On Tuesday, the FDIC will unveil the proposed Volcker Rule or, at least, a document with hundreds of questions about what the agencies might someday do about the former Fed chairman’s eponymous edict. The industry is already warming up its fingers for epic comment letters, but some banks believe they’ve beat at least some of this reaper by moving otherwise-banned hedge-fund and private-equity holdings into asset management. Will this work?

If banks can keep their hedge-fund and private-equity investments in their asset-management operations, they will have held a bit of their own against reforms that, as far as we can tell, have nothing much to do with any actual risk. Indeed, holding these vehicles in asset management reduces whatever risk there was because, here, customer-protection rules apply that insulate banks from market, investment and reputational risk.

However, getting a green light for hedge-fund and PE investments in the asset-management book is only part of the battle. Even if this is achieved, significant hurdles for banks remain, most notably in the capital treatment of restructured hedge/PE holdings. In the banking book, credit- and market- risk-based capital applies; in asset management, it doesn’t. This leads to the view that regulatory arbitrage results from this transformation.

But, asset management isn’t capital-free. Although not subject to the Basel III credit-risk charges or the Basel II.5 market-risk ones, asset management does come under the Basel II operational-risk requirements. These have yet to be fully implemented in the U.S., but they are a lurking charge of significant magnitude.

Indeed, the Basel II charge is about to be topped up – as we noted for clients last week, a new version of this capital requirement is in the works at the Basel Committee and it’s raising this capital requirement still higher than before. As a result, getting investment vehicles blessed for the asset-management book is only half the struggle; keeping them profitable in light of pending capital changes won’t be easy.

Does the operational-risk capital charge make sense? Not much, as we’ve said for years due to the complex methodology based on scant empirical evidence that underlies this Basel II construct. But, does the Volcker Rule itself make sense? Not so much, especially in light of all the costly rules and new resolution requirements built into Dodd-Frank. Does making sense matter any more in regulatory decisions? This, sadly, these days seems like just a rhetorical question.

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