The debate about systemic risk for asset managers and investment funds is showing signs of moving to a conclusion on some policy issues.
The European Central Bank (ECB), Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) have all issued further statements. The ECB paper continues to refer to “shadow banking” activity and asset management as a “less regulated” sector, but acknowledges that in many areas the UCITS Directive and AIFMD requirements go some way to addressing the issues. The FSB has proposed 14 recommendations, most of which concern liquidity management and leverage in open-ended funds and are already covered to a greater or lesser degree via existing rules or practice. IOSCO has set out its priorities regarding data gaps for open-ended funds, alternative funds and segregated accounts.
Within the European context, the debate reveals the ongoing tension between global institutions’ concern about the growth of assets under management in collective funds and the need for European economies to move away from bank-dominated funding to a more diversified funding model, one part of which is to encourage retail savers to move from cash to investment funds.
Putting aside the misnomer that the asset management industry is “less regulated” and unsubstantiated references to “herding” behavior by asset managers, the ECB comments positively that the sector has acted as an important buffer for the real economy as bank credit has contracted, that it bridges information gaps and that it widens the distribution of risk exposures. Imperfect liquidity transformation and leverage are cited as the main vulnerabilities of investment funds, which could amplify the effects of market shocks. The paper includes a number of interesting statistics, such as that in the traditional banking sector, assets are often 10-30 times the size of equity. Leverage is considerably lower in investment funds, with assets much less than twice the amount of equity, although this figure is a little understated as it does not take account of synthetic exposures via derivatives.
For open-ended funds, the FSB’s recommendations cover the collection of liquidity profile data, liquidity risk management tools, greater consistency between the underlying assets and the frequency of unit redemptions, and disclosures to investors. For any types of funds that use leverage, the recommendations cover the collection of data and the need for convergence around simple and consistent leverage measures. There is a recommendation on risk management frameworks for large, complex asset managers, including business continuity and transition plans. Also, the FSB recommends that authorities should monitor indemnifications provided by agent lenders and asset managers in relation to securities lending activities, although it notes that “a very limited number” of large asset managers engage in such activity. The FSB says it work will next focus on segregated accounts, but only after it has jointly revisited with IOSCO the scope of “NBNI G-SIFI” assessment methodologies.
The near-term impact for European asset and fund managers will come from IOSCO’s drive to widen and deepen collection of data by national regulators. For open-ended regulated funds, more data on derivatives, leverage, liquidity profiles and portfolio composition are sought. For segregated accounts, the dearth of data on leverage and derivative use is noted. For alternative funds, consistent definitions, particular for leverage, are a priority. The use of standardized identifiers is recommended, and regulators are asked to enhance their capacity for data processing and use.