We're not Lehman 2.0, global fund managers tell Carney's FSB

[LONDON] The world's biggest investment managers, from BlackRock Inc to Vanguard Group Inc, have a simple message for Mark Carney, head of the Financial Stability Board: stop trying to regulate us like banks.

The firms are seeking to avoid the fate of lenders and insurers that were deemed systemically important in the wake of the 2008 financial crisis. The too-big-to-fail designation by the FSB led to higher capital and leverage requirements and tougher liquidity rules for banks led by HSBC Holdings Plc and JPMorgan Chase & Co.

The funds have challenged a proposal to create a similar list for investment funds and asset managers, arguing that they don't take risks on their own balance sheets in the same way as banks or face the same liquidity shocks, and that size isn't an accurate measure of the amount of risk they pose to the global financial system.

The FSB's proposal, made jointly with the International Organization of Securities Commissions, has "problems arising from the imposition of a framework originally designed for the banking industry on the investment fund industry," the International Capital Market Association, which represents buyers and sellers in the debt market, said in response to the FSB's plans.

Regulators have shifted their focus from bankers to fund managers because of "a huge wall of money moving into the capital markets from the banking system and regulators wanting to be sure that the markets and institutions are going to be sound in systemically stressed conditions," IOSCO Secretary General David Wright said in an April 23 interview.

Assets of the global fund management industry grew by 13 per cent in 2013 to US$146 trillion, according to data from TheCityUK, which promotes the City of London. As much as 80 per cent of all assets outside of the banking and insurance industries are in the hands of such finance companies, broker- dealers and investment funds, according to the FSB.

The FSB and IOSCO said in March that the failure of an asset manager could "cause or amplify significant disruption to the global financial system," putting the world's largest fund managers in line for tougher rules.

Firms across the buy-side spectrum insist that they shouldn't fall under the FSB's proposal.

BlackRock, the world's largest money manager, said asset managers "are not the source of systemic risk," and that "none of the transmission mechanisms or impact factors" in the FSB's proposal are applicable to them.

Vanguard Group Inc, the world's second-biggest money manager, said "mutual fund investors pose a low risk to financial stability due to their long-term investment perspective."

The Managed Funds Association, which counts Citadel LLC and Paulson & Co Inc among its members, said "the hedge fund industry, a small but important component in financial and capital markets, does not create systemic risk."

Fidelity Management & Research Co urged the FSB to drop its "irredeemably flawed" plan to identify too-big-to-fail investment funds and it called on US firms to reject the proposal.

The regulators' "destructive" proposal "would fail to reduce systemic risk, but it would harm funds, managers, investors and markets," Fidelity said.

Some regulators agree. "It's not the players that are systemic, generally, it's the markets that they operate in," Martin Wheatley, head of the UK's Financial Conduct Authority, told the Financial Times in an interview published on June 2.

"The question is, do you give yourself comfort about those markets by affecting a subset of the players that operate in those markets, or by putting controls and constraints around the markets themselves," Mr Wheatley said.

The FSB argued that size thresholds "will provide an initial filter" to determine which funds should be considered as systemically important, an approach that BlackRock said "will create 'false positives' and 'false negatives.'"

BlackRock said leverage was a more accurate indicator of risk, while the FCA said hedge funds can use debt to boost profits and "become large enough to suggest they could impact the wider financial system in certain situations."

In a survey of the hedge fund industry, the FCA said that the gross leverage of sampled firms rose to 67 times net asset value as of September 2014 from 64 times a year earlier. The survey covered US$418.6 billion of assets managed by 52 firms, including US$265 billion managed out of the UK.

The FSB included debt levels in its methodology for identifying systemically important firms because high leverage would "indicate that the impact of the firm's failure on the financial system could be significant."

Regulators are also concerned about funds' liquidity, fearing a "jam-up of the system," Tim Cameron at the Securities Industry and Financial Markets Association said by telephone.

"But as it pertains to liquidity, it's not a run- risk as history shows that fund-based investors do not run," he said.

Asset managers argue that they don't take risks on their own balance sheet like banks, "acting often much more in an agent role" on behalf of clients, according to ICMA.

The FSB-IOSCO consultation period on the proposed "assessment methodologies for identifying non-bank non-insurer global systemically important financial institutions" ended on May 29.

The regulators haven't yet specified what additional rules funds will face, and this "significant legal uncertainty" is "cause for concern among market participants," ICMA said.

In the meantime, investment funds are trying to "establish in people's minds that asset management is different, that problems with one asset manager doesn't create a spiral of problems, as happens with banks," said Michael Wainwright, a financial services lawyer at Dentons LLP.

BLOOMBERG