On January 12, 2017, the G-20's Financial Stability Board (FSB) issued 14 policy recommendations (the Recommendations) to address four "structural vulnerabilities" from asset management activities. The areas that the FSB identified are: (i) liquidity mismatch between fund investments and redemption terms and conditions for open-end funds; (ii) leverage within funds; (iii) operational risk and challenges at asset managers in stressed conditions; and (iv) securities lending activities of asset managers and funds.
The FSB's Recommendations are not binding but have historically proven influential. The FSB began assessing perceived systemic risks posed by asset managers in March 2015 and issued draft recommendations in June of last year. The fund industry strongly objected to those recommendations and the underlying premise that asset managers are a potential source of systemic risk. After receiving more than fifty comments on the draft recommendations, the FSB finalized the Recommendations. The FSB has left open the possibility of designating specific asset managers as globally systemically important financial institutions (i.e., "G-SIFIs") in the future.
The SEC recently finalized rules related to liquidity risk management and has either already proposed or is in the process of drafting other rules that also reflect the issues raised by the FSB. Some of the Recommendations will be operationalized by the International Organization of Securities Commissions, which has been asked to work on the liquidity recommendations by the end of 2017 and on leverage measures by the end of 2018.
The FSB's Recommendations, which focus primarily on liquidity mismatch and leverage, are as follows:
- Collect information on the liquidity profile of open-end funds in their jurisdictions proportionate to the risks they may pose from a financial stability perspective. They should review existing liquidity reporting requirements and enhance them as appropriate to ensure that they are adequate, and that required reporting is sufficiently granular and frequent.
- Review existing investor disclosure requirements and determine the degree to which additional disclosures should be provided by open-end funds to investors regarding fund liquidity risk, proportionate to the liquidity risks funds may pose from a financial stability perspective.
- Have requirements or guidance stating that funds' assets and investment strategies should be consistent with the terms and conditions governing redemptions both at fund inception and on an ongoing basis, taking into account the expected liquidity of the assets and investor behavior during normal and stressed market conditions.
- Reduce barriers to the use of liquidity risk management tools to increase the likelihood that redemptions are met even under stressed market conditions.
- Make available liquidity risk management tools to open-end funds to reduce first-mover advantage (including swing pricing, redemption fees and other anti-dilution methods).
- Require and/or provide guidance on stress testing at the level of individual open-end funds to support liquidity risk management to mitigate financial stability risk.
- Promote clear and transparent decision-making processes for open-end funds' use of exceptional liquidity risk management tools.
- Provide guidance on the use of exceptional liquidity risk management tools in stressed conditions, taking into account the costs and benefits of such action from a financial stability perspective.
- Give consideration to system-wide stress testing that could potentially capture effects of collective selling by funds and other investors on the resilience of financial markets and the financial system more generally.
As noted, the SEC has already taken steps to address many of these Recommendations, finalizing rules for increased liquidity and redemption-related disclosures, along with more granular reporting to the SEC, and rules mandating open-end funds to implement a liquidity risk management program and permitting the use of "swing pricing."
- Identify and/or develop consistent measures of leverage in funds to facilitate more meaningful monitoring of leverage for financial stability purposes, and help enable direct comparisons across funds and at a global level.
- Collect data on leverage in funds, monitor the use of leverage by funds not subject to leverage limits or which may pose significant leverage-related risks to the financial system, and take action when appropriate.
- Collect national/regional aggregated data on leverage across its member jurisdictions based on the consistent measures it develops.
- Have requirements or guidance for asset managers to develop comprehensive and robust risk management frameworks and practices, especially with regard to business continuity plans and transition plans, to enable orderly transfer of client accounts and investment mandates under stressed conditions.
The SEC has proposed rulemaking related to business continuity and transition plans for investment advisers, and the staff of the Division of Investment Management has issued guidance concerning business continuity planning for funds.
- Monitor indemnifications provided by agent lenders/asset managers to clients in relation to their securities lending activities to detect the development of material risks or regulatory arbitrage that may adversely affect financial stability.
The Recommendations are available at: http://www.fsb.org/wp-content/uploads/FSB-Policy-Recommendations-on-AssetManagement-Structural-Vulnerabilities.pdf.