28 January 2014

IPE: Debate over systemic risk of asset management intensifies

The debate over whether the asset management industry poses systemic risk is heating up, after US lawmakers dismissed a report from the Office for Financial Research which warned that managers "herding" into asset classes, in search of yield, could push up prices and magnify volatility.

In September 2013, the research body released a report, 'Asset Management and Financial Stability', which highlighted four potential vulnerabilities to the US financial system. Its report said investment vehicles with unrestricted redemption rights also posed a threat, as did managers selling other assets to cover redemptions, leading to stress contagion in those assets. The report also highlighted what it considered to be excessive leverage in the industry.

Secretary to the US Treasury, a bi-partisan group of five Senators rejected the study. The letter said the study mischaracterised the industry and could damage the credibility of the OFR and FSOC. It also requested the FSOC not to base any policy or regulation on the contents of the study, which they said relied on faulty information in places.

Concerns over the asset management industry and what security measures – such as financial buffers – would mean have also been debated in Europe. Earlier this month, the Financial Stability Board (FSB), the international body set up after the 2009 G20 summit to monitor global financial systems, said it would consult with the industry regarding systemic risk. Its consultation focused of identifying which organisations were sufficiently large, complex and systemically connected to cause disruption to the wider system.

The FSB’s rationale is more towards looking at systemic risk at fund level, with the OFR’s paper more inclined towards asset managers. Tom Brown, partner in KPMG’s investment management practice, said: “Focusing on the funds seems sensible, as there is a principal/agent relationship between the fund and the manager, so the real economic exposure is at the fund level. It’s intellectually flawed focusing on the manager. If there is systemic risk, it lies with the fund.” He said potential outcomes could be limitations on counterparty risk, leverage and concentration, but he argued that this was still unclear and would depend on fund size.

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