SEC Commissioner Michael S. Piwowar

The looming and evolving threat of cybersecurity and its focus on the financial sector had experts at the Investment Company Institute's 2015 Mutual Funds and Investment Management Conference again calling into question industry practices and prevailing attitudes toward securing data and proprietary computer systems.

But the perceived threat of asset managers operating as a shadow banking system, thereby needing bank-like regulatory oversight from the Fed, produced the strongest commentary at the forum, as key speakers spoke of pushing back against any attempt to entwine firms into further government oversight.

"There is a continuing false narrative that one reason for the [2008] financial crisis was the expansion of a largely unregulated 'shadow banking system' rivaling the traditional banking sector in size," said SEC Commissioner Michael S. Piwowar in a speech at the event in Palm Desert, Calif.

"Having concluded that funds and asset managers represent a preconceived 'systemic risk' or 'threat to financial stability,' the FSOC and the FSB have been relentless in attempting to find a post-hoc rationalization for their decisions."

FSOC is currently considering whether to apply that SIFI classification to fund companies. In December the committee 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. Earlier this month it put out a second proposal to determine a designation methodology.

Piwowar launched his criticism of such calls by pointing out that before the financial crisis, the same regulatory bodies calling for stricter regulation of asset managers allowed a number of banks to rely on short-term borrowing to supply lending and operations.

"It is not only ironic, it is also tragic that, in their push for more oversight of the capital markets and non-bank participants, the prudential regulators are responsible for creating the dominant position of investment funds in providing liquidity in the fixed income market," he said.


In late February, the Fed cited potential misperceptions of liquidity with ETFs as posing real market risks, possibly resulting in fire sales and runs in some mutual-fund products, according to Bloomberg.

"As mutual funds and ETFs may appear to offer greater liquidity than the markets in which they transact, their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions," the Fed noted in its semi-annual report to Congress.

Despite improvements of high-yield, high-risk loans, the Fed sounded the alarm over the possibility of runs on prime money market funds with fixed net asset values if there was a drop in the price of securities.

Piwowar characterized the Fed's report as an "unsubstantiated assertion that these products contribute to increased volatility in the financial markets because they must rebalance their portfolios in the same direction as the contemporaneous return on the underlying assets in order to maintain a constant leverage ratio."

He cited a paper authored by Fed researchers that demonstrated capital flows actually reduce the need for leveraged ETFs to rebalance when returns are large in magnitude.

"The capital flows thereby mitigate the potential for leveraged ETFs to amplify volatility. In other words, one of the Fed's own economists concludes that concerns about leveraged ETFs are overblown."

Joining Piwowar in his criticism of Fed calls for more oversight of asset managers was David Blass, ICI's general counsel, though he attempted a slightly more diplomatic tone.

"I can understand bank regulators' look to cash buffers and capital requirements to protect the safety and soundness of deposit-taking banks," Blass said. "It is an entirely different story for regulated funds. Fluctuating asset prices can result in losses for fund investors ... but regulated funds have never experienced the kind of runs that the FSOC asserts."

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