U.S. regulator flags asset management risks

On the issue of liquidity and redemption risks, the council call for: mutual funds to adopt robust liquidity risk management practices, particularly in stressed conditions by funds that invest in less-liquid assets; clear regulatory guidelines on the ability of mutual funds to hold assets with very limited liquidity; enhanced reporting and disclosures by mutual funds of their liquidity profiles and liquidity risk management practices; tools for mutual funds to allocate redemption costs more directly to investors who redeem shares; and additional public disclosure of the external sources of financing for mutual funds.

On the question of leverage, more data and analysis is needed to better assess these possible risks, the FSOC statement says. It recommends creating an interagency working group to perform that work, and assess whether there are potential risks to financial stability stemming from leverage. That group will report its findings to the council by the fourth quarter of 2016.

Timothy Massad, chairman of the U.S. Commodity Futures Trading Commission (CFTC), issued a statement welcoming the report, and addressing its work on leverage in particular. He called for improved data collection to help assess the possible systemic risk posed by fund leverage.

“The first challenge is the metrics we use to measure leverage. As the report notes, we do not yet have a good metric for leverage in this context. We have not yet “connected the dots” between the leverage metrics cited in the report and the amount of underlying risk that it represents,” Massad said.

“A first step is to work with and improve the data we are now collecting. This can also help us transition from an emphasis on collecting ‘historical’ data on past quarterly periods to something closer to ‘real-time’ analysis of exposures across cleared and uncleared positions. This will take time, and the process is ongoing, but I believe this is the type of work that is necessary to assess potential risk to our financial system,” he added.

The FSOC also recommends further analysis of operational risks in the industry, particularly firms’ outsourcing activities; and, further work to assess the risks posed by firms’ securities lending activities.

“The council was created to bring the financial regulatory community together to look across the entire system, ask tough questions, and address potential risks to financial stability before they materialize. Our analysis of asset management products and activities is a crucial piece of that work,” said U.S. Treasury Secretary, Jacob Lew, chair of the FSOC. “As financial markets evolve, the nature of potential risks shifts, and we need to be vigilant in monitoring and understanding these changes.”

Mary Jo White, chair of the U.S. Securities and Exchange Commission (SEC), also welcomed the report, noting that the SEC is working on regulatory reforms for the asset management industry, including enhanced reporting of data, liquidity risk management and use of leverage. She also said that the FSOC report “should not be read as an indication of the direction that the SEC’s final asset management rules may take.”

“This exercise has also highlighted for me other important issues not directly or solely within the SEC’s jurisdiction, some of which were raised by commenters on the Council’s request for public comment – including the interaction of asset managers with other financial institutions, the use of economic substitutes across the industry, and the behavior of market participants both before and after the financial crisis,” she added. “Careful examination of these and other issues by both FSOC and the relevant regulators is important for analyzing both risks to financial stability and the materiality and likelihood of such risks.”