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Regulators Focus on Asset Management

January 14, 2015

In her first speech at One World Trade Center SEC Chair Mary Jo White chose as her subject the asset management industry, which she called “one of the agency’s most important responsibilities”. SEC staff is developing recommendations in three areas, data reporting, risks related to portfolio composition, and transition planning and stress testing.

Data reporting. The staff is developing recommendations aimed at modernizing and enhancing data reporting for both investment funds and investment advisers. Enhancements would be made in the reporting and disclosure of fund investments in derivatives, the liquidity and valuation of holdings, and securities lending practices. In addition, obtaining more data on separately managed accounts would better inform examination priorities and the assessment of the risks associated with those accounts.playfair2a

Risks related to portfolio composition. White has also asked the staff to consider whether broad risk management programs should be required for mutual funds and exchange-traded funds to address the risks related to their liquidity and derivatives use, as well as measures to ensure the Commission’s comprehensive oversight of those programs.  The staff is reviewing options for specific requirements, such as updated liquidity standards, disclosures of liquidity risks, or measures to appropriately limit the leverage created by a fund’s use of derivatives.

Transition planning and stress testing. Thirdly, the staff is developing a recommendation that would require investment advisers to create transition plans to prepare for a major disruption in their business. As part of that process, the staff is also considering ways to implement the new requirements for annual stress testing by large investment advisers and large funds, as required by the Dodd-Frank Act.

One week after White’s speech, the Financial Stability Oversight Council requested comment on the potential risks to U.S. financial stability posed by asset management products and activities. The Council is seeking comment on risks related to liquidity and redemptions, leverage, operational functions, and resolution in the asset management industry.

Liquidity and redemption. The Council is exploring whether investments through pooled investment vehicles that provide redemption rights, as well as their management of liquidity risks and redemptions, could potentially influence investor behavior in a way that could affect U.S. financial stability differently than direct investment. In particular, the FSOC is interested in exploring the ways in which investors in some pooled investment vehicles could have greater incentives to redeem than if they were to sell a direct investment in the financial assets comprising the vehicle’s portfolio. This incentive to redeem from pooled investment vehicles may be magnified for vehicles invested in less-liquid asset classes. The Council also is interested in redemption incentives associated with pooled investment vehicles in which lenders reinvest cash collateral received to secure a loan of securities.

Leverage. The FSOC is interested in the extent and full variety of ways that private funds and separately managed accounts obtain leverage. While the Council recognizes that registered funds are generally limited in their use of leverage, it is nonetheless interested in the nature and extent of leverage obtained by registered funds, including through the use of derivatives. The Council is interested in better understanding whether and how derivatives are used by various types of investment vehicles to obtain leveraged market exposures, as opposed to hedging risks relating to other investment positions.

Operational Risk. The Council is particularly interested in the risks that may be associated with the transfer of significant levels of client accounts or assets from one asset manager to another and the risks that may arise when multiple asset managers rely on one or a limited number of third parties to provide important services, including, for example, asset pricing and valuation or portfolio risk management. With respect to transfers, the FSOC seeks information on market practices, processes, and systems employed by asset managers and other market participants (e.g., custodians and transfer agents); these entities’ operational capabilities to transition client accounts and assets between managers; and the effectiveness of such market practices, processes, and systems in times of idiosyncratic or market stress.

Resolution. The FSOC is exploring whether there are specific financial interconnections that could present risks if an asset manager, investment vehicle, or affiliate were to become insolvent, declare bankruptcy, or announce an intent to close and liquidate. The Council seeks information on whether there are any financial interconnections, such as transactions, investments, or loans across affiliated investment vehicles, between investment vehicles and an asset manager, or with third parties, that could complicate resolution in the asset management industry, particularly during a period of financial market stress. The Council also is interested in understanding the potential implications of the failure or liquidation of a private fund for financial stability. Information is also sought on whether there are any actions that market participants or counterparties to contracts could take that would adversely affect a resolution or give rise to liquidity concerns. The FSOC would like to explore whether there are issues that could make the resolution or liquidation of an asset manager or an investment vehicle with international operations more complex.

In issuing its request for comments the FSOC made clear that it has not made any determination regarding the existence or nature of any potential risks to U.S. financial stability discussed in the notice. And Treasury Secretary Lew stated that the “Council’s focus on the asset management industry is directed at assessing whether the structure or mechanics of certain asset management products or activities could create, amplify, or transmit risk more broadly in the financial system in ways that could affect U.S. financial stability.” View the text of Lew’s remarks here.

Reaction to the FSOC’s request has generally been positive. See, e.g., American Banker. And according to Reuters, the comments submitted to the FSOC could influence the SEC’s actions. Comments on the Council’s notice are due by February 23, 2015.





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