New Regulation May Increase Profits at Securities Firms

Never mind that Wall Street’s profit growth in the second quarter probably was the worst in two years. A new regulation relieving capital restraints may enable the biggest American securities firms to make the rest of 2007 exceptional for shareholders.Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc., and Bear Stearns Cos. have the potential to earn $4.4 billion more annually as early as next year by moving money out of safe investments into higher-returning bets, a former treasurer at Paine Webber Group Inc. and Cowen Group Inc, Dorothy Leas, said. The earnings gain, which would equal 14% of the New York-based firms’s record profits of 2006, follows a rule change that allows them to hold less money in reserve for potential losses.Investors are underestimating the benefits of “alternative net capital requirements,” a regulation passed by the Securities and Exchange Commission in 2004 to keep Wall Street firms competitive with their counterparts in the European Union, an analyst at New York-based Sanford C. Bernstein & Co, Brad Hintz, said. Profits will get a boost in the second half of 2007, depending on how fast the five firms shift their capital, he said. Commercial banks in America are receiving a similar break from the Basel II agreement, set to take effect as early as next year.“They’re all increasing capital at risk because the new capital requirements allow it,” said Mr. Hintz, a former chief financial officer at Lehman. “As the transition to the new capital rules is completed, they’ll have more room to do so, and that will help their profit.”Goldman, Morgan Stanley, Merrill, Lehman, and Bear Stearns, the only firms cleared by the SEC to adopt the new capital-adequacy standards, declined to make executives available for comment.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 noncash assets, such as derivative contracts, to offset risk.“Basel II has increased the amount of risk, but that’s not troubling,” an associate professor of corporate law at Boston University, Charles Whitehead, said. “There’s a large focus on enterprise-level risk management. And the broker-dealers are the pioneers of that because they need to do it best before they can provide the same services to their clients demanding it.”

New Regulation May Increase Profits at Securities Firms

New Regulation May Increase Profits at Securities Firms

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