IAA, SIFMA: No Systemic Risk in Asset Management Industry
Message to the Financial Stability Oversight Council: There’s no systemic risk in the asset management industry and, even if there was, it is the SEC, not the FSOC, that should take the lead in identifying and addressing asset management risks.
That’s the core message one might take away after reading the March 25 comment letter and joint release issued by the Investment Adviser Association and the Securities Industry and Financial Markets Association in response to a December 18, 2014 FSOC notice for public comment on its evaluation of potential risk in the asset management industry.
The two industry associations said that "asset managers and the funds they manage do not present systemic risk," while also emphasizing that "the SEC and FSOC have distinct but complementary roles, and the SEC is already assessing issues raised in the FSOC notice." It is the SEC, they said, that "should lead further inquiries into these issues, and FSOC should fully evaluate the impact of any such measures taken by the SEC before taking any specific action of its own."
"The SEC, as the primary regulator of the asset management industry, has the responsibility and
expertise for assessing where potential new data, regulations or other tools are necessary," the two associations said. "In this context, FSOC has an important role but one that should be considered as supportive of the SEC, to serve as a forum for identifying and studying systemic risks."
The IAA and SIFMA called on FSOC "to pause" and allow the SEC, "as the primary regulator of the industry," to complete its own review and consider the cumulative impact of any new rules before taking action.
"Our hope is that the information we provided will be helpful to FSOC and that it will not take any further steps while the SEC proceeds to evaluate potential issues," said IAA president and chief executive officer Karen Barr. "What may happen, however, is that FSOC will analyze all the comments it received and then make determinations as to whether certain products or activities require further scrutiny."
"The comment letter reflects the feelings of virtually everyone in the asset management industry," said Wilmer Hale partner and former SEC Division of Investment Management associate director Matthew Chambers. "It seems that the ‘prudential’ regulators – meaning the banking regulators – are trying to assert jurisdiction over the securities and commodities markets, without good cause."
SEC commissioner Michael Piwowar made a similar point in a March 16 speech before the 2015 Mutual Funds and Investment Management Conference. "Despite incontrovertible evidence to the contrary, there is a continuing false narrative that one reason for the financial crisis was ‘the expansion of a largely unregulated ‘shadow banking system’ rivaling the traditional banking sector in size,’" he said. "Yet capital markets have always been about risk and, in the United States, where capital markets are subject to a comprehensive system of regulation overseen by the Commission and the Commodity Futures Trading Commission, capital market-based financing has dominated bank-based financing."
FSOC and its call for comments
Established after the financial crisis by the Dodd-Frank Act, FSOC sees its mission as providing "for the first time, comprehensive monitoring of the stability of our nation’s financial system," according to the organization’s web site. "The Council is charged with identifying risks to the financial stability of the United States; promoting market discipline; and responding to emerging risks to the stability of the United States’ financial system."
It was perhaps with this mission in mind that FSOC issued its notice calling for public comment on "whether asset management products and activities may pose potential risks to the U.S. financial system in the areas of liquidity and redemptions, leverage, operational functions, and resolution, or in other areas."
Mary Jo White, in a December 11, 2014 speech on asset management regulation (ACA Insight, 12/22/14), also lent her voice to the proper roles of the SEC and FSOC in this area. FSOC, she said, "is an important forum for studying and identifying systemic risks across different markets and market participants. The market perspective that the SEC brings is an essential component of FSOC’s efforts. And FSOC’s current review of the potential risks to the stability of U.S. financial system of asset managers is a complement to the work we are now undertaking."
Perhaps to address concerns about how it intends to carry out its mission, the FSOC, in its notice seeking comment, said that it "recognizes that the [SEC] is undertaking several initiatives that would apply to investment companies and investment advisers regulated by the SEC and may address some of the risks described in this notice. While the SEC’s initiatives are not specifically focused on financial stability, the [FSOC] intends to consider the impact these initiatives may have in reducing any risks to U.S. financial stability associated with the asset management industry."
Definitions, analysis and coordination
In addition to making clear the roles between the SEC and FSOC, the IAA and SIFMA also made the following points:
The FSOC must appropriately define and circumscribe the scope of its systemic-risk assessment. "To date, FSOC has not offered any significant data or analyses to suggest that the asset management industry presents systemic risks, and does not explain how the various hypothetical risks it describes could be converted into systemic risks," they said. "FSOC must recognize that investment funds and asset managers operate differently than other types of financial entities, and that their structural, operational and behavioral features effectively prevent them from being sources or amplifiers of systemic risk."
There should be better data analysis and coordination among regulators before moving forward. "Thorough data analysis and appropriate coordination among regulators are essential steps to the formation of any potential regulatory response," the associations said.
"It is imperative that policymakers recognize that the business structure of an asset manager and the funds they manage is fundamentally different from a commercial bank, does not present systemic risk, and as such should not be subject to SIFI (systemically important financial institution) designation, which would have a significant negative impact on investors and the capital markets," said Barr and
Timothy Cameron, managing director and head of SIFMA’s Asset Management Group, in their release.
Specific areas of focus
FSOC, in its notice, asked for comments in several specific areas in terms of how each might affect financial stability. Those areas are liquidity and redemptions, leverage, operational functions, and resolution. Here is a summary of how the IAA and SIFMA responded to each:
Liquidity and redemptions. Risks associated with liquidity and redemption in investment vehicles, such as mutual funds and closed-end funds, "do not pose a threat to financial stability" and "are effectively mitigated by regulation, fund structures and other market practices," they said in their release. Further, they noted that "regulatory intervention designed to address hypothetical systemic risk could harm individual investors saving for long-term goals like retirement, increase issuers’ cost of capital, negatively impact the diversity and resiliency of markets, and slow U.S. economic growth as a result."
Leverage. Noting that mutual funds, closed-end funds and other pooled investment vehicles "significantly limit their use of leverage to comply with statutory and self-imposed investment restrictions or deploy no leverage at all," the association warned that "a regulatory regime that channels investors into a more limited array of instruments or strategies could have deleterious effects on the industry as a whole, including lulling investors into a false sense of security, stifling innovation, and preventing investors from properly hedging or reducing risk."
Operational risk. The structures of products and services offered by asset management firms "minimize the risk of disruptions associated with operational risk, even under conditions of extreme market volatility," the associations said, noting that client assets are not held by asset managers, but by third-party custodians. In addition, there are a number of regulatory and market-driven measures in place to control operational risks.
Resolution. "There is not empirical evidence to support the premise that the resolution of investment funds or their managers could threaten the stability of the U.S. or, for that matter, the global financial markets," the association said. "Indeed, asset managers and funds routinely enter and exit the industry, and investors regularly reallocate their assets among strategies and products, and these actions do not lead to disorder."