A Bank of England executive warned FridayApril 4 of the risks the money management industry poses to financial stability, relating in particular to its size.
Andrew Haldane, executive director, financial stability, and member of the financial policy committee at the Bank of England, said in a speech at the London Business School on FridayApril 4 that the $87 trillion global industry poses risks to financial stability because of its growth, trends into more specialized asset classes and pro-cyclical nature.
According to a copy of his speech posted on the bank's website, Mr. Haldane highlighted the industry's move toward illiquid investments, such as high-yield bonds and emerging markets, whose growth, he said, has increased at an annual rate of about 40% per year since 2008.
“The shift toward illiquid assets heightens market risk for investors,” Mr. Haldane said. A move toward passive and tracking strategies also “increases the potential for investor herding and correlated market movements. Both potentially have implications for financial markets dynamics and systemic risk.”
Mr. Haldane said money managers cannot be compared with the banking industry, because they carry different risks — money managers, he said, do not take credit, market and liquidity risks on their portfolios. However, that does not mean they are not systemically important, he said.
“Distress at an asset manager may aggravate frictions in financial markets, in particular frictions in market liquidity,” Mr. Haldane said, according to the speech text. He cited the potential for an asset fire sale, which would drive down prices and might ripple into withdrawals or sales by investors or counterparties.
While these occurrences are not common, Mr. Haldane said, “Future liquidity pressures in financial markets, generated by asset management distress or wholesale portfolio reallocation, may be larger and more potent. In other words, black swan risk in asset management may be real and rising,” he said.
Mr. Haldane also highlighted the potential for money management “to amplify pro-cyclical swings in the financial system and wider economy. If so, it may contribute to the mispricing of risk with risk premia undergoing cycles of feast and famine.”
However, Mr. Haldane said money management also offers opportunity to the markets. “The industry is a key bridge between end-savers and end-borrowers, between the financial and real parts of the economy. As the banking system continues to derisk, strengthening that bridge could well strengthen both the financial system and wider economy.”