Fund industry fights systemic-risk regulation

At its annual conference, the ICI contended that mutual fund investors would be hurt by risk designation

May 21, 2014 @ 2:15 pm

By Trevor Hunnicutt

mutual funds, investment company institute, ici, annual conference, laurence fink. blackrock, SIFI, too big to fail, FSOC, paul schott stevens
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(Bloomberg News)

A trade group for fund companies launched a broadside against regulators who are considering designating some large fund managers as potential sources of disruption in financial markets.

Mutual fund companies and Paul Schott Stevens, who leads their trade association the Investment Company Institute, expanded their argument about what harms might occur for advisers and retail investment advisers if funds are designated a SIFI, or systemically important financial institution.

Under a potential rule, “the Fed could substitute its ‘prudence’ for the fiduciary judgment of a SIFIi-designated fund’s investment adviser,” according to Mr. Stevens, who spoke Tuesday at the ICI’s annual conference in Washington. "During times of market turmoil, for example, the Fed might impel a fund to maintain financing for a troubled bank, even the fund manager were to conclude that holding that position is not in the best interests of the fund’s shareholders.”

He added that if big banks fail, the government could assess the costs of bank bailouts to mutual funds designated as systemically important.

“Dropping that burden on retirement savers and other shareholders in large mutual funds is just a taxpayer bailout by another name,” he said.

He said the regulation could transform the Federal Reserve into an "uber-manager of the savings America’s households have put away for their retirement through mutual funds."

“Americans who own funds outside of retirement plans rely upon professional financial advisers, who help investors stay the course through proper diversification and asset allocation, especially at times when markets are in turmoil,” said Mr. Stevens. “The historical evidence is consistent and compelling: stock and bond funds have never faced the destabilizing ‘runs’ that regulators and reporters imagine."

The Dodd-Frank financial reform law established the Financial Stability Oversight Council to monitor the health of financial markets and to prevent firm failures like those that led to the 2008 stock market rout. So far, FSOC has designated three nonbank companies as SIFIs – American International Group Inc., GE Capital and Prudential Financial Inc.

The asset management industry is trying to avoid a similar fate. Advocates argue their business model is different from that of banks. They serve as agents for investors but do not risk their own assets or take on massive debt.

But FSOC officials have said that the fund companies are vulnerable to financial shocks due to herding behaviors, the risk of redemptions, their using leverage or if the institutions themselves fail. BlackRock Inc., the world’s largest asset manager, runs more than $4 trillion.

Perhaps no company is as interested in the debate as BlackRock, whose CEO, Laurence D. Fink also spoke Tuesday at the conference and described the regulators’ process for considering the issue “unfair."

“There is no transparency in how the FSOC works,” Mr. Fink said. “I learn about what’s going on via the press."

The industry has been aggressive in its opposition to the designation. A study released last week by the American Action Forum, a conservative economic think tank, argued that the designation could reduce returns for fund investors by up to 25%.

And even firms smaller than BlackRock that might not be directly designated themselves, have been opposed to the initiative.

“There’s a very big risk that with well-intended, let’s say prudential, regulation you’re chasing liquidity out of the market,” said Martin L. Flanagan, chief executive officer of Invesco, on Wednesday. “We’re highly regulated … it’s absolutely unclear what’s trying to be accomplished at the moment.”

Separately, the firms have been pressing their case on Capitol Hill. Firms including Pimco, BlackRock, AQR Capital Management, Fidelity Investments and Loomis, Sayles & Co. met with FSOC officials Monday. F. William McNabb III, the Vanguard Group Inc. chairman and CEO, Tuesday told a U.S. House of Representatives committee that a SIFI designation was “unwarranted."

Securities and Exchange Commission Chairman Mary Jo White, an FSOC member, has not taken a position but her remarks on the topic have been characterized as sympathetic to the view of asset managers. She's expected to address the ICI conference on Thursday.

A spokeswoman for the U.S. Treasury Department, which houses the FSOC’s activities, did not immediately respond to a request for comment.

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