Volcker specter haunts private equity

August 15, 2012, 10:14 PM UTC

FORTUNE — When private equity firm Catalyst Investors began raising its third fund in early 2011, it quickly found that many of its past investors didn’t want to re-up. Not because of performance, but because they were banks and other financial institutions that felt constrained by a part of the so-called Volcker Rule.

“The banks had been investing in us off of their own balance sheets, and none of them came back,” explains Brian Rich, Catalyst’s co-founder and managing partner. “So we basically had to reinvent our limited partner base.”

This is not an isolated example. Fund placement agents say it’s almost not even worth calling banks anymore, as few of them are willing to make new private equity commitments. “The banks are almost non-players at this point,” says Charlie Eaton, head of Connecticut-based Eaton Partners.

What’s remarkable about this pullback, however, is that the Volcker Rule doesn’t actually exist yet.

For the uninitiated, the Volcker Rule is part of the massive Dodd-Frank financial reform package signed into law by President Obama in 2010. Its goal was to stop banks from making risky balance sheet bets that could threaten their solvency, including such things as proprietary trading. Also banned were bank investments in third-party private equity funds, although they still would be allowed to sponsor in-house private equity funds of funds-of-funds so long as certain conditions were met (e.g.,   the bank cannot provide more than 3% of the fund’s capital).

But many of the specific details were left to the discretion of federal regulators, who had until July 21, 2012 to publish final language. That deadline came and went, with sources now saying that we aren’t likely to see anything before Labor Day. And, even then, certain Congressional leaders like Rep. Bachus (R-AL) are promising changes that could push implementation into 2013 (or even further, since some GOP reps would like to kill the Volcker Rule altogether).

Nonetheless, banks are acting as if Volcker already is in effect.

“I don’t think anyone fully knows how these rules are going to play out, but the uncertainty is causing financial institutions to pull back,” Eaton says. “They don’t want to make commitments to lots of funds and then be under pressure to divest.”

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