Asset management firms should not be designated as systemically important financial institutions (SIFIs), according to Sean Tuffy, senior vice president and head of regulatory intelligence at Brown Brothers Harriman, and doing so could cause investors to move capital into the shadow banking sector.
In May, the U.S. Financial Stability Oversight Council (FSOC), which was established as part of the Dodd-Frank Act, held a conference with members of the asset management community to discuss whether the industry needs further regulation. At this point, the FSOC says that it is only trying to determine what, if any, risks exist in the industry and if any further action needs to be taken.
While other institutions such as banks and insurance companies have been labeled as systemically risky, Tuffy notes that asset management companies made it through the financial crisis without requiring bailouts such as the one provided to insurer AIG. “So we would argue that, hopefully, 2008-2009 was a once-in-a-generational event, so if asset managers are able to weather that, without requiring assistance or without defaulting in mass…we in the asset management community would like to see the inclusion that asset management isn’t systemically risky.”
Indeed, Tuffy says that the FSOC was more conciliatory in its tone at the meeting than it had been in the past and could even end up finding that no additional oversight is necessary once its review is complete, but he says it’s more likely they will find some course of action necessary.
Last fall, the Treasury’s Office of Financial Research (OFR) published a paper identifying several risks that the industry poses, such as managers herding into popular asset classes or securities regardless of size or liquidity, which could then magnify market volatility and distress during a market shock. The paper also highlights risks such as large-scale redemptions amplifying market shock, and funds being too levered such as through the use of derivatives and thus increasing the risk of fire sales.
On an international level, the Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO) have worked on determining the criteria for non-bank non-insurer global SIFIs and are expected to report their findings to the G20 in November, which could lead to large asset managers garnering that designation. While the FSB’s course of action is yet to be determined, Tuffy says that the FSOC is likely to see what happens at that level and then make a similar implementation on a national level.
However, a report published by Douglas Elliott, a fellow at think tank The Brookings Institution, says that many of the FSB/IOSCO criteria are not overly significant for asset managers, such as that individual fund sizes are significantly smaller than fund families, and generally speaking, asset management activities could easily be moved from one firm to another. “On the whole, ready substitutability in the industry argues against SIFI designation,” the report says.
Elliott also says that asset managers primarily transmit the risk of end-investors but do not add substantial risk themselves. For example, in regards to the OFR’s concern of redemption risk, he says, “It is true that there is an incentive to exit early in a crisis, in order to avoid the full impact of fire sales and overall worsening liquidity. However, this is just as true for those investing directly.”
“With the possible exception of money market funds, which are a complex topic, it seems unlikely to me that any U.S. asset managers currently deserve to be designated by FSOC as SIFIs,” he says in the report. “To be fair, it is impossible to be completely certain of this without more information than is publicly available now. However, even the largest asset managers do not appear to cross the threshold of systemic significance, given that the bulk of their activities are undertaken as agents.”
If the FSOC were to designate asset managers as SIFIs, both Elliott and Tuffy note that this could cause investors to move money out of traditional asset management vehicles and into less regulated areas.
If the FSOC finds “funds risky, it would require certain funds to require capital. That would certainly drive yields down, and it would probably drive investment down,” says Tuffy.
“There is sort of a cognitive dissonance,” he says. “If you look at U.S. policy, on one hand you have the Treasury and FSOC saying asset management has grown so much and is so big that it may pose systemic risk, but on the other hand, with the vehicles like the 401(k) plan, for example, it’s essentially government policy to encourage investors and long-term savers to use asset managers and mutual funds as a way to grow and protect their capital…It’s sort of a confusing situation.”
Overall, though, Tuffy says he is “cautiously optimistic” that there will be a middle ground between what the asset management industry would like to see happen and what the FSOC deems necessary for regulation. He makes the analogy to how the two sides of the money market reform debate have come much closer together than where they started a few years ago. “So I think there’s certainly reason to believe that even if the FSOC does feel they need to do something, that it won’t be a traumatic action; it will be a more incremental change.”
BBH's Tuffy Argues Against SIFI Designation for Asset Managers
Asset management firms should not be designated as systemically important financial institutions (SIFIs), according to Sean Tuffy, senior vice president and head of regulatory intelligence at Brown Brothers Harriman, and doing so could cause investors to move capital into the shadow banking sector.
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