More clarity is needed on why asset managers should be subjected to bank-like stress tests as the industry is at risk of overregulation, say industry experts.
The International Monetary Fund is the latest organisation to call for asset managers to be subject to stress tests, in a similar way to banks, in a bid to determine potential systemic risks arising from the funds business.
The Asset Management Industry and Financial Stability report from the IMF stated the growth of the asset management industry, the increasing number of products offered to investors and the less liquid markets in which funds are investing are all cause for concern.
The report says: “Although these risks are not fundamentally new, their relevance has risen with structural changes in the financial sectors of advanced economies. The relative importance of the asset management industry has grown, and banks have also retrenched from many market-making activities, contributing to a reduction in market liquidity.”
But law firm Ropes & Gray partner Monica Gogna says a lot of regulation has already been targeted at asset managers since the financial crisis.
She says: “Looking at the IMF comments, it is clear they acknowledge that asset management firms don’t pose the same potential systemic risk as banks, but at the same time they seem to have failed to take into account the fact there has been quite a bit of additional oversight applied to the industry and is happening in a number of different shapes and forms.”
Among the regulation that has been introduced is Mifid II, the money market reforms, and AIFMD.
Gogna argues before the IMF and industry looks at how any stress test would be implemented they should “think quite deeply” about whether it should be applied in principle.
Investment Association director of regulatory affairs Richard Metcalfe says it is unclear what the IMF is aiming to achieve with stress tests, particularly as the business of asset management is “fundamentally different” to banking.
“We’d like to know more about what they are setting up to achieve because there are aspects that may make sense … and we need to really work out what it is trying to identify and remedy and how. We need to get a better fix on what the issue is that we’re trying to address.”
In particular, the IMF says its analysis shows it is not just the largest asset managers or funds that potentially pose the most systemic risk, but instead the investment focus is a more important factor.
Among the potential issues identified by the IMF are incentive issues created by delegating asset management decisions to funds, and first-mover advantage on some funds, which can lead a run on assets, particularly for funds where investors can immediately redeem assets.
Some in the industry believe the IMF’s announcement is politically motivated, with the banks having seen a lot of scrutiny since the crisis and regulators wanting more focus on securities regulation.
In March the Bank of England called for asset managers, as well as insurers and clearing houses, to be subject to stress tests. Financial Policy Committee member Alex Brazier told the Treasury select committee the FPC’s work on stability should be extended beyond the banks. The US Securities and Exchange Commission also recently suggested asset management firms should face bank-style stress tests.
But Metcalfe says if any stress test is going to work there needs to be a global framework, the first step of which should be gathering data to identify if any problems exist.
He adds: “[That would be a] first step to a situation where this is not a solution looking for a problem, but where we are identifying patterns and giving some possibility of identifying problems.”