US Treasury Sees 'Systemic Risk' from Asset Managers

Leverage and herding behavior could pose serious risks to broader financial security, the US Treasury Department has warned.

(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.

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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.

Related content: $19 Trillion—the Size of the US Institutional Market in 2018Problems with Rules & RegulationsTwo Weeks in September

NZ Super’s Orr Joins KIA to Lead SWF Group

Adrian Orr has been elected as deputy chair of the International Forum of Sovereign Wealth Funds, whose members include ADIA, the Future Fund, and CIC.

(October 8, 2013) – New Zealand Superannuation Fund CEO Adrian Orr has been elected to the second-highest post in the International Forum of Sovereign Wealth Funds (IFSWF).

Orr will join Kuwait Investment Authority head Bader Al Sa’adin in leading the voluntary organization for the next two years. In 2015, Orr will take over the chairmanship from Al Sa’adin.

“Sovereign wealth funds have been a rapidly growing influence in the global financial landscape, in terms of their proliferation, assets under management and their stabilizing influence as long-term investors,” Orr said, adding that he is proud to serve in the deputy chair role.

The world’s leading sovereign wealth vehicles belong to the group, which was established during a meeting in Kuwait in 2009.

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New Zealand’s fund, at US$19 billion, is petite compared to many of its fellow IFSWF partners. Hailing from 24 nations, the group’s members include Australia’s Future Fund, the China Investment Corporation, Alberta Investment Management Company, Abu Dhabi Investment Authority, and Singapore’s two funds.

“The IFSWF is now establishing a permanent secretariat, having initially worked with the International Monetary Fund’s services,” Orr said. “It will be a privilege to serve on the board during these formative stages in the organization’s development.”

Last December, Orr accepted Sovereign Wealth Fund of the Year at aiCIO’s Innovation Awards dinner in New York City. He and his team had a blockbuster 2013 fiscal year, riding their whole-fund allocation approach to a 25.8% return.   

Orr has a background in development economics, and is active in the international asset-owner community. Despite the strong global participation in the IFSWF, he has plenty of work ahead of him.

A recent GeoEconimca study found that only six sovereign funds are in compliance with the Generally Accepted Principles and Practices that 26 of them have signed. A precursor to the IFSWF drafted these “Santiago Principles” in 2008, which detail standards of transparency, governance, and reporting.

New Zealand’s fund ranked second-highest in the study’s compliance ranking, trailing Norway’s Government Pension Fund Global.

Related Content: Power 100 profile of Adrian Orr

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