Broader SIFI designation has managers scrambling

A number of large, global money managers are at risk of increased costs and competitive disadvantage if current proposals by global regulators to categorize them as systemically important financial institutions come to fruition.

The managers, along with the associations that represent them, are busy preparing responses to the second iteration of a consultation paper by the Financial Stability Board and the International Organization of Securities Commissions, “Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions.”

The paper broadens the scope of one from January 2014, including adding the potential for money managers to be deemed systemically risky “whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity at the global level.” Those entities might be in need of additional regulation, scrutiny and potentially need to set aside capital to mitigate future problems.

“We understand where the FSB and IOSCO are coming from. As guardians of financial stability, they need to lock down risks,” said Angus Canvin, London-based senior adviser, regulatory affairs, at The Investment Association, which represents U.K. money managers with a collective £5 trillion ($7.5 trillion) of assets under management. “If there is a serious problem, there needs to be the effective management of any risks to financial stability.”

However, sources in the money management industry warned that categorization as a SIFI would be detrimental to a money manager's business, and ultimately would increase costs for clients.

“There are risks in the process itself,” Mr. Canvin said. “Being designated a SIFI can cut both ways because the manager would face a heightened regulatory and supervisory burden and costs, which are likely to be passed on, of course. That could potentially alter the competitive playing field adversely, even ahead of final laws coming in.”

Mr. Canvin said The Investment Association will address this issue in its response. “This competitive disadvantage could be significant, while it is far from clear that there would be any benefit from being a SIFI, unless funds or managers were leveraged borrowers in the same way as banks,” he added.

“It would clearly increase costs,” said one senior executive at a global money management firm, who asked not to be named. “We feel that asset managers, and in particular those who focus on highly regulated mutual or commingled funds, do not present any systemic risk. This entire effort is misplaced.”

Soo Shin-Kobberstad, vice president, senior analyst in London at Moody's Investors Service Inc., said managers already are subject to regulation and capital requirement compliance. “This additional designation, and how it would have a material financial impact (to those existing requirements) is really, at the moment, unknown. It appears that the FSB and IOSCO are attempting to identify entities globally — be they asset managers or investment funds — that have extensive interconnectedness to the global financial system. What is clear (is) that they intend to expand disclosure requirements, which will increase operational cost. But transparency is a good thing for investors and debtholders,” she added.

The latest consultation, published early this month, builds on the initial 2014 version, which attracted almost 50 public responses from across the global money management industry. Comments on the second version are due at the end of May, and a number of money managers declined to comment for this article prior to submitting their responses to the regulators.

However, sources said they are concerned in particular about a new addition to the paper. The original had questioned whether individual investment funds — money market funds, exchange-traded funds and private funds, including hedge funds and private equity funds — larger than a certain threshold of assets should be classified as SIFI. This paper adopts a dual approach.

According to the latest paper, a SIFI would cover a hedge fund or other private fund with $400 billion or more of gross notional exposure, or a traditional investment fund with $30 billion in net asset value and balance sheet financial leverage of three times that figure or $200 billion in gross assets under management.

For money managers, the FSB and IOSCO have specified that those with balance sheet total assets of $100 billion or more, and/or a money manager with net assets under management of $1 trillion or more, would fall under the regime.

There is an important difference to be noted between money management and banks, which would mean banking-style scrutiny is not necessary, said the money management executive. “Banks are large, levered institutions and take on tremendous amounts of risk on their balance sheets. They are principles. Asset managers are agents, with generally little to no leverage.” Further, he said, client assets are held with a custodian.

Rather, he said the FSB and IOSCO should be looking at “activities and products that could be potentially systemically risky, and that way we would capture the risk regardless of who is involved.”

A spokeswoman for BlackRock Inc. said: “We continue to believe the focus for assessing systemic risk should be on products and practices, including leverage, rather than a fund's size alone or an individual company's total assets under management.” She also noted the difference between acting as principles or counterparties and as agents, and said the firm intends to provide a full response to the consultation.

However, The Investment Association's Mr. Canvin and others said the second consultation did heed some responses from the money management industry.

The new paper states that its dual approach consists of “a refined methodology for investment funds with an increased focus on leverage, taking into account the comments noting that higher leverage implies greater interconnectedness through borrowing.”

“That is a fairly major improvement,” Mr. Canvin said.

Another improvement is the fact that the FSB and IOSCO appear to have listened to the industry when it comes to the potential classification of pension funds and sovereign wealth funds as SIFIs, sources said. “Based on (responses to the January 2014 paper) the FSB and IOSCO are considering excluding public financial institutions, sovereign wealth funds, and pension funds from the scope,” said the new paper.

The potential exemption for sovereign wealth funds is because “they are owned and fully guaranteed by a government,” and pension funds because “one rationale is that they pose low risk to global financial stability and the wider economy due to their long-term investment perspective,” the paper said. However, pension funds would potentially be caught up in the SIFI rules because of their contractual relationships with money managers or through their investments in qualifying funds, the paper said.

One aspect raised for further discussion by the paper is substitutability — effectively, shifting a business line, such as the management of a portfolio or contract, to one entity from another in the event of a failure.

The money management executive — in a veiled reference to the departure from Pacific Investment Management Co. last September of William H. Gross — pointed to the recent departure of “a flagship” person from a large money manager, and how there had been questions over whether there would be a significant effect on the financial markets, in particular bonds, because of an anticipated transfer of assets to other money management firms. “There was virtually no impact on the markets,” he said. “It is very common in the asset management industry for clients to change advisers with virtually no impact. When clients change managers, they don't generally change out of (an) asset allocation.”

“The ready substitutability of managers reduces their threat to financial stability,” Mr. Canvin said. n