Is asset management too big to fail? Global regulators have been wrestling with this question for the last three years. Since 2013, when the FSB (Financial Stability Board) first announced it was working to create a methodology to determine if asset managers are global systemically important financial institutions, it has published two consultations on the subject.
Both consultations, which focus on whether large asset managers or funds should be considered as systemically risky, were widely criticized by the asset management community. In short, the industry felt that the FSB’s approach was flawed because it was using a banking mindset to evaluate asset management. Critics of the FSB’s approach argue that funds and asset managers aren’t like banks because their business model is on an agency basis, meaning they simply invest money on behalf of their clients and rarely take principle positions.
Based on this feedback, the FSB has taken another bite at the apple and last month published its third consultation on the issue. There is a notable difference in the latest paper. This time the FSB did not focus on managers or funds, but rather asset management activities.
The FSB paper details fourteen policy recommendations designed to address four key areas of potential financial stability risks:
- Liquidity mismatch between fund investments and redemption terms and conditions for open-ended fund units
- Leverage within investment funds
- Operational risk and challenges in transferring investment mandates in stressed conditions
- Securities lending activities of asset managers and funds
Overall, this is a welcomed development for the industry as it removes the specter of a potential “too big to fail” label for either funds and/or managers. Broadly speaking, the suggested policy recommendations are in line with what national regulators were already working on. For example, the policy recommendations around liquidity mismatches are very similar to the SEC’s fund liquidity proposals from last year.
All told, this really should be seen as a victory for the asset management industry but it would be premature to declare mission accomplished just yet.
Once the FSB policy recommendations are finalized, the next phase in the debate will move to the national regulators, as they seek to implement the FSB’s finalized policy recommendations. This will likely result in multiple policy proposals from the US, European, and Asian regulators. As always, despite regulators’ best intentions, the local rules will almost certainly not be completely harmonized, forcing global asset managers to deal with different flavors of the FSB recommendations.
It’s important to remember that the FSB has no actual statutory authority to enact rules or policy. It can only make policy recommendations that can lead to inconsistencies like the FSB considering MetLife a SIFI while, pending the outcome of the court case, the US does not. This doesn’t preclude the possibility that a national regulator may decide that asset managers or funds are in fact, in and of themselves, systemically risky. Worryingly for the industry, this is just the conclusion that the ECB (European Central Bank) drew in a recent paper. In the paper the ECB argues that there’s a need for both an entity and activity level approach needed to address potential systemic risk of asset management.
So, the debate is probably far from over. Nonetheless, the change in direction from the FSB can really only be seen as a positive for the industry.