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Debate over systemic risk of asset management intensifies

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The debate over whether the asset management industry poses systemic risk is heating up after US lawmakers dismissed a report from the Office for Financial Research (OFR).

In September 2013, the research body released a report, Asset Management and Financial Stability, which highlighted four potential vulnerabilities to the US financial system.

The OFR was created in the wake of the financial crises and serves part of the US Treasury, responsible for providing research for the Financial Stability Oversight Council (FSOC).

Its report warned that managers ”herding” into asset classes, in search of yield, could push up prices and magnify volatility.

It said investment vehicles with unrestricted redemption rights also posed a threat, as did managers selling other assets to cover redemptions, leading to stress contagion in those assets.

It also highlighted what it considered to be excessive leverage in the industry.

However, according to a letter seen by the Reuters news agency and sent to Jack Lew, secretary to the US Treasury, a bi-partisan group of five Senators has rejected the study.

The letter said the study mischaracterised the industry and could damage the credibility of the OFR and FSOC.

It also requested the FSOC not to base any policy or regulation on the contents of the study, which they said relied on faulty information in places.

Concerns over the asset management industry and what security measures – such as financial buffers – would mean have also been debated in Europe.

Earlier this month, the Financial Stability Board (FSB), the international body set up after the 2009 G20 summit to monitor global financial systems, said it would consult with the industry regarding systemic risk.

Its consultation focused of identifying which organisations were sufficiently large, complex and systemically connected to cause disruption to the wider system.

The FSB said it would not currently designate any specific entities in the category.

But it added that, once its methodology of identifying them was complete, it would develop policy measures.

Tom Brown, partner in KPMG’s investment management practice, said the FSB’s proposal was still a long way from policy.

However, he pointed out that the FSB and the US Treasury’s papers currently differed on what the target of said policies might be.

The FSB’s rationale is more towards looking at systemic risk at fund level, with the OFR’s paper more inclined towards asset managers.

Brown said: “Focusing on the funds seems sensible, as there is a principal/agent relationship between the fund and the manager, so the real economic exposure is at the fund level.

“It’s intellectually flawed focusing on the manager. If there is systemic risk, it lies with the fund.”

He said potential outcomes could be limitations on counterparty risk, leverage and concentration, but he argued that this was still unclear and would depend on fund size.

Sheila Nicoll, financial services senior adviser at Ernst & Young, said the debate concerning systemic risk in asset management would continue.

“If they do decide fund management activity can have a systemic impact, the remedies will not be the same as those for banking – capital is not necessarily the answer,” she said.

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