Are Asset Managers ‘Too Big to Fail’?

(May 20, 2014) — US financial regulators are considering adding asset management firms to the list of institutions that are “too big to fail,” much to managers’ chagrin.

The Financial Stability Oversight Council (FSOC), established by the 2010 Dodd-Frank reforms to monitor potential dangers to the US financial system, said it was in the process of deciding whether to designate certain asset managers the title of “systemically important financial institutions” (SIFI).

“It is entirely appropriate for the council to analyze all the major sectors of the financial system, including the asset management industry, to determine whether they pose any risks to US financial stability,” said Mary Miller, under secretary for domestic finance at the Treasury Department, in her opening remarks at the FSOC’s conference on Monday. “The council is working to determine what, if any, risks exist in the asset management industry, before we consider what, if any, action the council should take in this area.” 

Banks with more than $50 billion in assets already qualify as SIFIs by the regulator. So far, AIG, Prudential Financial, and GE Capital have been named systemically important. Recently, the council has been making moves to add asset managers to the list, an effort supported by a 31-page research document issued by the Treasury Department’s financial research division last year.

Qualifications for SIFI include the firm’s size and “interconnectedness,” leverage, off-balance sheet exposures, relationships with other financial institutions, and “any other factors the [FSOC] deems appropriate,” according to a legislative memo. 

The FSOC’s conference—with panels made up of academics and representatives from PIMCO, BlackRock, Citadel, AQR, Fidelity, and Loomis, Sayles & Company—opened the conversation to industry experts and practitioners. The discussion took up asset management firm structures, risk management systems, and various operational issues. 

Miller emphasized that the council had no “predetermined outcome” in mind coming into the talks. “It is possible that at the end of this comprehensive review, the council may choose to take no action,” she said. “However, if the council identifies risks posed by asset managers or their activities that pose a threat to financial stability, it has a number of policy options.”

Ken Griffin, CEO of Citadel, one of the largest hedge funds in the nations, said identifying certain asset managers as SIFIs would bring an end to specialization and the lower costs he said large managers can offer. The designation would also lead institutional investors to pull assets and bring them under their own control, he added. 

“I don’t see systemic risk in our asset managers,” Griffin said. “I see systemic risk in the megabanks around the world.”

Griffin was not alone in opposing the FSOC’s attempts at new regulations. One day after the conference at the US Treasury, the issue took hold on Capitol Hill at a hearing with the House Committee on Financial Services.

During the full committee hearing, titled “Examining the Dangers of the FSOC’s Designation Process and its Impact on the US Financial System,” Jeb Hensarling, chairman of the committee, and other House Republicans asked Congress to review the FSOC’s methods.

“I call on FSOC to cease and desist further SIFI designation until Congress can review the entire matter,” Hensarling said. “Insurance companies are heavily regulated at the state level, and asset managers operate with little leverage. And since they manage someone else’s funds, it is almost inconceivable that an asset manager’s failure could cause systemic risk.”

Instead, Hensarling said the FSOC should be more wary of Fannie Mae and Freddie Mac, “which lay at the epicenter of the financial crisis. They are not only a source of systemic risk—they are its very embodiment.”

The hearing also raised issues regarding a close collaboration of FSOC and the Financial Stability Board (FSB), an international body dedicated to “develop and promote the implementation of effective regulatory, supervisory, and other financial sector policies,” according to its website. The FSB is chaired by Mark Carney, the governor for the Bank of England.

“Americans should also be worried that FSOC seems take its directions from an international organization that meets secretly—the FSB,” Hensarling said. “Though the US is ‘represented’—and I use that word advisedly—on this international board by the Treasury Department, the Federal Reserve, and the Securities and Exchange Commission (SEC), neither Treasury nor the Fed nor the SEC has ever reported to Congress about its participation, nor have they ever asked for Congress’s approval to participate in this global organization.”

Since the FSB's issuance of a document outlining methodologies to identify SIFIs January this year, the international organization has faced almost an unanimous dissent from asset managers.

BlackRock responded to the proposal with suggestions of using leverage as an initial screen for excessive risk, instead of size. “We believe that ‘size’ is not an appropriate initial screen, as often the size of an investment fund is not indicative of risk, and the use of size is likely to identify funds that do not present risk while also overlooking funds that may,” the firm said in a statement. “Importantly, we also believe that many risks are not specific to one investment fund or one asset manager, but rather result from common practices undertaken across all market participants.”

Bond shop PIMCO said the FSB need to better characterize the risk profile and more accurately explain reasons for a SIFI designation. Both Vanguard and GE Capital said existing regulatory requirements for both insurers and asset managers already “serve to prevent such funds from being exposed to ‘forced sales’ and ‘runs’ on assets.”

However, FSOC’s Miller said the council would adhere to the standards listed in the Dodd-Frank Act, independent of any processes the FSB would use. “The council is the only authority that can designate an entity for Federal Reserve Board supervision and enhanced prudential standards,” she said.

According to a presentation by an SEC official at the FSOC’s meeting, there are 11,000 investment advisers registered with the SEC with $16.2 trillion in assets under management.

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