The asset management industry has grown exponentially in the past decade, for example, through an increased variety of fund structures and cross border distribution. Consequently, this means that vulnerabilities associated with asset management activities need to be monitored. Therefore, since its launch in March 2015, the Financial Stability Board (“FSB”) has been addressing these potential structural vulnerabilities and making public policy recommendations where necessary.
At the G20 nations on 21 June 2016, the FSB presented the authorities with their proposed policy recommendations to address structural vulnerabilities from Asset Management activities (the “Consultative Document”) which has been publically published for comments. Additionally, another important document that should be read in conjunction with the Consultative Document is the recently released statement of Priorities Regarding Data Gaps in the Asset Management Industry (the “Statement”) issued by the International Organisation of Securities Commissions (“IOSCO”). FSB and IOSCO are working together in tackling any structural vulnerabilities through their own remit: the FSB will produce the policy recommendations and IOSCO will put them into operation.
The FSB’s Consultative Document highlights the following four financial stability risks and their respective proposed policy recommendations:
1. Liquidity mismatch between fund investments and redemption terms and conditions for fund units:
- Authorities should consider system-wide stress testing e.g. to capture the effects of collective selling by funds and other institutional investors, resilience of financial markets and the system more generally.
- Authorities should also provide guidance and direction regarding an open-ended funds’ use of extraordinary liquidity risk management tools. IOSCO should review its existing guidance and enhance where appropriate.
- If an open-ended fund uses extraordinary liquidity risk management tools, authorities should provide regulatory requirements or guidance to ensure that the process of using such a tool is transparent to investors and authorities. IOSCO should review its existing guidance and enhance where appropriate.
- Authorities should require and/or provide guidance on stress testing and how it could be done at the level of individual open-ended funds to support liquidity risk management to mitigate financial stability risk. IOSCO should review its existing guidance and enhance where appropriate.
- Where first mover advantage may exist to an open-ended fund, the availability of liquidity risk management tools by authorities can reduce this. IOSCO should review its existing guidance and enhance where appropriate.
- To ensure redemptions are met even under stressed market conditions, authorities should reduce barriers and increase the availability of liquidity risk management tools to open-ended funds. IOSCO should review its existing guidelines and enhance where appropriate.
- Authorities should collect information on the liquidity profile and risks (from a financial stability perspective) of open ended funds in their jurisdiction along with reviewing and ensuring reporting requirements are adequate, sufficiently granular and frequent. IOSCO should review its existing guidance and enhance where appropriate.
- Authorities should review investor disclosure requirements and whether additional disclosures are necessary in proportion to the level of liquidity risk the open ended fund may pose.
- Liquidity mismatches can arise by virtue of the structure of an open ended fund. Therefore, authorities should create requirements and/or guidance to encourage consistency between the funds’ assets and investment strategies with the terms and conditions governing fund unit redemptions. IOSCO should review its existing guidance and enhance where appropriate.
2. Leverage within investment funds:
- IOSCO should develop measures in relation to leverage in funds to enhance the authorities’ understanding of the risks related to it and encourage more meaningful monitoring of leverage with the ultimate goal of comparing such funds on a global level.
- Authorities should collect data and monitor the use of leverage by funds, in particular those without leverage limitations or which pose significant leverage-related risks to the financial system and consequently take action where appropriate.
- IOSCO should collect national/regional data on leverage across its member jurisdictions.
3. Operational risk and challenges in transferring investment mandates in stressed conditions:
- Authorities should have requirements or provide guidance for large and complex asset managers that may provide critical services to ensure they have risk management frameworks in place e.g. business continuity and transition plans to adequately protect and transfer clients’ accounts and investment mandates in stressed conditions
4. Securities lending activities of asset managers and funds:
- Where agent lenders/asset managers are carrying out securities lending activities, authorities should monitor the indemnifications they provide to clients. Subsequently, where material risk or regulatory arbitrage is identified which may adversely affect financial stability, authorities should verify and confirm with the agents that they are able to cover potential credit losses from the indemnifications provided to clients.
The aim of these recommendations is to provide both authorities and asset management firms with the information needed to effectively detect and address any identified risks they may have.
As mentioned under 2(iii) above, structural vulnerabilities can arise through the lack of information available and the FSB are relying on IOSCO to collect such data and, in other circumstance, review the guidance offered to their members. IOSCO’s statement focuses on the data gaps in the asset management industry and encourages its members to collect data in such a way that is conducive to improving identification of systemic risk. The data which IOSCO identified as a priority for firm’s to collect (to improve risk monitoring), cover the following areas:
- Data collection on open ended regulated Collective Investment Schemes (“CISs”): data collection of CISs required because securities regulators do not have a comprehensive understanding as to how these types of vehicles operate.
- Data collection on separately managed accounts: more data required in relation to the leverage and derivative exposure of these vehicles on a global scale.
- Data collection on alternative investment funds (“AIFs”): data relating to AIFs required to provide consistent definitions for fund metrics across jurisdictions.
The FSB aim to finalise their policy recommendations by the end of 2016 and they are welcoming any comments to their Consultative Document which should be submitted by 21 September 2016.
The full statement produced by IOSCO can be found here: https://www.iosco.org/library/pubdocs/pdf/IOSCOPD533.pdf.
The full Consultative Document including the 14 recommendations by the FSB can be found here: http://www.fsb.org/wp-content/uploads/FSB-Asset-Management-Consultative-Document.pdf
We would encourage all firms to respond to the Consultation Document so that the FSB and IOSCO can begin work together on creating appropriate policies to reduce the structural vulnerabilities present within the asset management sector.
Should you need any assistance with regards to the implementation of any of the policy recommendations which may be put into operation, Cleveland & Co, your external in house counsel, are here to help.
