Asset managers dub FSOC's approach too bank-like

A growing drumbeat of criticism over the federal government's attempts to prevent a financial crisis in the asset management industry by applying bank-like rules appears to be having little effect.

The Financial Stability Oversight Council “is marching along, making its designations,” said Hester Peirce, a senior research fellow at the Mercatus Center at George Mason University, Arlington, Va. “I don't see anything to suggest that it won't, un-less you get a more aggressive stand” from the asset management industry, said Ms. Peirce, who served on the staff of the Senate Committee on Banking, Housing and Urban Affairs during the financial crisis and passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.

The Financial Stability Oversight Council was created by the Dodd-Frank Act and given broad authority to identify and monitor excessive risks to the U.S. financial system, and determine which firms are systemically important financial institutions.

An FSOC report issued in September by the Treasury Department's little-known Office of Financial Research was intended to help regulators on the multiagency council gauge the level of systemic risk in the $53 trillion money management industry, but the preliminary information and conclusions reached have asset managers worried that a little-understood FSOC process for considering systemic risk will lead to asset management firms being subjected to enhanced prudential standards and supervision by virtue of being labeled systemically important financial institutions.

“We have some fundamental questions about the purposes and potential uses of the report,” wrote Vanguard Group Chief Investment Officer Tim Buckley and principal John Hollyer, head of Vanguard's risk management group, in a Nov. 26 letter to the SEC, characterizing it as “incomplete and inaccurate in several respects.“

While they argue that any additional regulatory decisions should come from the SEC, they worry about why the OFR report was ordered. “We are deeply concerned that such a brief overview would or could be used by FSOC as a foundation for such a significant determination,” they wrote.

Part of the frustration of money management firms with the systemic risk designation process is a sense that the 10 voting members of the FSOC are approaching their task from the perspective of regulators more familiar with banking rules, and staffers drawn largely from the Department of Treasury and the Federal Reserve. FSOC members include the heads of the Treasury Department, the Federal Reserve, the Consumer Financial Protection Board, the Securities and Exchange Commission, the Federal Deposit Insurance Corp., the Commodity Futures Trading Commission, the Federal Housing Finance Agency and the National Credit Union Administration.

“If you're not a bank, you have no idea what you're arguing against,” said Thomas Vartanian, a partner in the Washington law office of Dechert LLP and a former banking regulator. “These are bank-like regulations.”

There is also a sense that FSOC officials are operating in a vacuum with little public insight or input. “It sort of bypasses the normal regulatory process,” said Alice Joe, executive director of the Chamber of Commerce's Center for Capital Markets Competitiveness. “There are many, many shortcomings in the report. It's obvious that they've used it more for political purposes. There is no doubt they are targeting asset managers.”

The report listed 20 of the largest money managers by assets under management. Topping the list is BlackRock Inc., which OFR officials note has widespread and diverse investment operations, including money market funds that are also getting more scrutiny from regulators. Also on the Top 20 list are Vanguard Group Inc., State Street Global Advisors, Fidelity Investments and Pacific Investment Management Co.

The report went on to say that the FSOC “could consider” additional reporting requirements, but acknowledged insufficient data to fully analyze the nature and extent of financial stability risks in the sector, with the biggest gaps in separate accounts, counterparty risks, and amounts of leverage, particularly related to securities lending and the repo market.

“The FSOC is likely concerned that some parts of asset management may constitute what they view as shadow banking,” said Douglas Elliott, an economics fellow at the Brookings Institution and a former investment banker. “In general, there is a very valid concern about shadow banking, but there has not been nearly enough good thinking about what that really is and how to regulate it appropriately. We do not want excessive or inappropriate regulation, but shadow banking is too important to ignore.”

Some asset managers are trying to help FSOC regulators gain a better understanding of their industry. One key distinction that comes up in meetings with regulators is how asset managers are different from investment banks when it comes to the potential for systemic risk.

In a Dec. 3 comment letter to the SEC, which created a feedback forum for the OFR report after the criticism, BlackRock Inc. Vice Chairwoman Barbara Novick wrote that the New York-based firm hopes to continue the dialogue, and encourages a public round table to show the diverse types of managers.

“Based on the questions we have been asked, it is apparent that there is a need to develop a better understanding of the term 'separate accounts,'" Ms. Novick wrote. “Asset managers generally do not invest for their own account, and therefore do not assume high levels of balance sheet risk.”

Another key distinction that she and other asset managers would like FSOC officials to keep in mind is that investors can and do move quickly if a particular asset manager faces distress.

The next FSOC meeting has not been scheduled yet, and there is no formal timeline for the next steps, said a Treasury spokeswoman who declined to be identified.

Kenneth Willman, chief legal officer for Russell Investments in Seattle, complained in a Nov. 7 letter to the SEC that the study “contains a number of unsupported conclusions and overly broad assertions, including mischaracterizations of the role of asset managers (and) exaggeration of the risks.” Russell is one of many firms and industry trade groups, including the Securities Industry and Financial Markets Association and the Chamber of Commerce's Center for Capital Markets Competitiveness, calling for the OFR study to be withdrawn before FSOC makes any recommendations for further regulation.

Improving the process for understanding how FSOC members assess the asset manager industry “would go a long way” to allaying the concerns, said Ms. Peirce, who added that members of Congress are starting to pay closer attention, in part due to complaints from constituents. “There is great concern in the House about how aggressive the FSOC is,” she said.

“But I don't know how you stop the train from moving forward. You can get traction but the FSOC has the power to designate (systemically important institutions), and they have every incentive to designate” to avoid another financial crisis in the making.