On April 18, 2016, the Financial Stability Oversight Council (“FSOC”) published its report, Update on Review of Asset Management Products and Activities (the “Review”). The Review is best understood in historical context.
- In July 2014, FSOC stepped backed from its previous, heavily criticized recommendations regarding asset managers, and directed its staff “to undertake a more focused analysis of industry-wide products and activities to assess potential risks associated with the asset management industry.”
- In December 2014, FSOC published a notice (available here) inviting public comment on whether certain asset management products and activities could pose potential risks to the U.S. financial system (the “Notice”). The Notice stated that as part of its ongoing evaluation of industry-wide products and activities associated with the asset management industry, FSOC was seeking comments on risks posed to U.S. financial stability in the following areas: (i) liquidity and redemptions, (ii) leverage, (iii) operational functions, and (iv) resolutions (i.e., failure of an asset manager, investment vehicle or affiliate).
The Review, which encapsulates the Notice and comments in response to the Notice, presents a status report on FSOC’s thoughts on “potential risks to financial stability that may arise from certain asset management products and activities.” Specifically, it provides the status of FSOC’s review of four topics in the Notice plus a new topic: potential risks arising from securities lending.
Liquidity and Redemption Risk. The Review recommends that robust liquidity risk management practices, especially for funds that invest in less-liquid assets, should be considered for mutual funds. The detailed recommendations include: creating clear regulatory guidelines regarding mutual funds’ abilities to hold very illiquid assets, enhancing mutual funds’ reporting and disclosure of their liquidity profiles and liquidity risk management practices, facilitating mutual funds’ use of tools to allocate redemption costs to investors redeeming their shares and requiring additional disclosure of funds’ external sources of financing (such as lines of credit and interfund lending) so that FSOC can assess the extent to which mutual funds could transmit liquidity strains to broader markets.
The Review notes that, in May 2015, the SEC proposed modernized and enhanced disclosure by mutual funds regarding their portfolios and, in September 2015, the SEC proposed rules for mutual funds and ETFs designed to enhance liquidity risk management, provide new disclosures regarding fund liquidity and allow funds to adopt swing pricing to pass on transaction costs to entering and exiting investors. The Review states that FSOC welcomes these SEC initiatives, and that FSOC intends to review and consider whether risks to financial stability remain after the SEC initiatives are implemented.
- Other Risk Topics. In respect of the four other areas of risk to financial stability that FSOC states may arise from asset management products and activities – leverage risk, operational risks, resolution/transition risk and securities lending risk – the Review cites insufficient data and incomplete analyses as the basis for FSOC’s refraining from making any recommendations on these four topics in the Review.
On the same day that FSOC published the Review, SEC Chair White published a statement regarding the Review. She stated that she supports FSOC’s publication of the Review. Chair White also cautioned that the Review “should not be read as indication of the direction that the SEC’s final asset management rules may take.”