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UK central bank weighs in on asset manager systemic risk debate

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The Bank of England (BoE) has weighed into the on-going debate on the systemic risk posed by asset managers, suggesting distress at large firms could create friction in financial markets.

Executive director for financial stability at the BoE, Andrew Haldane, said given the asset management industry’s projected growth, it was viable to consider whether the industry runs greater risks to financial stability.

Speaking at the London Business School Asset Management Conference, Haldane said with expected assets under management to reach $400trn (€292trn) by 2050, it was essential managers strengthen the financial system and the real economy.

He said two relevant factors to discussing whether managers posed any risk was the level of concentration, suggesting this was broadly similar to that of the banking sector, and the scale of the largest firms.

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“On the face of it, then, the structure of banking and asset management is not too dissimilar. But the risks to these balance sheets are also quite different,” he said.

“They are not, however, insolvency-immune. An individual manager or fund does face operational and reputational risk.”

He said there are three risks posed by managers which could undermine financial security for the markets, starting with the sheer size.

“Even if the ‘fail’ element of too-big-to-fail is a red-herring, the ‘big’ is not. Distress at an asset manager may aggravate frictions in financial markets, in particular frictions in market liquidity.”

Haldane also said managers could “amplify pro-cyclical swings” in the economy and contribute to the mis-pricing of risk.

He also highlighted the recent trend for managers to move into more illiquid assets, and passively managed funds, suggesting these would create greater illiquidity risk, correlated price movements and leaving manager susceptible to runs.

Liability contracts have also put more risk back onto investors which may increase their incentive to run, he said.

However, he commended international work currently being done by European and US agencies on whether asset managers pose systemic risks.

He said prudential policy would be the best way to regulate, and defend against pro-cyclical swings, and initiatives on long-term financing would protect against illiquidity risk.

The argument over asset manager’s impact on the global economy has been on-going since the financial crisis.

While the regulation and containment of systemic risk within banks has been the focus since 2008, both the Office for Financial Research (OFR) in the US, and the Financial Stability Board (FSB), backed by the G20, have launched consultations on the topic.

An OFR report published last Autumn caused controversy, after it highlighted four ways asset managers were susceptible to systemic risk.

However, the report was dismissed by a bi-partisan group of US Senators, who accused the OFR of mischaracterising the industry, and warned of credibility damage to the US Treasury.

The, FSB, while not currently designing any policies, is working on identifying which organisations are large, complex and systemically connected enough to cause financial disruption.

Once this was defined, the FSB said it would develop policy measures.

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