In testimony before the House Committee on Financial Services on November 18, 2015, Securities and Exchange Commission (SEC) Chair Mary Jo White announced that in addition to recent rule proposals concerning liquidity risk management and disclosure enhancements, the SEC is working on additional initiatives to fully address “the increasingly complex portfolio composition and operations of the asset management industry”.1

These include; new requirements to limit the leverage in the use of derivatives; transition plans to prepare for major disruptions in business; third party compliance reviews for registered investment advisors; and stress testing for large investment companies and advisors.2 On June 22, 2016, the Financial Stability Board (FSB) released a plan which in some cases goes beyond what the US regulators have proposed for bolstering the safety of the mutual-fund industry, which many regulators fear could be the spark for the next financial crisis. The plan outlines how regulators in the US, Europe and other wealthier countries should approach oversight of the $31 trillion mutual fund industry.3

Background

The twenty-four nation Basel-based Financial Stability Board, which includes leaders of the Federal Reserve and the Bank of England, recommended system-wide and individual stress testing of asset managers, as well as examining whether more disclosures should be made by mutual funds.4 The report also called for new rules restricting the ability of funds to hold harder to sell, illiquid assets. The tightening of regulations around mutual funds is also topping the priority lists of other regulators, including the International Monetary Fund (IMF). “Supervision of funds and asset managers is generally weak across jurisdictions,” said the IMF.5 Regulators lack uniform data on leverage used by hedge funds and mutual funds because reporting requirements vary widely by country.6 The FSB has called on a consortium of international securities regulators, including the SEC to develop a “simple and consistent measure” of leverage that would help governments compare risk levels across funds and across countries.7 Some of the largest asset managers have endorsed stress testing of mutual funds in a communication to the Financial Stability Oversight Council (FSOC). Some US fund managers were considered “systemically important non-banks” by the FSOC, which would subject them to oversight by the Fed, but there is still a debate as to whether this is a decision for the FSOC or the SEC.8

What this Means

“The proposed policy recommendations are designed to enhance the resilience of asset managers and funds to future stress in financial markets,”9 Federal Reserve Governor Danial Tarullo, who leads the FSB’s Standing Committee on Supervisory and Regulatory Cooperation, said in a statement accompanying the report. The FSB, while recommending stress tests, did not propose to designate certain asset managers as systemically important, a label which would mandate greater oversight. However, fund managers are playing an increasingly important role in bond trading and other securities markets, as banks have scaled back their participation as middlemen matching buyers and sellers. Assets under management globally have grown from $50 trillion in 2004 to $76 trillion in 2014, or 40% of global financial system assets.10 Sovereign Wealth Funds and Pension Funds, which between them may manage approximately $42 trillion in assets globally, were not included in the FSB’s recommendations because of a problem in data collection.11

Key Client Take-Aways

With the “systemically important” designation shelved companies have less to fear from the FSB’s proposals.12 Paul Schott Stevens, CEO for the Investment Company Institute, said, “We emphasize again that there is no empirical basis for the FSB to pursue a designation of regulated funds or their managers as global systemically important financial institutions.”13 Many assets managers are likely to welcome the proposal to introduce redemption fees, which would limit outflows in a crisis, while stress testing may be an extension of risk management practices they already carry out.14 Asset managers would likely push back at being required to hold more capital as a result of stress tests, and work to reduce the cost of any new rules. It could also be a challenge to agree on standardized ways to measure liquidity and leverage across complex portfolios. The Investment Company Institute responded warily, Paul Schott said, “Globally, regulated funds have decades of experience in successfully managing areas that the FSB now identifies as “structural vulnerabilities” – Liquidity management, leverage, operational risk and securities lending…”15

References

  1. “SEC Agenda for 2016: Tighten Rules on Leverage for Funds; Stress Testing and Third-Party Compliance Reviews for Advisers,” Morrison Foerster, The BD/IA Regulator, November 18, 2015. Access at: http://www.bdiaregulator.com/2015/11/sec-agenda-for-2016-tighten-rules-on-leverage-for-funds-stress-testing-and-third-party-compliance-reviews-for-advisers/
  2. Ibid
  3. “Global Regulators Push New Crisis-Prevention Arsenal, Oversight for Mutual Funds,” The Wall Street Journal, June 22, 2016. Access at: http://www.wsj.com/articles/global-regulators-push-new-crisis-prevention-arsenal-oversight-for-mutual-funds-1466611202
  4. Ibid
  5. “Regulators propose stress testing for mutual funds,” Workiva. Access at: https://www.workiva.com/blog/regulators-propose-stress-testing-mutual-funds
  6. “Global Regulators Push New Crisis-Prevention Arsenal, Oversight for Mutual Funds,” The Wall Street Journal, June 22, 2016. Access at: http://www.wsj.com/articles/global-regulators-push-new-crisis-prevention-arsenal-oversight-for-mutual-funds-1466611202
  7. Ibid
  8. “Regulators propose stress testing for mutual funds,” Workiva. Access at: https://www.workiva.com/blog/regulators-propose-stress-testing-mutual-funds
  9. “Global Regulators Push New Crisis-Prevention Arsenal, Oversight for Mutual Funds,” The Wall Street Journal, June 22, 2016. Access at: http://www.wsj.com/articles/global-regulators-push-new-crisis-prevention-arsenal-oversight-for-mutual-funds-1466611202
  10. “FSB proposes stress testing for asset managers,” Financial Times, June 22, 2016. Access at: https://next.ft.com/content/5b60ba04-387e-11e6-a780-b48ed7b6126f
  11. Ibid
  12. Ibid
  13. Ibid
  14. Ibid
  15. “Global Regulators Push New Crisis-Prevention Arsenal, Oversight for Mutual Funds,” The Wall Street Journal, June 22, 2016. Access at: http://www.wsj.com/articles/global-regulators-push-new-crisis-prevention-arsenal-oversight-for-mutual-funds-1466611202

Newsletter Author: Samantha Regan, Mairi Bryan

Newsletter Contact Person: Nghi Pham

Visit www.accenture.com/RegulatoryCompliance for latest insights on regulatory remediation and compliance transformation.

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