Hedge Funds Could Be Systemically Important Under FSB-IOSCO Guidelines

The Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) have published guidelines for determining non-bank non-insurer global systemically important financial institutions (NBNI G-SIFIs). These institutions include finance companies that provide loans, market intermediaries such as broker-dealers and investment funds such hedge funds.

In laying out the guidelines, the FSB and IOSCO largely made the same determinations as for other G-SIFIs, in that NBNI G-SIFIs are those that pose systemic risk in the event of failure due to significant exposures to other market participants and the negative impact of liquidation and discontinuation of services.

The specific categories for making these determinations are size, interconnectedness, substitutability, complexity and global activities. For example, with size, the threshold is set at $100 billion in balance sheet total assets for finance companies and market intermediaries in order to be considered NBNI G-SIFIs. For investment funds, the threshold is set at $100 billion in net assets under management, and specifically for hedge funds, another threshold will be set at a value between $400-600 billion in Gross Notional Exposure (GNE), so they could meet the size requirement based on either threshold. The other indicators include a variety of quantitative and qualitative assessments such as leverage ratios for determining interconnectedness and determining an institution’s substitutability by considering its market share.

Theses guidelines, however, are only to determine which institutions are NBNI G-SIFIs, but they do not determine how they should be regulated, which will come later. The FSB and IOSCO are accepting comments until April 7, 2014.

“[The] proposals are an essential first step towards addressing the risks to global financial stability and economic stability posed by the disorderly failure of financial institutions other than banks and insurers. They are integral to solving the problem of financial institutions that are too big to fail,” says Mark Carney, chairman of the FSB.

Greg Medcraft, chairman of the IOSCO Board and a member of the FSB Plenary, adds, “The development of assessment methodologies for identifying NBNI G-SIFIs is challenging as it needs to capture the wide range of business models and risk profiles in the non-bank non-insurer financial space while maintaining broad consistency with the overall SIFI framework. This public consultation will help us to better understand the market intermediaries and investment funds whose failure pose systemic risks. I look forward to industry views.”