[LONDON] Stricter curbs are needed on the 10-trillion-euro asset management sector to control leverage and stop any heavy outflow of money rocking the financial system, the European Central Bank's vice-president said.
Monday's comments from Vitor Constancio mark the latest signal from regulators that the growing asset management sector will face far closer scrutiny in coming years, as risks shift from the banking sector to so-called shadow banking.
Constancio said the amount of leverage taken on by private equity and hedge funds should be kept under control as it has the potential to destabilise the European financial system.
"First, we need to develop a framework to better control the leverage of alternative investment funds in the European Union,"Constancio said in speech at Chatham House in London. "Given that the use of leverage by investment funds could create and amplify systemic risk, it is important that we ensure that leverage remains within acceptable limits."
A near doubling in assets held by funds in Europe, up from 5.4 trillion euros at the end of 2009 to 10.5 trillion in the first quarter of 2015, has global regulatory attention.
Policymakers are worried about potential instability if many investors pulled money out of these funds at the same time.
They fear this could spark forced selling of assets to raise funds for redemptions, particularly in secondary bond markets where liquidity is under more strain. "To address such risks, additional liquidity requirements, guided stress tests, minimum and time-varying load, and redemptions fees should be part of the macroprudential toolbox,"Constancio said.
The global Financial Stability Board, part of the Group of 20 economies (G20), is due to report in September on draft policy measures to tackle such issues.
Constancio said policymakers should have the power to change the level of margin and haircuts on derivatives and securities financing transactions, or how much cash must be posted to back a derivative against default and the amount of collateral required to back a loan of assets like shares.
While such measures have been introduced or are in the pipeline, none are so-called "time varying", Constancio said.
Time-varying would reinforce the general approach to margins and haircuts introduced so far by allowing regulators to intervene in boom times to raise them further to cool lending to asset managers and limit increases in leverage in the sector.