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FSOC Requests Comments on Asset Management Industry

Last week the Financial Stability Oversight Council issued a notice requesting comments on systemic risks posed by products and activities in the asset management industry. Specifically, the notice poses questions in four areas: liquidity and redemptions, leverage, operational risk, and the resolution of an asset management industry entity. The notice asserts that risks to the broader financial system can arise even where measures are in place to protect market participants “because these measures may not fully take into account the effects of possible stress on other market participants, markets themselves, or the broader economy” and market risks can aggregate across market participants or surge during periods of stress on the markets or at a particular firm. The FSOC acknowledged that the SEC has undertaken initiatives to address some risks and noted that it will consider the impact of the initiatives in reducing systemic risk. SEC Chair Mary Jo White’s recent speech outlined these asset management initiatives.

The FSOC is seeking comment on the extent to which redemption rights and risks could influence investor behavior and in turn affect the stability of the financial system. “In particular, the Council is interested in exploring the ways in which investors in some pooled investment vehicles could have greater incentives to redeem than if they were to sell a direct investment in the financial assets comprising the vehicle’s portfolio.” Additionally, the FSOC is interested to what extent these redemption incentives may render “fire sales” more likely in portfolio assets, correlated assets, and in the broader market. The notice also requests comment on the risk that the requirement to repay cash collateral upon the termination of securities loans may trigger redemptions, and how pressure from investors preferences and competition may affect liquidity risk management practices.

The notice seeks comment on “ways in which the use of leverage by investment vehicles could increase the potential for forced asset sales, or expose lenders or other counterparties to losses or unanticipated market risks” such as where investment vehicles face margin or collateral calls.  The FSOC expressed particular interest in gaining information regarding the “extent and full variety of ways that private funds and SMAs (separately managed accounts) obtain leverage.”  Acknowledging the limitations of permissible leverage in registered funds, the FSOC nonetheless is “interested in the nature and extent of leverage obtained by registered funds, including through the use of derivatives. 

The notice also seeks comment on operational risk in the asset management industry, and in particular the risk associated with the transfer of client assets between asset managers and the potential concentration of risk where multiple asset managers rely on a small number of key service providers, including those that provide asset pricing information.  The notice specifically seeks comment on the “operational interconnections” “between the asset manager and the investment vehicles it manages, among investment vehicles managed by the same asset manager or affiliated managers, or between the asset manager and its affiliates,” and the extent to which asset management firms rely on shared personnel, technology, or services among affiliates.”  The notice also questions how asset managers rely on service providers and the impact should one of the service providers cease to offer the service or provide the service “in a seriously flawed manner.”

Lastly, the FSOC seeks comment on the effect of the broader financial system of the failure of an asset manager or investment vehicle even though the notice acknowledges that investment vehicles are separate legal entities from asset managers and the assets of the investment vehicles are not the assets of the asset manager. The notice poses questions regarding the interconnectedness of entities and the transmission of risk in times of financial stress, as well as the effect of international operations on these issues.