(October 8, 2013) — Asset management firms could pose and amplify “systemic risk” to the market and overall financial security, according to the Office of Financial Research (OFR).
In a 31-page document, the OFR of the US Treasury Department concluded that the asset management industry’s actions could create “vulnerabilities” that could have serious implications on financial stability.
The data and insights from the report will be used by the Financial Stability Oversight Council to label non-bank “systemically important financial institutions (SIFI)” and implement stricter government regulations to their operations. AIG, Prudential Financial, and GE Capital were already named as SIFI earlier this year.
OFR cited multiple reasons for such categorizations of management giants.
It stated that the industry that manages $53 trillion is highly competitive and concentrated. Top five mutual funds managed 49% of total US mutual fund assets, and 10 management firms have more than $1 trillion in global assets under management.
In addition to their sheer magnitude, asset management firms often “reach for yield,” purchasing riskier assets for higher returns, and adopt “herding” behaviors by flocking to similar assets at the same time, the study found. Such large pooled investments within a risky environment could contribute to asset price bubbles and market volatility.
The paper also cautioned the readers of a “redemption risk”: investors tend to empty a fund all at the same time in times of market duress, causing increasing illiquidity and fire sales.
“If a number of funds were invested in similar assets or correlated assets, market events affecting that strategy or set of assets may affect and cause heavier redemptions in a number of funds, and sales of assets from any of those funds could create contagion effects on the related funds, spreading and amplifying the shock and its market impacts,” the report said.
Use of leverage could also spur rippling effects throughout the markets, OFR said.
However, the report stated the riskiest of all was the intricate and complex links that tied together management firms, banks, insurance companies, and other financial companies.
“Instability at a single asset manager could increase risks across the funds that it manages or across markets through its combination of activities,” the report said. “Material distress at the firm level, or firm failure, could increase the likelihood and magnitude of redemptions from a firm’s managed assets, possibly aggravating market contagion or contributing to a broader loss of confidence in markets.”
Gaps in data add fuel to the fire.
According to OFR, top five firms manage over $5.5 trillion in separate accounts, funds that are not subject to government regulations.
“Supervisors today are unable to fully assess the nature or extent of any financial stability risks that could be amplified or transmitted by the activities of these accounts,” the report stated.
With heavier regulations on the line that could hinder their operations, asset managers are standing up against OFR’s accusations.
Federated Investors Inc. called the report “misleading,” “inaccurate,” and even “ridiculous” in a statement.
Vanguard told aiCIO that it expects to file a comment letter to the Securities & Exchange Commission before the deadline on November 1.
“Given the strength of the current regulatory scheme, the nature of our business as an asset manager (not an asset owner), and our enterprise-wide risk management functions, we do not believe that Vanguard and other highly regulated asset management firms pose systemic risk,” the firm said in a statement.
Read OFR’s full paper here.
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