Big Money Managers Must Stop Stampedes

Asset managers escaped ‘too-big-to-fail’ rules, but they still pose stability risks

By Paul J. Davies 

   Bank of England Governor Mark Carney chairs the Financial Stability Board. Photo: European Pressphoto Agency


Fund managers aren’t too big to fail, but that doesn’t mean their actions can’t have a big impact on the financial system.

Global rule setters decided against treating asset managers like super-large banks or insurers last summer. However, the Financial Stability Board did plow on with efforts to understand how they can hurt wider markets if they are forced to sell heavily due to the demands of skittish investors in difficult markets.

This is important because asset managers have become an ever larger part of the global financial system. The top 10 fund managers in the world now manage more than $20 trillion of assets among them, according to the board.

With investors everywhere chasing yield, billions have poured into fixed-income funds that buy relatively illiquid assets while promising nearly instant cash redemptions to investors. Many also juice their returns using borrowed money or derivatives.

The rule-setting body has now identified several risks to the wider financial system that aren’t fully captured by current regulations or common practices and come up with proposals to fix these.


The most important—and obvious—is to try to reduce risks of big mismatches between the ease with which investors believe they can pull their money out of funds and the difficulty the manager may have in selling the underlying assets.
 
U.S. markets got a big reminder of these risks last December when a distressed-debt fund run by Third Avenue was forced to block investor withdrawals, prompting a mini-panic among investors in other high-yield bond funds.

The FSB wants local regulators to make sure that any fund that plans to invest in assets that are less liquid always has more restrictions on when and how investors can redeem their cash. Investors should be well aware of what they are buying into.

The board also wants to see more stress testing of funds overseen by local regulators to help monitor interconnections between funds, fund managers and the wider markets.

Other proposals relate to better information gathering and monitoring, especially regarding how to measure funds’ exposure to borrowed money and derivatives, which can add leverage, too.

Fund managers rightly escaped designation as too big to fail, but they should back the main thrust of these proposals to help ensure safer markets for all.

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