Views on the integrity of global capital markets
07 December 2016

Asset Management Industry: Systemically Risky or Business as Usual?

Posted In: Systemic Risk

Despite ongoing pushback that the asset management industry does not present the same types of systemic risk implications as other financial market sectors do, the Financial Stability Board (FSB), an international body that monitors and makes recommendations about the global financial system, is looking at ways to address “structural vulnerabilities from asset management activities.”

FSB Considers Systemic Risks in Four Areas 

Despite recognizing that most open-end funds “have been generally resilient” and, with the exception of money market funds, “have not created financial stability concerns in recent periods of stress and heightened volatility,” the FSB has nonetheless renewed its interest in trying to address any related risks to global financial stability. In its recent Consultation, the FSB offers 14 recommendations in four areas to address potential structural vulnerabilities from asset management activities: (1) liquidity mismatch between fund investments and redemption terms and conditions for fund units, (2) leverage within funds, (3) operational risk and challenges in transferring investment mandates in stressed conditions, and (4) securities lending activities of asset managers and funds.

Continued Regulatory Attention on the Asset Management Industry 

The FSB’s latest foray into looking at the asset management industry for systemic risks follows similar attempts dating back years.

In 2013, the Financial Stability Oversight Council (FSOC) of the US Treasury directed its research arm —the Office of Financial Research — to explore whether asset management firms posed such systemic risks that they should be considered for “enhanced prudential standards.” Many industry experts and commentators resoundingly derided the FSOC’s assumptions, citing its apparent lack of understanding that how the asset management industry works — managers do not own the underlying assets, but instead serve as agents for client assets — is distinct from how the banking sector works. Nonetheless, in 2014, the FSOC followed up with another notice seeking comment on asset management products and activities, in which it highlighted areas perceived to be potential risks to US financial stability.  Then in 2015, the FSB published a “Consultation on Methodologies for Identifying Non-Bank Global Systemically Important Financial Institutions” in which it examined aspects of the asset management industry for its susceptibility to risks.

CFA Institute Speaks Out

CFA Institute has taken a consistent approach in responding to these calls to further regulate the asset management industry. It supports the monitoring of investment companies, asset management firms, and other entities for their systemic risk potential, while also urging recognition of characteristics that distinguish them from those central to the financial crisis of 2007–2008. We also have encouraged all parties to take into account the measures that have been implemented or proposed by regulators in response to the financial crisis to address perceived weaknesses before implementing additional regulations.

In particular, we believe that regulatory actions in the two primary markets (Europe and the United States) already address and mitigate concerns about runs, first redeemer advantage, and contagion related to money market funds as well as about investment fund practices. We also have noted the high degree of substitutability in the investment fund industry, whereby a pool of asset managers would be available to able to take over the management of client assets upon the dissolution of a fund or management company.

Given the nature of the asset management industry and the regulatory reforms implemented since 2008, the persistent regulatory attention to this area may seem puzzling. But given the magnitude of the global financial crisis, regulators may feel they need to leave no stone unturned.

 

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Photo Credit: ©Getty Images/wakila

 

About the Author(s)
Linda Rittenhouse, JD

Linda Rittenhouse, JD, is a director of capital markets policy at CFA Institute. She focuses primarily on issues related to investment products and investment regulation. Rittenhouse holds a JD degree.

1 thought on “Asset Management Industry: Systemically Risky or Business as Usual?”

  1. Stephen Campisi says:

    I applaud the CFA Institute for taking a reasoned approach to financial oversight without over-reaching. As you note, the types of risk that have been identified have been with us ever since we established tradable financial markets in the mid 1800’s – there are no new risks here. Each of these risks is the result of an investment opportunity that works to the benefit of investors who willingly participate in these financial markets.

    What can regulators do to help, without applying potentially harmful limits to the free markets? They can require honest disclosures and adequate transparency, so that investors can understand the risks they face as they make their own decisions. In this regard, illiquidity risk is probably the most misunderstood type of risk, and I welcome all efforts to shed light on this.

    But the great danger we face from over-regulation is the tendency for new rules to hamstring markets, creating new problems while making existing problems worse. We are just beginning to see that one of the effects of the Pension Protection Act (PPA) has been the decrease in both retirement plans and the number of workers covered by such plans. This is a significantly harmful unintended consequence of well-intentioned legislation, and the opposite of what this law hoped to accomplish. So, let’s not rush into passing additional laws that threaten to harm the investment markets themselves. Volatility and losses are a part of investing, and no amount of regulation will change this, despite the best intentions of regulators.

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