Asset management could be the next group of financial institutions to face tighter government regulations, the US Treasury’s Office of Financial Research (OFR) said in a report on Monday.
The study from the OFR, was solicited by the Financial Stability Oversight Council and details the ways in which the asset management industry could "pose, amplify, or transmit threats to financial stability".
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The study shows that some of the highlighted activities that could create vulnerabilities — if improperly managed or accompanied by the use of leverage, liquidity transformation, or funding mismatches — include risk-taking in separate accounts and reinvestment of cash collateral from securities lending.
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According to the report, data for separate accounts managed by US asset managers are not reported publicly and their activities are less transparent than are those of registered funds. Such accounts include roughly two-fifths or more of total assets under management (AUM) in US firms.
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By GlobalDataFurthermore, privately owned asset management firms do not disclose information comparable to the public financial reports filed by asset managers that are public companies or subsidiaries of public companies. Data on some activities, such as involvement in repo transactions and the reinvestment of cash collateral from securities lending, are found incomplete, thereby clearly limiting visibility into market practices.
Among the key factors that make the industry vulnerable to shocks are the following:
- "Reaching for yield" and herding behaviours could contribute to increases in asset prices, as well as magnify market volatility and distress if the markets, or particular market segments, face a sudden shock. Competitive pressures may increase incentives for managers to take on extra risks. Also, herding investment behaviour, that is the tendency of asset managers to crowd into similar, or even the same, assets at the same time, if in illiquid assets may be likely to amplify financial stability shocks.
- Redemption risk in collective investment vehicles. The study says that any collective investment vehicle offering unrestricted redemption rights could face the risk of large redemption requests in a stressed market if investors believe that they will gain an economic advantage by being the first to redeem.
- Leverage, which can amplify asset price movements and increase the potential for fire sales. Institutional investors and high-net-worth individuals face fewer limitations than smaller retail investors in obtaining leverage through managed funds and accounts. As already mentioned, the report said that data are currently insufficient to understand the exposures and the extent of leverage in separate accounts.
- Firms as sources of risk. The failure of a large asset management firm could be a source of risk, depending on its size, complexity, and the interaction among its various investment management strategies and activities. Distress at a large asset manager could amplify or transmit risks to other parts of the financial system.
The U.S. asset management industry oversees the allocation of approximately $53 trillion in financial assets.
