by Silla Brush
Global regulators have moved to rein in risk at the world’s largest money managers, calling for new curbs on trading activities to protect against the potentially devastating threat investment fund losses would pose to the broader financial system.
The Financial Stability Board, whose members include the U.S. Federal Reserve and the Bank of England, said on Wednesday that exchange-traded, mutual and other funds deserve extra oversight to ensure they can sell assets to meet investors’ demands to pull out their money during volatile markets. While there is scant history of funds spreading risk throughout the system, the growth of the $76-trillion industry and funds’ move into more complex assets have drawn regulators’ attention, the FSB said.
As a result, authorities are planning to require funds to provide greater disclosure to clients about risks and to strengthen internal standards for managing investments in stressed markets. Regulators also plan to beef up rules for overseeing funds’ leverage and use of derivatives and to review asset-managers’ lending of securities to other parts of the market. The FSB said it may still move to designate certain asset-management companies as systemically important and in need of stricter supervision.
“Given its increased importance, a resilient asset management sector is vital to finance strong, sustainable and balanced growth,” BOE Governor Mark Carney, who chairs the FSB, said in a statement. Daniel Tarullo, a governor of the Federal Reserve, said that the recommendations “are designed to enhance the resilience of asset managers and funds to future stress in financial markets.”
The draft policy recommendations are the latest step by regulators around the world to curb risks beyond the banking and insurance industries, which received most of authorities’ scrutiny in the aftermath of the 2008 financial crisis. As scores of post-crisis rules have taken effect, banks have stepped back from certain markets, such as corporate bond-trading, while asset managers have taken on a greater role.
Assets under management rose to $76 trillion in 2014 from $50 trillion in 2004 and have grown since the crisis, according to the FSB.
The board said in its report that it will seek comments on the proposals until Sept. 21 and intends to complete the recommendations by the end of the year. It will then turn its attention to considering whether an asset-management company itself, or possibly a sovereign-wealth fund, rather than their activities, can be a source of systemic risk.
Regulators and the asset-management industry have clashed repeatedly in the past few years, with firms such as BlackRock and Fidelity Investments arguing that authorities misunderstand the nature of the asset-management business and have inappropriately compared them to to banks. Banks designated as systemically important face higher capital and other requirements to help them withstand losses in a potential downturn.
The FSB and the International Organization of Securities Commissions, a group of market regulators, had earlier considered whether to assess investment funds with more than $100 billion in assets to determine if they’re too big to fail. That idea ran into strident opposition from the fund industry, with BlackRock, Fidelity Investments, Vanguard Group Inc. and Pacific Investment Management Co., among others, meeting with regulators and lawmakers and writing letters and reports in a lobbying effort to get them to reconsider.
BlackRock, the world’s largest money manager, said in a May 2015 letter to the FSB that asset managers “are not the source of systemic risk,” and that “asset managers are fundamentally different from banks and other financial institutions.”
The industry argued that instead of a list of too-big-to-fail investment firms, regulators should consider ways of bolstering oversight of specific products, practices or activities. The FSB and IOSCO agreed last year, and decided to wait to finalize the method for assessing systemically important financial firms that aren’t banks or insurers.
“The good news is we’ve been able to shift this discussion from looking at asset managers as systemically important to looking at the activities that asset managers engage in,” Paul Andrews, secretary general of IOSCO, said this month.
The FSB said in its 43-page consultation that although there haven’t been recent problems, funds may “amplify market stress” by rushing to sell assets to meet unanticipated or large demands from clients to redeem their investments. In periods of stress, there might be a so-called first-mover advantage for investors to rush to redeem their funds ahead of others, which could then lead to a fire-sale of assets and spread panic in markets.
In the U.S., the Financial Stability Oversight Council, a panel led by the Treasury secretary, said in April that there may be financial stability concerns arising from funds that invest in assets that are difficult to sell in volatile or stressed markets. Meanwhile, the U.S. Securities and Exchange Commission conducted a review of the industry following the collapse in late 2015 of a fund overseen by Third Avenue Capital Management LLC that focused on high-yield and distressed debt.
The SEC has also proposed rules requiring funds to have more cash and assets to sell quickly, while the FSB said on Wednesday that more disclosure to investors about funds’ liquidity and explicit or enforceable limits on illiquid assets might be necessary.
The investment industry has rejected concerns about potential fire-sales. The Investment Company Institute, a lobbying group for mutual and exchange-traded funds, has said that large redemptions at individual high-yield bond funds haven’t undermined the stability of the financial system and that funds have instead added liquidity during periods of market turmoil.
The largest asset-management companies are also likely to oppose an FSB recommendation for greater scrutiny of their lending of securities to other traders. Financial institutions often pay a fee and provide collateral to a fund company in order to borrow securities for their own trading purposes. Mutual and other retail investment funds accounted for 44 percent of the 14 trillion euros ($15.8 trillion) in securities made available for lending, according to 2015 data cited by the FSB.
Large asset managers sometimes also provide insurance to their own investors through the form of an indemnification against any possible losses from the arrangements if the borrower doesn’t return the securities. As new regulations apply to banks, the FSB said asset-managers may play a larger role in the lending market which “could potentially result in a concentration of systemic risks outside the banking sector.”
The FSB said regulators need better data to oversee the lending and should look to also verify or confirm that asset-managers have resources to cover the losses. The industry has previously said regulators’ worries are overstated.
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