A Financial Stability Oversight Council proposal that would regulate asset management firms in the same way large banks are regulated could have a major impact on fund company technology, operations and marketing.
The FSOC, which is comprised of 15 federal and state regulators, is weighing whether to place asset managers into the systematically important financial institutions category. This designation, commonly referred to as SIFIs, has the potential of bringing regulation to fund companies that in the aftermath of the 2008 financial crisis have applied to Too Big to Fail banks.
Scott Burns, global director of research at Morningstar, says the FSOC applying the same regulatory standards to asset managers as they do banks has the potential of leading to increased operating expenses that could impact other areas of an investment firm's business such as marketing and technology. The SIFI designation would also likely lead to firms needing to increase compliance staffers and database providers to assist with extra reporting requirements. "Any time you add these regulatory burdens you can expect costs to go up," says Burns. "This would create indirect costs."
While there are many unanswered questions on the cost impact if a SIFI designation is approved, the American Action Forum estimates in in a study released on May 15 that asset managers would need to set aside 8% of capital from a fund's returns each year. The FSOC designation would apply to funds with more than $100 billion in assets, which currently impact 14 from Vanguard Group, Pimco, State Street Global Advisors, Capital Research & Management, TIAA-CREF, Fidelity and J.P. Morgan Chase.
Sean Tuffy, senior vice president and head of regulatory intelligence at Brown Brothers Harriman, says asset managers he has been in contact with are concerned about the uncertainty surrounding the FSOC proposal. Whether the potential 8% capital rule would apply to asset management companies or individual funds will make a difference on the force of impact, but he says either way there would be an effect on budgeting.
"If the 8% capital caps comes in it will be a serious change to the existing business models of asset managers," says Tuffy. "If asset managers are the ones who are getting regulated as SIFIs it will certainly change their role."
Discouraging Asset Growth
Aaron Izenstark, co-founder and chief investment officer at IRON Financial, says the increased regulation from the FSOC may result in asset management firms focusing less on acquiring assets and more on generating revenue through joint partnerships. This would lead to companies likely shifting their budgeting since the responsibilities of team members would be largely changed.
"It may slow growth and slow [asset managers] from purchasing other assets," says Izenstark. "It may force them to do business different than they are now." Tuffy says the SIFI designation could result in larger asset managers near the $100 billion asset threshold for funds choose not to cross that barrier due to the regulatory costs that would result. "Certainly you'll see some asset managers question whether it is worth it to accrue additional assets that cross that barrier," he says.
Status Quo Still Possible
The FSCOS hosted an asset management industry conference on May 19 in which the Treasury Department's Under Secretary for Domestic Finance emphasized in opening remarks that "a number of options" were being considered including the possibility of keeping the status quo. "We are here today because the Council is working to determine what, if any, risks exist in the asset management industry, before we consider what, if any, action the Council should take in this area," said Miller in her remarks.
"Our work to assess these risks is ongoing, and it will be based on a thorough analysis of information from a wide array of sources." Vanguard CEO William McNabb III spoke before the U.S. House of Representatives Financial Services Committee on May 20 on behalf of the Investment Company Institute and voiced concerns about what the SIFI process could mean for its members. He explained that funds do not have the need or ability to meet capital requirements that would apply under the SIFI designation and this would result in hurting the number of people who invest in mutual funds. "The increased costs associated with SIFI designation clearly would lead to higher expenses for fund investors-a cohort that has shown itself to be quite sensitive to costs," said McNabb in his prepared remarks.
"The costs and fund management implications of SIFI designation would make any designated fund less competitive and less attractive to investors. This, in turn, would distort competition in the fund marketplace and could limit investor choice."