In a strong defense of the stability and safety of the asset management industry, Investment Company Institute President and CEO Paul Schott Stevens
told the Mutual Fund and Investment Management Conference that not only are asset managers and the funds that they offer not sources of risk to the overall financial system, but some misguided efforts to regulate them as such may do vastly more harm than good. Mr. Stevens' remarks were a reaction to reports recently issued by the Office of Financial Research (OFR)
and others concluding that asset management firms and the activities in which they engage can introduce vulnerabilities that could pose, amplify, or transmit threats to financial stability. Stevens worries that the conclusions of the OFR report and a similar report by the Financial Stability Board, "could be the predicate for new, bank-style prudential regulation of the asset management industry—which could significantly harm funds and the investors who use them."
Stevens is not alone in his belief that bank-like regulation is right for banks and bank-like entities, but a decidedly wrong fit for asset managers. Recently, five senators voiced similar concerns about the potential negative effects imposing the SIFI framework on the asset management industry. The OFR and FSB's focus on SIFIs is misplaced, Stevens says, and Dodd-Frank provides appropriate tools to address particular kinds of risks in the areas where they arise without resorting to SIFI designation. Mr. Stevens believes he has an agenda that addresses the kinds of risks posed by asset management that is a better fit than treating asset managers and mutual funds like banks.
But it is important to think critically about where and how risks appear. Dodd-Frank offers regulators a choice of tools for this purpose—and it is important to choose the right tool for the job at hand.
So I will also suggest today an affirmative agenda to address specific risks in market activities and practices—steps that would be far more effective in making the financial system more resilient for investors and markets than any move to “designate” individual managers or funds as systemically risky.
According to Mr. Stevens, mutual funds, the largest players in the asset management industry are entirely distinct from the banking industry with almost no leverage, no bailouts when mutual funds fail, and no historical evidence of runs. In addition, the asset management industry is already heavily regulated in a way that not only protects investors, but limits systemic risk and the transmission of risk. Mr. Stevens' alternative approach augments the existing regulatory framework and the regulators already in place to deal with asset managers and funds based on their activities, not just their size.
We believe that there’s a better way forward: an activities-based approach that would involve the regulators that already have expertise with specific industries and markets. Instead of assuming that an entire industry is risky and then looking for remedies to address undefined problems, these regulators would address specific activities or practices that pose demonstrable risks to the financial system, then follow regular rulemaking procedures—with public meetings, notice, and comment, and requirements to follow the record and apply cost-benefit analysis.
Mr. Stevens sees two main risks to the potential designation of asset managers and funds as SIFIs and the overall idea of regulating asset managers and funds in the same way as banks. First, the SIFI framework is completely untested, and it is entirely uncertain what form SIFI regulation could take. But we do know that bank-like nature of capital charges and liquidity fees could do serious damage to the fund industry.
There are significant uncertainties about what lies in store if funds or their managers are designated as SIFIs. The Federal Reserve Board—the agency charged with supervising non-bank SIFIs—has not specified what its “remedies” for systemic risk may be, and the remedies suggested by Dodd-Frank are unclear. We do know that capital comes at a cost, and that it wouldn’t take much in added fees, assessments, and capital costs to increase significantly what designated funds would have to charge investors—distorting the competitive landscape for funds and investors.
Second, bank-like SIFI regulation ignores one of the central tenants of the way the asset management industry has been regulated for years: fiduciary duty. Funds and their advisers and asset managers are all bound by a duty to act in the best interests of their investors, not in the best interests of the banking system.
Most significantly, as a systemic-risk regulator the Fed would practice “prudential supervision,” which focuses primarily on preserving the banking system, rather than fiduciary duty—the unwavering responsibility always to act in the best interests of your funds or clients. In times of market turmoil, the Fed might well decide that it is necessary for a fund to maintain financing for a troubled company or financial institution, irrespective of the best interests of the fund’s shareholders.
Mr. Stevens is a true believer in the soundness and safety of the asset management industry, particularly mutual funds. Mutual funds had little, if anything, to do with the financial crisis. So, it is understandable that he and the entire industry he represents are nervous that they may be caught up in the post-crisis regulatory fervor and may pay a great price for it.