Advisors could need to recalibrate their portfolio strategies if federal authorities move to expand regulation of large mutual fund companies, a move that opponents say threatens to bleed value out of the fund industry and aims to solve a problem that doesn't exist.
In question is whether financial institutions such as asset managers like BlackRock and Fidelity should be designated as "systemically important," a regulatory classification that would entail bank-like oversight by the Federal Reserve, a scenario that critics say would have adverse effects on investors.
RESTRICT ASSET MANAGERS?
"Regulating asset managers like banks would limit consumers' investment opportunities," Paul Kupiec, resident scholar at the American Enterprise Institute, a conservative think tank, said recently at a conference on asset management regulation. "There's really no evidence that I know of that government regulators can really pick good investments, and yes, this is really kind of the power they're seeking. They want to restrict what asset managers can do. They want to direct investment in the economy at some level."
To date, the Financial Security Oversight Commission, a consortium of financial regulators formed by the Dodd-Frank Act, has only designated MetLife, AIG, General Electric Capital and Prudential Financial as nonbank systemically important financial institutions, or SIFIs.
However, the panel is currently considering whether to apply the SIFI classification to fund companies. In December, one day before announcing the designation of MetLife as a SIFI, FSOC put out a request for public comment on the "potential risks to U.S. financial stability from asset management products and activities," including liquidity and redemptions, leverage and firms' operations.
Brian Reid, chief economist at the Investment Company Institute, says that some of the concern over runs is misplaced, noting that aggregate inflows and outflows in the fund space, driven by individual investors with long-term positions, generally balance out.
"It's a relatively closed system," Reid says. "The investors are wanting to maintain their market exposure, they're wanting to stay in their investment profile that they've set up. They're usually doing this through a 401(k) or with the help of an advisor -- this money is not sort of racing by trillions of dollars and large percentages into cash or something like that. It just doesn't happen in that stock and bond fund space."
Established in response to the financial crisis of 2008, FSOC was chartered in order to guard against the domino-like effect that brought the economy to the brink of collapse as large institutions began to fail. In their consideration of nonbank SIFI status, regulators are looking at the systemic risk posed by individual firms, and determining whether additional obligations like capital requirements and fees to support the expanded government oversight are warranted.
Some investor advocates have welcomed that scrutiny, arguing that asset managers, particularly those working outside the traditional mutual fund space, should be held to higher liquidity requirements to guard against destabilizing redemption waves.
Marcus Stanley, policy director at the consumer-advocacy coalition Americans for Financial Reform, warns "the mismatch between promises of liquidity to investors and investments in complex and illiquid products could lead to what are effectively bank runs on asset managers or on funds."
Stanley stops short of endorsing SIFI designation for specific fund companies (though he doesn't rule it out), but as more money moves into the asset management space, he sees a direct connection between the health and integrity of large asset managers and the overall economy.
"Disruptions in asset markets are becoming ever-more important both to the solvency of safety net banks and to the supply of real economy credit," he says. "There's also a close relationship between micro-level investor protection and broader system stability, because financial panics tend to happen when you break promises to investors."
'2015 IS NOT 2008'
Investment companies counter that the fund industry is already highly regulated, and oversight has only tightened since the crisis.
Says Barbara Novick, vice chairman of BlackRock: "2015 is not 2008." She adds, "As policymakers, I would find it refreshing to both take credit for the work they've already done, and take responsibility for the implications of the work they've already done."
For instance, Novick credits federal authorities for taking steps to shore up the banking system, updating the rules for cash pools and extending oversight of managers of alternative investments, "so you know who to call in a crisis."
But she likens the feds' approach to financial regulation to the plight of a homeowner, where the house is forever a work in progress and there is always another project to be tackled.
"As they wind down looking at banks, there seems to be a need to look at something else. The something else is asset managers," Novick says, arguing that bank-like regulations administered by the Federal Reserve shouldn't apply to an industry whose liabilities are dwarfed by the banking sector.
"Asset managers are significantly different than banks," she says. "Asset managers manage other peoples' money. It's on their balance sheet, not on the asset managers'. And asset managers don't create exposures for taxpayers."
Novick appeals to regulators to consider the real risk that fund companies pose to the overall economy. Their investors, by definition, are a hugely varied group with different objectives, tax situations and appetites for risk, along with any number of other complicating factors that, taken together, argue against the potential for a mass liquidation event or any other situation where the owners of a particular asset class would move as a herd.
"There is no scenario I can think of where all of our clients would act in the same way, on the same day, to make the same investment decision," Novick says. "There's no commonality, so you can't assume everyone's going to stampede in this direction or in that direction at any moment in time."
Reid argues further that more stringent regulation of the sort that would come with the SIFI designation could perversely encourage the very type of herd mentality that it would seek to guard against.
"What I'd caution is that as we move forward in terms of regulatory ideas or proposals from policymakers is that we don't end up causing more herding going on by becoming highly prescriptive in the ways in which we indicate how funds must be managed -- that is, by having specific liquidity requirements and mandating how those liquidity requirements must look," he says. "That will cause these portfolios ... to become much more correlated and move in much greater lockstep with one another, particularly during periods of financial stress."
Kenneth Corbin is a Financial Planning contributing writer in Washington.
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