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In an effort to comply with the Volcker Rule, Citigroup Inc. (C - Analyst Report) will sell part of its stake in private-equity unit, Metalmark Capital. Metalmark will cease to be an affiliate of Citigroup but the banking major will continue to hold limited-partner interests in the Metalmark Capital Partners II fund.

Incorporated in 2004 by the former management of Morgan Stanley Capital Partners, Metalmark will be managed by the same investment team after the stake sale by Citigroup. It was previously domiciled under the Citi Capital Advisors division, which has mostly been wind down by Citigroup.

Metalmark has $2.5 billion in committed capital in its latest fund. The firm invests in companies in the energy and natural resources sector as well as healthcare and industrial sectors.

Citigroup’s decision to divest its stake in the private-equity unit was taken to accord to the new regulations in the U.S. banking sector. The most notable rule among these is the Volcker Rule, which restrains banks from utilizing their own capital to speculate – in a measure to prevent huge risky bets.

According to the Volcker Rule, banks will only be able to invest a minimal amount of 3% of Tier 1 capital in hedge or private-equity funds or can own 3% of the fund. Therefore, it will not be possible for Citigroup to keep a significant stake in the private equity unit.

Under pressure from the Volcker rule, Citigroup spun off an internal hedge-fund unit earlier this year and renamed it Napier Park Global Capital. Citigroup also sold its Citi Venture Capital International unit to Rohatyn Group this year. Moreover, other major U.S. banks like JPMorgan Chase & Co. (JPM - Analyst Report), The Goldman Sachs Group, Inc. (GS - Analyst Report) and Morgan Stanley (MS - Analyst Report) have divested their hedge fund units in order to conform to the new regulations.

The Volcker Rule has been the center of much debate as it poses a challenge to the future profitability of banks. This rule will definitely affect the top-line growth of banks.

Moreover, most industry players believe that the Volcker Rule could lower market liquidity, raise transaction costs and divert trading volumes to other jurisdictions, thereby making the whole economy suffer. However, it should not be forgotten that the primary aim of the Volcker Rule is to limit risky activities of banks to safeguard taxpayers’ money as well as the health of the economy.

Currently, Citigroup carries a Zacks Rank #3 (Hold).

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