Citigroup (NYSE:C) pulled the plug on one more of its proprietary trading desks as the bank continues to tighten up operations before the Volcker Rule goes into law later this year.  Citigroup’s Equity Principal Strategies unit will cease to exist after a week and most of the staff will leave the organization. The global banking group has been systematically exiting the proprietary trading business since early 2011, aiming to be ready before the government clamps down on these operations through the rule to be implemented as a part of the Dodd-Frank financial sector reforms. Investment banking competitors Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE: GS) who relied quite heavily on proprietary trading in the past have also been doing away with these operations.
We maintain a $35 price estimate for Citigroup’s stock and believe that the near 15% premium can largely be attributed to the widespread pessimism among investors toward the financial sector in the wake of the macroeconomic uncertainty and the European debt situation.
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Volcker Rule is Coming To Town…
After the meltdown of the U.S. banking system in 2008, the Dodd-Frank Act was quickly cleared to reduce the possibility of future bankruptcies among ‘too big to fail’ banking groups. A series of recommendations, which became popular as the Volcker Rule, sought to limit the exposure of large banks to risky trading activities. The main directives include a complete ban on banks from using their own capital to trade – banks must raise funds from clients for trading operations – and a restriction on financial institutions from investing more than 3% of their Tier 1 capital in private equity and hedge funds.
… And Citigroup Is Preparing to Welcome it With Open Arms
Besides the recently announced unit, another notable prop unit Citigroup closed was its $400 million proprietary hedge fund business that made bets based on mathematical models (See Citi Shuts Another Prop Group as Banks Prepare for Volcker Rule).
Although shutting down its prop trading desks will not result in a significant decrease in the overall capital invested for Citigroup’s sales & trading business, the change is expected to reduce margins as prop trading usually yields considerably higher returns.Notes:
- Citigroup Exits Proprietary Trading, Says Most of Unit’s Workers to Leave, Bloomberg, Jan 27 2012 [↩]