The Office of Financial Research study on “Asset Management and Financial Stability,” released Sept. 30, has generated a firestorm of protest from the money management community. The community is right to be disturbed.
The Financial Stability Oversight Council commissioned the study to examine potential threats to the stability of the financial system that might arise from the investment management industry and the $53 trillion in assets under its management.
The study appears to be a potential road map for further regulation of investment managers by designating some firms as “systemically important financial institutions.” Firms that receive non-bank SIFI designation could be subject to bank-like Federal Reserve supervision, but this study is too shallow to base any such regulatory action on.
The FSOC should examine the vital role the asset management industry plays in the financial system and its contribution to financial instability, but it must do so with more thorough research and a better understanding of the industry.
In a comment letter sent to the Securities and Exchange Commission, David Oestreicher, general counsel, T. Rowe Price Associates Inc., noted the study “is generally inconclusive due to its emphasis on anecdotal claims and a scarcity of supporting data.”
Paul Schott Stevens, president and CEO of the Investment Company Institute, in another comment letter, said by double counting and including overseas assets, the study exaggerates the size of the U.S. asset management industry by almost 50%. He also noted that while the study claimed government bond funds experienced outflows of $31 billion in 2008, ICI data showed net inflows of $7.4 billion.
Indeed, Mr. Schott declared the Office of Financial Research appears to have decided in advance “that asset managers pose risks to the financial system ... and then hypothesizes circumstances to support that conclusion.”
Money management firms were not the cause of the recent financial market crisis, and until an obvious role is established, additional regulations imposed on them would not prevent a future crisis and would divert regulatory resources from targeting other areas in greater need of more oversight. At the same time, additional regulation would increase costs unnecessarily to investment management clients and possibly harm investment performance and innovation.
The study failed to fully consider the differences between the asset management industry and commercial banking and insurance activities.
A relationship based on the amount of assets under management has no necessary connection to risk a money manager might pose. For example, a large part of the assets of some of the biggest investment management firms is in indexed and other passive funds. These strategies tend to be anchors of stability to the capital markets and the financial system, as they encourage long-term investing, in large part through their competitive returns compared with active portfolio management.
This indexing partially explains concentration in some assets in the industry. The study acknowledges the industry, while in some ways highly concentrated, is also highly competitive. The competitive nature of the business is a source of strength to mitigate risks.
The report acknowledges “the client retains direct and sole ownership of the assets under management, which are typically held at an independent custodian on behalf of the client.”
The custody of assets promotes a relatively easily transition from one money manager to another without necessarily disrupting portfolios, and encourages a focus on client performance and other objectives.
Institutional clients subject the asset management firms to due diligence scrutiny. They examine and monitor closely their risk management practices, compliance, organizational issues, compensation structures and other factors that could increase risk to the firm.
The study fails to explore the fiduciary relationship between investment management firms and clients. For pension funds and other institutional investors, money managers serve as fiduciaries, required to act in the best interests of clients and this serves to mitigate risks.
Aside from client due diligence and monitoring, the report understates the degree of regulation under which the money management industry already operates.
The OFR study is premature and lacks the comprehensiveness that oversight of financial stability demands. It should have sought comment from executives of the firms, as well as practitioners and academics. It should have reached out to provide a forum for public comment.
Instead, the SEC is soliciting public comment. The OFR should have coordinated its study with the SEC. Because the SEC regulates money managers and is one of the 10 voting member of FSOC, it should have been closely involved in the study.
As David Hirschmann, president and CEO, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce, notes in an Oct. 30 comment letter, “Investors have placed what the report estimates to be $53 trillion with asset managers, because they value the services and the wide range of investment options that asset managers offer. Investor action of that scale is also indicative of their comfort with the risk profiles of the industry. Unnecessarily impairing the activities and operations of asset managers will directly and substantially harm the interests of U.S. investors by limiting the availability of asset management options, increasing costs, and reducing competition and innovation.”
The FSOC should withdraw the study and begin an engagement with market participants, including investment managers and institutional asset owners, as well as the SEC and major exchanges to produce a deeper, more thorough, more balanced report.
To proceed with further regulation on the basis of this study would be to commit regulatory malpractice.