WASHINGTON — A group of international regulators are recommending that further controls be put in place to prevent systemic risk associated with the asset management industry, a sector that the group says is growing in size and influence.
The Financial Stability Board — a group composed of national financial regulators from around the world based in Basel, Switzerland — Thursday issued a series of policy recommendations for individual countries to reduce the potential systemic risk posed by asset managers such as hedge funds and mutual funds.
The report notes that the total value of assets controlled by regulated open-ended funds — including mutual funds, hedge funds, money market funds, exchange-traded funds and other mechanisms — has grown from $53.6 trillion in 2005 to $76.7 trillion in 2015 and makes up some 40% of assets in the global financial system.
Mark Carney, Chair of the FSB and governor of the Bank of England, said that while the asset management industry provides "diversity to our financial system" it is important that safeguards be put in place to ensure that the growing sector does not become a source of financial unrest.
"The policy recommendations published today will enhance the resilience of asset management activities so that this form of market-based finance can help underpin strong, sustainable and balanced economic growth," Carney said. "This will be of lasting benefit to our collective economies."
The recommendations focus on four areas: redemption risk, leverage, operational risk and securities lending. Of those four, particular attention was paid to redemption and leverage risks. Redemption risk is the potential for a fund that is composed of illiquid assets but that offers its customers instant or near-instant redemption to become distressed if too many of its customers withdraw their assets at the same time. Leverage risk is simply the risk that the fund will hold too much debt to withstand a stress scenario.
With respect to liquidity and redemption risk, the paper recommends that individual jurisdictions should "collect information on the liquidity profile of open-ended funds … proportionate to the risks they may pose" as well as examine investor disclosure requirements and the redemption rules that may apply to those funds. Regulators might also consider establishing and widening the availability of both preventative and responsive tools such as redemption restrictions, stress testing, redemption notice periods, settlement periods, and various gates to prevent runs.
As for leverage, the paper noted that while many funds do not pose a leverage risk in themselves, many may find themselves in a less favorable position when a funds' derivatives and securities positions, as well as netting assumptions, are taken into account. To that end, the paper calls on the International Organization of Securities Commissions — a sister organization to FSB — to develop consistent measures for regulators to apply risk-based measures to asset managers. The paper also calls on regulators to collect leverage data on open-ended funds and for IOSCO to collect national and regional aggregate data to identify concentrations of risk.
The asset management industry has been the focus of U.S. regulators for some time. The U.S. Financial Stability Oversight Council — an interagency regulatory body tasked with identifying sources of systemic risk — launched an inquiry into the asset management industry in December 2014, and the Office of Financial Research and other agencies have likewise examined the industry's risks. FSOC's primary concerns have been similar to those outlined by the FSB — namely the risks posed by leverage and by the susceptibility of open-ended funds to runs during times of stress.
The Securities and Exchange Commission — which holds jurisdiction over must asset managers' activities — issued new liquidity and redemption rules in December.
Federal Reserve Gov. Daniel Tarullo has already voiced support for many of the kinds of policy recommendations outlined in the FSB paper. In a September 2015 speech in Paris, Tarullo said that despite the growth in the asset management sector, the leverage risks those funds pose is quite different than the risks posed by banks. Thus, he said, the industry's risks would likely be better addressed through prudential market regulation like liquidity and redemption rules than through higher capital buffers.
In response to the paper, Investment Company Institute President Paul Schott said some of the recommendations were helpful, but the group had concerns.
"We remain troubled that this report continues to perpetuate the FSB's flawed assumptions about liquidity risk management by open end funds, despite detailed economic analysis from ICI in the comment record that calls into question these assumptions," he said in a press release. "We remain concerned that the FSB states an intent to return to its prior work on methodologies to identify global systemically important financial institutions (G-SIFIs) outside of the banking and insurance sectors."