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From Securities Regulation Daily, March 26, 2015

Industry urges FSOC caution in attacking potential asset management risks

By Amy Leisinger, J.D.

Several industry groups have submitted comments in response to the Financial Stability Oversight Council’s (FSOC) request for comment on whether asset management products and activities pose potential risks to the stability of the U.S. financial system in connection with liquidity and redemptions, leverage, operational functions, and resolution. While generally supporting FSOC’s mission to identify and mitigate systemic risk, the groups urge the council not to make any hasty decisions that may impede the work of the SEC or inappropriately increase the burdens imposed on already intensively regulated funds or, indirectly, on investors.

FSOC notice. In its notice seeking comment on aspects of the asset management industry, FSOC recognized that risk is inherent in capital markets but noted that more information is necessary to thoroughly assess whether asset management products or activities could create, amplify, or transmit risk more broadly in the financial system. The council asked whether investments through pooled investment vehicles involving redemption rights could influence investor behavior in a way that could affect financial stability in a different manner than direct investments and whether the structure of these vehicles fosters a “first-mover advantage” and how redemption rights and liquidity-management practices may affect investor incentives or increase the probability of fire sales. These vehicles employ a variety of techniques to manage liquidity risks, and FSOC is interested in the effectiveness of these measures during periods of overall market stress and potential means by which to mitigate risks to financial stability.

Noting that high degrees of leverage can pose risks to investment vehicles by magnifying the potential impact of changes in asset price or rates, FSOC requested information as to how different types of investment vehicles obtain and use leverage and derivatives, as well as the degree to which leverage use may increase the potential for forced asset sales and expose lenders and other counterparties to losses or unanticipated risks. As to operational risk, FSOC sought input on the potential risks associated with significant transfers of client accounts or assets and asks whether asset managers’ reliance on service providers for key functions could have a negative impact in the case of serious service disruptions, particularly in cases where multiple asset managers rely on a concentrated group of service providers. The council also requested comment on the extent to which closure of an entity could adversely affect the financial markets and the potential that financial interconnections that could affect or complicate a resolution.

SIFMA and IAA. In joint comments SIFMA’s Asset Management Group and the Investment Adviser Association (IAA) provide information suggesting that asset managers and funds do not present systemic risk. Risks associated with liquidity, redemptions, and leverage in and by investment vehicles do not pose a threat to financial stability, as these risks are already mitigated by funds’ self-imposed restrictions and SEC regulations, according to the associations. Further, asset managers already structure their product and service offerings in a way to minimize the risks of disruption, and limiting instrument types or investment strategies could hamper innovation and ultimately create a false sense of security for investors. Asset managers and funds operate differently than other types of financial entities, according to the associations, and FSOC has not offered significant evidence suggesting that they pose a threat. The associations recommend that FSOC defer to the SEC on further inquiries into these issues and allow the regulator to finish its own review of asset management before taking any action. Unnecessary rules targeting the asset management industry could increase capital costs, slow economic growth, and negatively affect investors on an individual level, they explained.

U.S. Chamber of Commerce. The U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness (CCMC) noted that FSOC should focus on market participants known to create risk and assess the collective impact pre- and post-financial crisis regulations before placing new limitations on the financial industry, particularly asset managers and funds. Further study of the effect of these rules on economic growth and financial stability is necessary to ensure that they are working as intended. CCMC recommends that FSOC assess the effectiveness of the extensive regulatory operational protections and limitations already in place for asset managers and mutual funds and quantify the nature, historical evidence, probability, and potential harm of a particular risk or event before making a determination. Asset managers and funds do not pose a general systemic risk, the center concludes, and, before acting, FSOC should conduct economic analyses to ensure that “the regulatory medicine is not more harmful than the market concern being treated.”

FSR. In its comments, the Financial Services Roundtable (FSR) urged FSOC to collaborate with other member agencies with authority over the asset management industry to identify issues that could pose risks to U.S. financial stability and to refrain from immediate action in light of ongoing SEC asset management oversight initiatives. Further, the FSR stated that FSOC must take measures to fully understand the scope and role of the asset managers and funds to avoid making decisions that could interfere with access to affordable investment products and services for retail investors. The costs of new regulatory burdens would likely be passed on to investors, and “errors in judgment could have real (negative) impacts on financial security for millions of Americans,” the group concluded.

Systemic Risk Council. Commending FSOC for its efforts to comprehensively review the asset management industry in terms of potential systemic risks, the Systemic Risk Council’s comments also encouraged FSOC to work closely with the SEC. Additional data and analysis is necessary to comprehensively assess the risks that may warrant additional liquidity, leverage, and redemption regulations for funds, and collaboration with regulators, including banking agencies, will facilitate understanding of interrelationships and aid in preventing regulatory arbitrage between the banking and managed funds sectors, the group concluded.

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