The Missouri-born SEC Chair Mary Jo White set out a raft of recommendations in December of last year in a bid to bring enhanced risk monitoring and regulatory safeguards to an asset management industry much-changed from years passed. This is a transformed American market that boasts more than $63trn in assets under management and one that has fast become a key contributor to the national and global economy.
Whereas in 1940 the industry was made up of only 51 firms, who managed and supervised $4bn in assets, the number of registered investment advisers today has crossed the 11,000 mark. Gone are the days when asset managers were left largely to their own devices, and regulators today are forced instead to recalibrate their programmes and more closely mirror the “facts on the ground”, as it was put by White at The New York Times DealBook Opportunities for Tomorrow Conference. Despite the costs of cranking up regulatory ties, the volume of assets under management cannot escape the attention of regulators.
[T]he regulatory overhaul gripping the financial services sector is about to make its mark on asset management, irrespective of the industry’s lobbying clout
The often-made assertion that asset managers must be more tightly controlled than they have been previously is an opinion that has – at least in part – been fuelled by fears of a looming financial crisis. Whereas the American housing market and banking industry were at fault for the last collapse, the influence of asset management in financial markets today has led some to believe that the market could play a decisive role in spawning another.
The issue is not necessarily isolated to American shores, and sources even at the Bank of England warned that the asset management industry could upset financial stability and exasperate boom-and-bust cycles. In a speech last year, Andy Haldane, BoE’s Chief Economist and Executive Director of Monetary Analysis and Statistics, said: “Asset management has at least the potential to amplify pro-cyclical swings in the financial system and wider economy.”
For further proof of these same concerns, the Financial Stability Board (FSB) flirted with the prospect of attaching a ‘systemically important financial institution’ (SIFI) sticker to fund managers, a distinction that would mean imposing much tighter restrictions on firms.
Facing opposition
However, a report by Douglas Elliott of the Brookings Institution warns against attaching a SIFI status so readily, and says that it would be “inappropriate and ineffective for asset managers to be viewed as responsible for actions that are essentially just the passing through of end-investor decisions.” Before any radical reforms are passed, authorities must first gain a deeper understanding of the systematic risks posed by asset management. There is an argument – and a valid one at that – that greater restrictions could push investor funds into areas where there are none, yet the dangers associated with the sector, as they’re regulated at present, are sorely under priced.
Calls for tighter regulations have not gone unnoticed by under-threat industry names, who claim that the focus should fall first on risky products and activities rather than the firms themselves. As a result, fresh capital and liquidity requirements put forward in recent years have been shouted down by firms such as BlackRock and Pacific Investment Management, who have succeeded in dousing calls for stronger ties on the industry.
Following months of sustained lobbying from senior industry figures, the Financial Stability Oversight Council (FSOR), at the mid-point of last year, turned tail on a decision to fix a SIFI label to asset management firms – a consideration that dated back to 2011. Insofar as the destabilising influence of asset management is short of major banks, the members agreed that the risks were not sufficient enough to merit a SIFI certificate. And the most compelling argument put forward by those opposed to the proposal was that firms were merely executing investment decisions on behalf of their clients, and that the process does not necessarily expose their balance sheets to risk. Unlike those in the banking sector, errors made by asset management firms seldom – if ever – ask that governments step in to redress any imbalance.
Regulation is protection
The industry’s proven ability to overturn certain regulatory proposals doesn’t mean, however, that firms are exempt from stricter oversight. In fact, a wave of new regulatory restrictions has been sweeping financial services for some time now, squeezing already marginal gains and testing firms’ ability to rethink now-unprofitable business models. True, the costs of compliance can be high and many asset managers believe regulation to be their biggest concern moving forwards, yet the value of these ties in boosting governance and transparency mustn’t be lost amid the debate.
“Asset managers need to analyse how new regulations will affect their businesses – the effects may range across their organisational structures, cultures, capital requirements, product development, investment strategies, marketing and distribution”, reads one PwC report, looking at the impact of regulation on the industry. “They need to think about how to adapt in order to grow profitably in a world where some business models might become outdated; where regulatory risk is rising; yet where financial regulation is leading to opportunities to launch new investment products and to access new markets.”
Many have been quick to overlook the importance of regulation in assessing the potential impact of out-and-out failure, and it is in this area above all else that regulators are looking to make progress. One proposal put forward by the FSB and the International Organisation of Securities Commission toys with the idea of compiling a list of leading asset management groups. The purpose of the system would be to identify firms whose collapse might bring significant disruptions to financial markets, comparable to the steps taken of late to prevent banks from becoming ‘too big to fail’.
Stress testing
Likewise, White’s speech in December brought to light some measures that could prove effective in accurately charting the risks associated with winding down. “[One] focus of our regulatory enhancements is on the impact on investors of a market stress event or when an investment adviser is no longer able to serve its clients. There are several risks associated with such events. For example, during an adviser’s dissolution or following the departure of key personnel, an adviser may face challenges in serving its clients’ needs while also swiftly transferring its asset management services to another firm”, she said. “Implementing this new mandate in asset management, while relatively novel, will help market participants and the Commission better understand the potential impact of stress events.”
The proposals ask that asset managers disclose practical details on how they plan to unwind their operations in the event of a crisis or major disruption, and share a certain likeness with post crisis requirements for banks. Stemming from a less-often-seen detail in the 2010 Dodd-Frank act that stipulates any firm managing over $10bn or more in assets must conduct regular checks, if passed, the measures should serve to reassure regulators that firms have the resources to weather any unexpected market shocks. And although similar measures have faced tough criticism in recent years, the growing number of assets under management means firms will find it harder than they historically have done to stop the proposals in their tracks.
Still, critics maintain that the stress test recommendations could inhibit the profit-making potential of even the biggest asset managers, namely by asking that funds hold more capital in volatile conditions. Some have even gone so far as to suggest that the bigger firms will suffer ahead of their smaller rivals, assuming that only those with assets above a certain threshold will be subjected to the checks.
The recommendations are still in the early stages of development and it could well take years before the proposal is introduced in any formal capacity. It’s still unclear whether the SEC will be able take away any firms’ ability to reward shareholders in the event of failure, as is the case with banks, or whether the consequences might take a different form.
What is clear though is that the regulatory overhaul gripping the financial services sector is about to make its mark on asset management, irrespective of the industry’s lobbying clout. Asset management, whether leading industry figures care to accept it or not, is now comparable to banking in terms of its influence on financial markets, and if it is to grow further still, it must accept the regulatory consequences that come with that growth
