Asset management poses systemic risk: Haldane

“If these trends are even roughly right, asset management may not only have come of age – we may be about to enter the age of asset management,” he said.

Additionally, the composition of worldwide AUM is changing too, with allocations to more illiquid assets on the rise; and, conversely, an increase in passively-managed index products, away from actively-managed funds. And, at the same time, given the shift away from defined benefit pensions, these assets are increasingly under the control of retail investors who may be more skittish than traditional pension managers.

“These trends potentially have implications for financial markets dynamics and systemic risk – for example, greater illiquidity risk, correlated price movements and susceptibility to runs,” he said.

While large asset managers pose different risks from large banks, Haldane suggests that their sheer size means that, “stress at an asset manager could aggravate frictions in financial markets, for example through forced asset fire-sales.”

Asset managers could also “amplify pro-cyclical swings in the financial system and wider economy,” he said, citing a number of factors that could see the industry feed pro-cyclicality, including accounting rules, regulation, and practices, such as benchmarking, which could encourage firms to behave similarly, which, … may contribute to the mispricing of risk with risk premia undergoing cycles of feast and famine,” he warns.

The question for policymakers then, is what should be done about the risks posed by asset management. First, Haldane said that the Financial Stability Board (FSB) is looking at whether asset managers should be classified as systemically-important financial institutions; and, if so, how should that be determined. The FSB is due to issue a report on that later this year.

If asset managers are designated as systemically important, said Haldane that the measures used to deal with banks, such as capital requirements and leverage rules may not be appropriate. Rather, measures that focus on liquidity risk may be more suitable, he said.

Second, Haldane suggested that policymakers may have to devise macro-prudential policy tools to deal with pro-cyclical swings in risk premia. Traditionally, these tools have focused on bank capital, so this represents, “the next frontier for macro-prudential policy,” he said.

Finally, he pointed to various initiatives designed to encourage the financing of long-term investment. “If successful, the prize for regulators and asset managers is a big one,” said Haldane. “For regulators, it would enable non-bank investors to do more of the heavy lifting when financing the wider economy… For asset managers, it would have the potential to offer both duration and yield, thereby helping them meet the needs of end-investors.”

Haldane concluded with the observation that the role of banks in the financial system has been well studied, but that the asset management industry increasingly requires a similar level of attention. “Academics, practitioners and regulators have been studying banks, their behaviour and failure, for several centuries. Analysing and managing the behaviour of asset managers is, by contrast, a greenfield site,” he said. “The risks and opportunities asset management poses, while different, could be every bit as important. To avoid the pitfalls of the banks, this greenfield site will need to be cultivated carefully.”