UK-based hedge fund management companies could have problems accessing working capital if a provision in the ring-fencing chapter of the Independent Commission on Banking (Vickers report) stands.

Hedge fund management companies could be squeezed for working capital if a provision in the UK Independent Commission on Banking (ICB) stands.

The provision says ring-fenced banks will only be able to lend to non-financial companies. This would exclude a number of small and medium-sized businesses such as insurance companies, pension funds, asset managers, broker/dealers and hedge funds – basically most of the businesses making up the financial sector other than lawyers and accountants.

As most hedge fund management companies are relatively small although they have large assets under management, their individual revenues and staff numbers are small.

"Dealing with prime brokers who do not have access to the retail side of the ring-fenced bank will not change," comments Alasdair Steele, a corporate partner and head of financial sector at city law firm Nabarro.

They will be drawing down big enough amounts so the wholesale side will be open to them. The issue, says Steele, is that the day-to-day funding of a hedge fund business, including things like cash flow, paying salaries until the next management fees come in and working capital flows, will be affected.

"These are smaller amounts and if you shut out the retail banks where most businesses go to get a few millions of funding – which are not massive amounts but too small to open the wholesale market to the business – the question is where exactly can they get cash from?"

In answer to a question submitted by Steele to the ICB on this point, the commission said: "As a general position, the non-financial/financial split takes precedence over business size, therefore we would expect implementation to exclude financial companies even if they are SMEs [small and medium-sized enterprises] by the definitions in the report. However, this is really a question that will be left for implementation by government."

Whether or not they fall into the strict UK Companies Act definition of SMEs or are slightly larger than the £26 million ($40.7 million) turnover/£13 million ($20.4 million) balance sheet tests proposed, non-bank financial companies will find it difficult to get funding other than from the traditional lenders as they will likely be too small or looking to borrow too little to be able to access the larger wholesale markets, concludes Steele.

The effect on their borrowing costs and on competitiveness in a global environment would then be an open question. Steele believes these restrictions would pose a risk to a key sector of the UK economy, depriving hedge funds of a source of funding which will be available to global competitors.

Steele says hedge fund managers have time to lobby against the provision, pointing out that there is effectively a three-year lobby period available before the rule hits the statute book. Although the Association of British Insurers is expected to argue against the provision on behalf of its smaller members and the Confederation of British Industry at the larger business end, Steele cautions that hedge funds should not sit back.

"At the moment the Treasury select committee is taking evidence on the report. It is an opportunity. Managers should submit comments to government. Any trade bodies that take up lobby activities should get involved and make [the government] aware of the issue and put pressure on the government," says Steele.

In its final report the ICB cemented its proposal to ring-fence the retail arms of UK banks from their investment operations. However, this leaves many questions unanswered as to exactly what will be caught by the division.

The deadline given in the report for final implementation to be completed by was 2019, matching the cut-off for the Basel III rules.

Chancellor of the Exchequer George Osborne says legislative action will be taken by 2015 and that the government will consider "which changes can be in the existing Financial Services Bill and which will need a new bill".

The chancellor's suggestion is that some or all of the ICB's recommendations could be included in the Financial Services Bill, the legislation overhauling the regulatory system of the UK banking industry, disbanding the Financial Services Authority.