Money managers are nervously watching to see whether a Financial Stability Oversight Council report sets the stage for further scrutiny and regulation.
The review, conducted by the Treasury Department's little-known Office of Financial Research, was designed to help regulators on the multiagency council gauge how much systemic risk could exist in the $53 trillion money management industry.
The report, acknowledging an incomplete picture of the asset management world, offered no conclusions but did identify factors that could make those money management firms vulnerable to financial shocks, including:
na reach for yield, driven by competition, performance fees and other factors that increase risks that might not be fully recognized by investors;
n”herding” or going after similar assets, particularly in less liquid assets, including exchange-traded funds of fixed-income securities or emerging market assets, or mutual funds of hedge fund and private equity managers using alternative strategies;
nredemption risk in mutual funds and similar vehicles, which “have little ability to impose restrictions to prevent heavy redemptions in times of stress.” The report noted that during the financial crisis, sophisticated investors tended to react more quickly to deteriorating market conditions and perceived liquidity shortfalls to the detriment of retail investors;
nleverage obtained through borrowing, derivatives, securities lending and repurchase agreements, that can increase the risk of fire sales; and
nfailure risk of the money manager itself, depending on its size, complexity and level of interaction among diverse investment strategies. “Instability at a single asset manager could increase risks across the funds that it manages or across markets,” the report stated, especially if firm managers “fail to understand or anticipate” the financial stability implications of those risks.
The report said there are data gaps that hinder regulators' ability to “fully analyze the nature and extent of financial stability risks relating to the asset management industry.” The biggest data gaps, the report said, come from a lack of transparency in separate accounts, “their counterparty and other risk exposures, and amounts of leverage” especially related to securities lending, and the repo market. While acknowledging the added expense of gathering such information, the report suggests regulators “could consider” the costs and benefits of additional reporting requirements for these less-understood practices.
Part of a broader effort to see which other financial firms are “systemically important financial institutions,” this latest review of asset managers was “to better inform (OFR's) analysis of whether — and how — to consider such firms for enhanced prudential standards and supervision,” the report said.