changes in the alternative net capital requirements should ensure that the biggest brokers continue to allocate capital to capital at risk strategies. Good news for stockholders and employees at Goldman, Morgan Stanley, Merrill, Lehman and Bear, the only firms that have been cleared thus far to take advantage of the new capital adequacy standards.

Under the old regime, securities firms had to reserve a set percentage of every dollar of capital at risk to ensure solvency in the event of a market collapse or failure of a major client. At the end of every week, each firm would calculate the difference between what it owes and what it’s owed and have to keep cash on hand to cover any net liabilities.

The new rule takes a more nuanced approach. Reserves are determined according to a combination of risks including losses from credit deterioration, adverse market movements, inadequate internal controls and changes in legislation. They permit securities firms to use non-cash assets, such as derivative contracts, to offset risk.

No doubt some of you are already guesstimating the effect this will have on the bonus pool. The impact will be felt in the second-half of 2007. Don’t fret if you are a stakeholder in one of the large U.S commercial banks, they get to participate early in 2008.

Of course, that should give Goldman et al time to position themselves ahead of the pack. And stay tuned, as we are likely to hear from pundits about the dangers of more capital being put at risk.  And it begs the question.

How much of this has already been priced in?

Wall Street Gets Lift From SEC Rule, May Earn $4.4 Billion More
Bloomberg
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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author. No position in securities mentioned

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