By Amy Leisinger, J.D.
The Investment Company Institute and SIFMA’s Asset Management Group have filed comments in response to the Financial Stability Board’s proposed recommendations regarding vulnerabilities in the asset management industry. Both organizations criticized the FSB’s lack of evidence to support the purported “threats” identified in the proposal and strongly suggest reevaluation of the solutions posed to address what they view as unsubstantiated regulatory and investor protection concerns.
FSB proposal. The FSB issued 14 proposed policy recommendations to address vulnerabilities from asset management activities that could present financial stability risks. According to the FSB, the main threats include, among others, liquidity mismatch, use of leverage, and operational risks. Specifically, to address potential mismatch between fund investments and redemption terms and conditions, the FSB recommended that authorities collect information on the liquidity profile of open-ended funds proportionate to the risks they may pose and review existing reporting and disclosure requirements, enhancing them as appropriate to ensure sufficient quality. In addition, according to the FSB, authorities should have rules in place or issue guidance stating that funds’ assets and strategies should be consistent with the terms and conditions governing redemptions and should broaden the availability of liquidity risk management tools to increase the likelihood that redemptions are met and to reduce first-mover advantage. Authorities should also consider requiring stress testing to support liquidity risk management and mitigate risk, the FSB stated.
Noting that funds’ use of leverage is another potentially important vulnerability in the asset management industry and that consistent and accessible data on leverage is lacking, the FSB recommended that the International Organization of Securities Commissions develop simple, consistent measures of fund leverage in funds and collect additional information on it to assist authorities in understanding and monitoring leverage risks. In addition, according to the FSB, to address operational risk in transferring investment mandates or client accounts, authorities should have requirements or guidance for large, complex asset managers to have comprehensive risk management frameworks and practices.
ICI comments. In its comments on the FSB’s consultation, the ICI suggested that the justifications underlying the recommendations suffer from flaws similar to those the organization cited in its response to the FSB’s recommendations on global systemically important financial institutions, particularly with regard to the FSB’s consideration of funds’ “liquidity mismatch.” The FSB makes assumptions about potential destabilizing effects from fund redemptions while discounting substantial evidence to the contrary. Moreover, the ICI stated, robust existing requirements are already in place to ensure sufficient liquidity to meet redemptions. According to the ICI, solutions are only necessary when there is strong evidence of a problem. The organization also objected to the FSB’s presumption that the use of “extraordinary” liquidity risk management tools could negatively affect other funds and cautioned that the suggestion that IOSCO develop a “simple and consistent” measure of leverage could fall short in accounting for actual risks.
The ICI did, however, offer support for reporting requirements to enhance regulatory oversight and to ensure sufficient liquidity information for investors so long as changes avoid imposing additional undue burdens on funds. As stress testing, the ICI recommended that any requirements and guidance be treated as “very different” from those applicable to banks and that testing only occur at an individual fund level in conjunction with other risk management tools. In response to the FSB’s concerns regarding transfers of investment mandates, the ICI noted that regulated funds and managers routinely exit the market with no systemic impact and present no real financial stability concerns.
According to the ICI, the FSB must consider more exacting analyses that involve clear definitions of each problem to be addressed and thorough examination of all relevant evidence. “Flawed processes can lead to bad policy outcomes which, in turn, may harm the economy, growth, markets, and real people’s financial wellbeing,” the ICI concluded.
SIFMA comments. In its comments on the proposed recommendations, SIFMA AMG echoed many of the ICI’s concerns. The organization highlighted aspects of the existing, “intricate” regulatory framework governing funds and their managers and noted that current rules and proposed initiatives address many of the FSB’s concerns, particularly with regard to leverage and operational risk. Using simple metrics to measure fund leverage would be inappropriate given the unique circumstances of individual funds, SIFMA stated, and there is no evidence to show that the funds have experienced problems in meeting redemption requests during periods of market stress. Further, when market exit is necessary, funds are able to do so without causing a threat to overall financial stability, according to SIFMA AMG. The group also noted the existence of a “conceptual problem” with stress testing a fund’s capital adequacy and suggested the FSB’s position demonstrates a misunderstanding of the differences between bank and mutual fund risk profiles.
IOSCO should coordinate securities regulators’ inquiries into liquidity challenges and take the lead in operationalizing any proposed changes, SIFMA AMG stated.