Why Too-Big-to-Fail Doesn't Fit for Funds: Global Regulator

WASHINGTION -- Bank-style oversight is a poor fit for the asset management industry and regulators should not overreach.

The explanation from the head of a global standards body on Monday as to why it backed away from imposing too-big-to-fail regulations on asset managers carried a warning to U.S. regulators contemplating a similar move.

"In the market space, it's not about prudential regulation -- it's about conduct supervision and enforcement. That's how you regulate markets," says Greg Medcraft, chairman of the International Organization of Securities Commissions.  

"We should not use tools developed for [the] banking and insurance space as our starting point," he adds. "Frankly, it's like creating a square peg for a round hole. It's got to be appropriate for use."

At their core, the banking and fund industries have very different risk profiles that call for different regulatory frameworks, Medcraft argues, saying that bank-style prudential regulation runs counter to the business model of the asset-management sector.

"The markets that we regulate are built on the idea of risk-taking," he says.

In the United States, a consortium of regulators dubbed the Financial Stability Oversight Council has been evaluating financial firms outside the banking industry for potential designation as systemically important financial institutions, a classification that would entail bank-like oversight from the Federal Reserve, a development that has drawn fierce opposition from many in the fund industry.

Fund leaders like BlackRock and Vanguard, along with the Investment Company Institute, the industry trade group, have argued that SIFI designation is a misguided approach for the industry, where regulated funds use little leverage and risk is concentrated on assets that aren't on the fund companies' balance sheets, unlike banks.

'TRAUMATIC EXPERIENCE'

As foreign regulators have been considering similar SIFI designations for asset managers, Medcraft warns that they may be overreaching, acting reflexively in response to the financial crisis that he contends had little to do with the fund industry.

"The international regulatory community I believe may have been too willing to draw conclusions about the nature and the scale of risks posed by market-based financing to financial stability," Medcraft says. "Given our traumatic experience in '07 and '08, that is not surprising, but there is a concern that the international regulatory community may have gone too far in seeing problems, and has underestimated the effectiveness of the existing tools to regulate market-based financing."

Medcraft says that his organization is now taking a step back from supporting SIFI status for institutions outside of the banking and insurance sectors, and embarking on a thoroughgoing review of the asset-management sector to gather data and evaluate how the industry manages risk and liquidity.

In the meantime, Medcraft says that IOSCO, a global standards-setting body, will shelve its work on evaluating the methodologies for designating non-bank, non-insurance entities as SIFIs.

"I'm firmly of the view that we should not look to find new and possibly inappropriate solutions before we understand what we're already using," he says.

He stresses that that review must be collaborative, saying that its success will hinge on working with industry to understand what tools asset managers have to guard against risks in times of stress, including leverage restrictions and redemption fees and gates. Moreover, Medcraft urges regulators to evaluate the authorities they currently have to oversee the fund sector through oversight and enforcement actions.

He also notes that the interests of regulators and the fund industry really should be aligned, that asset managers have a bedrock interest in preserving stability in the markets in which they operate.

"They don't want to blow themselves up, either. They want to run their businesses for the long-term," Medcraft says. "I'm not convinced that there is evidence that asset managers put financial stability at risk simply because they're large."

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