Investment funds bigger than $100 billion are set to be designated as “systemically important” by global regulators.
The Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) last week published a consultation document detailing how they will assess the systemic importance of asset managers, investment funds, and other financial entities outside of banking and insurance.
“An individual investment fund could have the capacity under certain circumstances to exert downward pressure on the market prices of assets.”The regulators proposed a total assets threshold of $100 billion for “traditional” funds, while individual hedge funds would be deemed systemically important if they have more than $400 billion in total exposure, including long and short positions. Several other factors were proposed, including leverage, counterparty exposures, and the nature of a fund’s investors.
The consultation paper also looked at how a run on a fund could hurt the wider market in which it operates.
“An individual investment fund could have the capacity under certain circumstances to exert downward pressure on the market prices of assets,” the regulators wrote, “if their sales are large relative to the market and trading volumes of the particular asset.”
Illiquid markets, such as high yield bonds and emerging market debt, were particularly susceptible to the negative effects of forced selling, the FSB and IOSCO said.
Inviting feedback, the regulators said they “wish to explore particular situations where certain individual investment funds may play a significant role in a particular market segment and what impact that could have in the event of distress or forced liquidation, particularly during periods of broader market turbulence.”
However, respondents to the FSB’s initial consultation last year disagreed with the organization’s inclusion of fire sales as a risk to market stability.
Fixed income commentators told CIO in October that the shock departure of Bill Gross from PIMCO was unlikely to have a significant impact on bond markets, despite billions of dollars being withdrawn from PIMCO funds. Between the end of March 2014 and the end of February 2015, the group’s flagship PIMCO Total Return fund shrank from $232 billion to $125 billion.
Rating agency Moody’s said it expected a “limited number” of groups to be affected, including BlackRock and Fidelity. It said the proposed requirements “will result in lower risk, but will lower asset managers’ margin because of the cost associated with maintaining higher required capital and amplified risk assessment procedures.”
The inclusion of individual funds as systemically important would give asset management groups “incentives to limit any of their funds’ assets under management and leverage,” Moody’s added. It predicted more product innovation and, as a knock-on effect, “less revenue volatility and stronger business profiles.”
On asset management companies, the two regulators said assets under management measures may not take into account other risks to business models, such as securities lending activities, leverage ratios, and off-balance sheet activities. The paper proposed a threshold of $100 billion in balance sheet assets, and $1 trillion in total assets under management.
The full consultation paper is available on IOSCO’s website.
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