Asset managers create vulnerabilities “that could pose, amplify, or transmit threats to financial stability,” according to the Treasury Department’s Office of Financial Research (OFR) in a September 2013 report.
The report, “Asset Management and Financial Stability” could have a significant impact on regulation of entities that oversee about $53 trillion in financial assets. The Financial Stability Oversight Council (FSOC) commissioned the report to help it determine whether and how it should impose prudential standards and supervision, as required by Section 113 of the Dodd-Frank Act. Translation: FSOC may want to designate asset managers as SIFIs (systemically important financial institutions).
The report concludes that the diversity of investment management activities create vulnerabilities that could have implications for financial stability if they are not properly managed and if accompanied by use of leverage, liquidity transformation or funding mismatches. The risks to the financial system, the report said, include risk taking in separate accounts and reinvestment of cash collateral from securities lending.
The report summarizes the nature and scope of investment management in the U.S., and cites four key factors that make the industry vulnerable to shocks:
“Reaching for yield” and herding behaviors;
Redemption risk in collective investment vehicles;
Leverage, which can amplify price movements and increase the potential for fire sales; and
Firms as sources of risk.
It also identifies the key channels through which shocks can be transmitted and the impact that fire sales may have on funds and asset management firms, and presents data that purportedly support its claims. The report does not focus specifically on money market funds, and does not does not address in detail the risks posed by hedge funds, private equity funds and other private funds.
The report states that there are gaps in the data that, if available, could help the FSOC to further its analysis. This data includes information related to separately managed accounts, privately-held asset management firms, use of repurchase agreements and the investment of cash collateral from securities lending.
The report states that the asset management industry, while highly competitive, is also highly concentrated, with the top five mutual fund complexes managing nearly half ($6.6 trillion) of mutual fund assets.
It appears that the report will set the stage for FSOC to expand its reach and justify SIFI designation of asset managers or funds themselves.