Post-crisis, after global regulators had agreed a method for identifying which banks are “Globally Systemically Important Financial Institutions” (G-SIFIs), they turned their attention to investment managers and insurance companies. The ensuing debate about asset managers revealed two fundamental flaws. First, it is necessary to identify the existence and the sources of systemic risk before designing a methodology that encapsulates them. The International Organization of Securities Commissions’ (IOSCO) announcement in June last year re-focused the debate on the identification of risks and vulnerabilities.
The second, and it seems, ongoing flaw in the debate is that collective investment funds are the focus of most commentary and study, yet they represent only a small proportion of total assets under management. Moreover, the regulation of investment funds differs markedly as between institutional or private funds and widely-held retail funds, and between jurisdictions. Some regulators set detailed investment and liquidity risk management requirements, others do not or are only just putting such rules in place.
Little has officially been said since last June, but a number of announcements have recently been made. The Financial Stability Board’s (FSB) work program for 2016 includes the analysis and assessment of any structural vulnerabilities associated with asset management activities. It says this will cover liquidity mismatch and leverage in funds; operational risks in transferring investment mandates; and securities lending. The FSB will consult on its assessment of these vulnerabilities and the policy recommendations to address them. It will also work with IOSCO to finalize the G-SIFI assessment methodology for asset management.
IOSCO’s Securities Markets Risk Outlook 2016 notes that neither the IOSCO Risk Survey mentioned potential systemic risks stemming from the asset management industry, nor has the topic been flagged by experts in the Committee on Emerging Risks. However, it acknowledges that concerns have been raised about the interaction of asset management activity and less-liquid bond market segments, especially within open-ended investment funds offering frequent redemption, and is seeking more data and information to inform the debate. Meanwhile, it points to its 2015 report on liquidity management tools for funds.
The differences in policy-makers’ views is demonstrated by a Federal Reserve staff blog which questions the conventional wisdom that an open-ended floating net asset value (NAV) investment fund with no leverage could not experience a run and hence would never have to fire-sell assets. It states that the main reason a fund could be vulnerable to runs is that investors who redeem early have a first mover advantage – later redemptions will be subject to a falling NAV if the sale of illiquid assets drives down their price (making runs more likely in funds that invest in corporate bonds rather than sovereign debt). Moreover, the authors show that since 2009 bond funds have grown substantially and that investors have become more likely to redeem shares, and in larger amounts, for a given degree of fund underperformance.
Two immediate observations. First, the SEC is now introducing liquidity risk management requirements for US mutual funds, whereas UCITS and European alternative investment funds (AIFs) have been subject to such requirements and have has access to a range of liquidity management tools for some years. Second, IOSCO notes that jurisdictions have reported very few incidents over the past decade of funds having insufficient liquidity to meet redemptions, a period covering instants of sharp market corrections.
And so the debate continues. Meanwhile, firms can expect yet more requests from regulators for data and information as they seek to come to a common view.