Alternatives industry associations are warning the international financial stability watchdog to reconsider “potentially disruptive” policy recommendations aimed at nonbank sector leverage, warning that moving ahead with proposals actually is a risk to financial stability.
The Financial Stability Board’s latest consultation on leverage in nonbank financial intermediation, such as at hedge funds and other investment firms, proposes enhancements to the ability of authorities and market participants to identify, monitor and contain financial stability risks associated with leverage. The proposals also aim to ensure sufficient counterparty credit risk management by providers of leverage, and are designed to work out whether and how to address any inconsistencies in regulatory treatment, the FSB said in December.
However, the Alternative Investment Management Association said in a response published on Feb. 28 that a more balanced, evidence-based approach to assessing leverage risks is needed, and that the FSB should begin with “a smarter, streamlined data collection process and enhanced regulatory information sharing.”
In its consultation paper, the FSB cites a number of examples of leverage used by nonbank financial institutions playing a role in market stress, such as the March 2020 U.S. Treasury sell-off and the collapse of the Archegos family office in March 2021. “NBFI leverage played a significant role in some recent episodes of stress,” the paper said.
However, AIMA said these examples are “flawed” and “selective,” highlighting that hedge funds were not the primary drivers of market stress in the U.S. Treasury sell-off, where rather other nonleveraged market participants were larger sellers of the instruments; and that the issue with Archegos stemmed “from inadequate risk management” of the situation.
The FSB has proposed “a large set of potentially disruptive regulatory interventions without much detailed explanation of how they might be justified in relation to the actual risks posed or calibrated to avoid serious market and liquidity disruptions,” AIMA said in a news release accompanying its response.
“Hedge funds have a proven ability to manage leverage and risk, delivering strong returns — especially in market downturns,” said Jiri Krol, deputy CEO and global head of government affairs, in the release, adding that almost 20 years after the global financial crisis “and despite extensive regulation, policymakers continue to push scattered proposals instead of refining existing rules.”
In a separate response, the Managed Funds Association said the FSB has taken a “prescriptive approach” and warned the watchdog that “inappropriately regulating nonbank leverage jeopardizes financial stability.”
The MFA said that market participants differ in regulatory structure, risk profile and strategy, adding that “imposing prescriptive and arbitrary leverage regulations on alternative asset managers is unnecessary, and would lead to higher capital costs for businesses, inefficient capital allocation, and stunted economic growth.”
Rather, the current regulatory framework for alternatives managers “is well-developed and fit for purpose,” Bryan Corbett, president and CEO of the MFA, said in a news release accompanying the response.
“The responsible use of leverage by alternative asset managers, provided by highly regulated bank counterparties, supports financial markets by reducing portfolio risk and the cost of capital for businesses of all sizes,” he added.
