The asset management business dodged a bullet in late July when the Financial Stability Oversight Council decided not to regulate large fund firms the same way as big banks and industry experts are projecting that the industry will now be in the clear going forward.
The FSOC opted at its July 31 meeting to not include asset management companies as systematically important financial institutions when the topic was raised. The group, which is comprised of 15 federal and state regulators, has instead decided to focus their review on the asset management industry's risky products and activities rather than the fund companies themselves.
"I think there is definitely a huge sense of relief in the asset management industry," says Scott Burns, global director of research at Morningstar. "The industry had gotten as combative with regulators as I have ever seen them."
If asset managers were to face the same regulatory standards as "Too Big to Fail" banks it would mean the potential for big increases in operating expenses that would trickle down to other areas of the firms' businesses operations like marketing, distribution and technology. While the FSOC didn't formally rule out SIFI designations for asset managers at a future date, Burns calls the regulators'' action a major victory for the industry.
"Never say never but my experience with this is that is that these issues that get left open are a reason to conveniently walk away," says Burns,
Fidelity and BlackRock helped lead the lobbying effort for the asset management industry against the designation commonly referred to as SIFIs arguing that it has the potential to burden firms with extra costs and responsibilities due to the new supervision that would be required. The SIFI designation would have applied to funds with more than $100 billion in assets. This would currently affect 14 funds from Vanguard Group, Pimco, State Street Global Advisors, Capital Research & Management, TIAA-CREF, Fidelity and J.P. Morgan Chase.
"BlackRock supports efforts to promote transparent and stable markets, which we believe are in the best interests of all investors, and we are encouraged by FSOC's focus on assessing industry-wide products and activities," said Tara McDonnell, a spokeswoman for the New York-based asset manager in a prepared statement following the July 31 ruling.
BlackRock issued a whitepaper in April exploring the implications of increased financial regulation saying this focus is "misplaced" and that regulators would be better served addressing solutions for asset flows across all funds rather than targeting a small group of asset managers. The company also argued against screening asset managers by size pointing out in comments to the FSOC about the SIFI proposal that mutual funds regularly experience high volumes of redemptions with "little market impact" such as what occurred with bond funds last year.
"THE RIGHT DECISION"
Jeff Tjornehoj, head of Americas research at Lipper, says the FSOC action was "the right decision" and does not expect most asset managers to be impacted by the designation in the near future.
"It did not make good sense to generally compare asset managers to commercial banks, which have capital requirements to maintain solvency," says Tjornehoj. "Furthermore, mutual funds are liquidated fairly frequently-something that banks rarely do without a lot of attendant problems."
Tjornehoj says hedge fund managers could face the SIFI designation risk going forward but expects mutual funds and ETF providers to be safe.
"Some assets managers who make great use of leverage might find themselves back under the microscope as a 'nonbank SIFI' but otherwise I doubt that mutual fund managers and ETF sponsors will," says Tjornehoj. "Would the oversight only apply to large mutual funds? Or large firms? Or large asset classes? No good answers out there."
How much a SIFI designation would impact large fund companies is still unknown, but the American Action Forum estimated in a recent study that it would require asset managers to set aside 8% of capital from a fund's returns each year. A report issued by Vanguard this past spring emphasized that SIFI designation would "mark a destabilizing paradigm shift in the regulatory model that has governed the mutual fund industry for nearly 75 years" and would threaten the disruption of capital markets.
UNKNOWNS REMAIN
The Investment Company Institute has expressed concerns about the potential of the SIFI designation with Vanguard CEO William McNabb III speaking on behalf of the industry trade group before the U.S. House of Representatives Financial Services Committee about the issue. ICI spokesman Mike McNamee says despite the July 31 FSOC decision there are still many unanswered questions and they are "seeking more information and clarity from the FSOC."
John Cochrane, a professor of finance at the University of Chicago Booth School of Business, says asset managers being considered SIFIs would create immense challenges for the industry including increased costs from extra required paperwork and constantly being in the government's shadow. "It would add costs and add bureaucracy for them," says Cochrane, who is a senior fellow at the Hoover Institution and an adjunct scholar at the Cato Institute. "It would create a lot of uncertainties."
Cochrane adds that while the mutual fund industry can claim victory for now, uncertainty over what future regulations may come down the pike still may leave a cloud over asset managers and their daily operations.
"The ideas are still in the air and that is dangerous," says Cochrane on possible future asset management regulatory measures. "The industry is still probably on edge because bad ideas are still floating around Washington."
