By Cady North, Senior Finance Analyst | Bloomberg Government
It’s possible that at least two asset managers, BlackRock Inc. and Fidelity Investments, could be designated as systemically important financial institutions by the Financial Stability Oversight Council sometime in the next 12 months. The potential regulatory standards that the designated institutions would have to meet, however, are far from clear.
It is unlikely that strict bank-like capital requirements would be imposed on these asset managers. The Senate recently set a precedent by passing a bill, S. 2270, that would give the Federal Reserve more flexibility in setting capital standards for insurance companies designated as SIFIs. Current and former House members, including Barney Frank, one of the authors of the Dodd-Frank law, have said that designating asset managers makes no sense.
Asset managers provide investment advice and offer money market funds, mutual funds, exchange-traded funds (ETFs), alternative investments and private funds to their institutional and retail clients. They are subject to reporting and examination requirements through the Securities and Exchange Commission.
The FSOC’s decision to consider designating asset managers as SIFIs has set off a multisided debate between Congress, the industry, and various regulators. If the asset managers aren’t designated, the FSOC could ask the SEC to write new rules. SEC commissioner Daniel Gallagher, meanwhile, has called the FSOC’s efforts a “power grab,” saying that asset managers do not pose systemic risks. Regulators will have several options to consider, and there are three areas of regulation that are probable, given the concerns that have been publicly raised:
In a September 2013 study, the Treasury Department’s Office of Financial Research (OFR) raised several issues with asset managers, including insufficient information on their involvement in “shadow banking” activities, such as derivatives trading, securities lending or repo market borrowing and lending. The OFR also complained about incomplete counterparty exposure data; that information could help determine how connected asset managers are with each other and with systemically important banks.
One fix would be requiring asset managers to provide periodic reports detailing their exposure to shadow banking markets and clearly defining the companies to which they are exposed across all asset classes. Private hedge funds and private equity funds, including those run by some of the largest asset managers, already have to do this on Form PF, which is filed with the SEC. These reports will also be required quarterly for SIFI banks once regulators finish writing the rules, and will shed light on banks’ exposures to asset managers.
The private sector is pushing for activities-based or product-based regulation rather than rules that apply to particular industries, companies or funds. BlackRock, for instance, sought new redemption requirements for certain types of funds to prevent runs. Vanguard Group Inc. wrote in a comment letter that “activities-based regulation offers the best form of protection against systemic risk.”
In addition to product-based rules for derivatives, regulators also have floated proposals to increase the safety of shadow banking products, such as:
- Imposing margin requirements on any party that uses short-term collateralized funding to finance its securities holdings.
- Creating capital surcharges on short-term funding such as repurchase agreements, known as repos, and other securities lending products.
- Modifying liquidity standards for repurchase agreements.
- Creating redemption limits and gates for money market mutual funds.
The OFR study raised concerns that some asset managers may be too leveraged, which could amplify investor losses during a crisis. The report did acknowledge that mutual funds are already limited in the amount of leverage they can take on. For instance, regulations require private funds to report the extent of leverage used, and mutual funds’ leverage from bank debt cannot exceed 33 percent of assets.
Exchange-traded funds, however, can take on leverage, and may not adequately disclose their strategy or exposures. BlackRock CEO Laurence D. Fink said in May that leveraged ETFs should carry a different label than other ETFs because they carry risks that could “blow up the industry.”
Hedge funds and private-equity funds can take on leverage, but they are required to report to the SEC how leverage is used.
Regulators could address concerns with leveraged ETFs by limiting the use of leverage or adding new reporting requirements to glean more information on the leverage used by asset managers.
The Fed has said it will tailor prudential standards to address the specific business models of SIFIs, but has shared very few details on what those regulations might look like. Even if asset managers aren’t designated as SIFIs because of opposition from the industry, the SEC and members of Congress, more regulations that affect the industry could be coming.
Regulators, including the Fed, have been adamant that more regulation is needed to prevent problems within the shadow banking system, especially repos and money market funds. The latter are being addressed through a multiyear initiative by the SEC to write new rules, while the former have yet to be addressed by the Fed.
The Fed also hasn’t finished writing the rules mandating counterparty credit exposure limits or quarterly reports — a feature that would provide valuable data on whether or not asset managers are systemically intertwined with the largest banks.
The FSOC could also recommend that the SEC create additional rules specific to asset managers that address leverage or redemption requirements. A separate global regulatory process through the International Organization of Securities Commissions (Iosco) and the Financial Stability Board may create fund-level rules for some of the largest international asset managers.
There is no clear timeline for action because the FSOC operates without a public involvement process. Even if asset managers are designated as SIFIs, it could take months longer for the Fed to write specific rules for them. It’s clear, however, that asset managers are under greater scrutiny and will spend more time complying with whatever rules and standards global and U.S. regulators impose.
(Cady North is a Senior Finance Policy Analyst with Bloomberg Government.)
To contact the analyst: Cady North in Washington at firstname.lastname@example.org To contact the director of government affairs research: Anthony Costello at email@example.com Editors: Loren Duggan, Jodie Morris