FSB and IOSCO to Consider Standards for Treating Investment Funds and Asset Managers as Global Systemically Important Financial Institutions

by Dechert LLP

The Financial Stability Board (FSB), in consultation with the International Organization of Securities Commissions (IOSCO), issued “Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions: Proposed High-Level Framework and Specific Methodologies” (Assessment Report) on January 8, 2014. It was prepared at the request of the G20 Leaders, who asked for methodologies to identify systemically important non-bank non-insurer (NBNI) financial entities. This effort is parallel to, and likely to impact, the U.S. Financial Stability Oversight Council (FSOC), which is also considering the extent to which systemic prudential regulation should be applied to a larger group of non-bank financial companies.

Summary of the Assessment Report

The Assessment Report looks at the systemic risks that may be posed by finance companies, broker/dealers and asset managers. It identifies three channels where financial distress of an NBNI is most likely to be transmitted to other financial firms and markets so as to threaten global financial stability:

(i) the exposures of creditors, counterparties, investors, and other market participants to the NBNI;

(ii) the liquidation of assets by the NBNI financial entity, which could trigger a decrease in asset prices, significantly disrupt trading or funding in key financial markets, or cause significant losses or funding problems for other firms; and

(iii) the inability or unwillingness of the NBNI financial entity to provide a critical function or service relied upon by market participants or clients (e.g., borrowers), for which there are no ready substitutes.

To measure systemic stability threats, the basic set of impact factors the Assessment Report suggests are:

(i) Size – the importance of a single entity for the stability of the financial system is assumed to increase with the scale of financial activity that the entity undertakes.

(ii) Interconnectedness – systemic risk can arise through direct and indirect inter-linkages between entities within the financial system so that individual failure or distress can have repercussions throughout the financial system.

(iii) Substitutability – the systemic importance of a single financial entity is assumed to increase in cases where it is difficult for other entities in the system to provide the same or similar services in a particular business line or segment of the global market in the event of a failure.

(iv) Complexity – the systemic impact of a financial entity’s distress or failure is expected to be positively related to its overall complexity (i.e., its business, structural and operational complexity). The more complex a financial entity, the more difficult, costly and time-consuming it will be assumed that company’s resolution will be.

(v) Global activities (cross-jurisdictional activities) – the global impact from a financial entity’s distress or failure will be presumed to vary in line with its share of cross-border assets and liabilities. The greater the global reach of a financial entity, the more widespread the spill-over effects from its failure.

The quantitative information derived from these indicators may be supplemented with qualitative information incorporated through supervisory judgment. The Assessment Report states that a key challenge in assessing the global systemic importance of NBNI financial entities is the difficulty in obtaining appropriate and consistent data/information.

The Assessment Report sets forth thresholds for systemic significance. Based on a preliminary analysis of NBNI financial entities, the FSB, in consultation with IOSCO, decided to set the materiality threshold as follows:

(i) For finance companies and for market intermediaries (broker-dealers), the threshold is set at USD 100 billion in “balance sheet total assets” for determining the firms that will be assessed in detail by the relevant assessment methodology.

(ii) For investment funds, the threshold is set at USD 100 billion in net assets under management (AUM). Alternatively, the FSB and IOSCO are seeking comments on whether size should be evaluated by looking at a family of funds, an asset manager on a stand-alone basis or asset managers and their funds collectively.

(iii) In the case of hedge funds, an alternative threshold will be set at a value between USD 400-600 billion in Gross Notional Exposure (GNE).1 Hedge funds with either USD 100 billion (or more) in net AUM or a value set between USD 400-600 billion (or more) in GNE would be subject to an assessment by national authorities.

The Comment Period

The FSB and IOSCO have requested comments on the Assessment Report, which must be filed by April 7, 2014. Parties that may potentially be impacted by FSB and IOSCO actions and related FSOC actions should consider commenting.

Status of the U.S. Effort by FSOC

As noted, in the United States, the FSOC is engaged in an ongoing process of considering how asset managers and asset management entities should be evaluated for purposes of potential designation as systemically important financial institutions. As part of this process, the Department of the Treasury’s Office of Financial Research in October 2013 issued a report on Asset Management and Financial Stability, as to which the U.S. Securities and Exchange Commission requested comments. See Dechert OnPoint U.S. Office of Financial Research Issues Report on Asset Management


1.) GNE does not directly represent an amount of money (or value) that is at risk of loss. It is a referential figure used to calculate profits and losses. But it still represents a fairer appreciation, in the FSB’s view, than NAV of the economic or market exposure (i.e. market footprint) of a fund’s positions.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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