When the Financial Stability Oversight Council (“Council”) adopted its final rule last year for designating nonbank financial companies as systemically important (i.e., as “nonbank SIFIs”), it made clear that the Council was assessing whether certain asset management firms might also be included in its reach. The OFR late last month issued a study called Asset Management and Financial Stability (“Study”), which describes potential threats to US financial stability from vulnerabilities of asset managers.
The Study suggests that the industry’s activities as a whole make it systemically important and may pose a risk to financial stability. The Study is therefore best viewed as a first step toward individual asset manager SIFI designations. Drawing from the Study, the Council will likely focus on industry vulnerabilities and how these vulnerabilities could be amplified and transmitted throughout the financial system during financial shocks. The Council will have broad discretion when making particular designations because, as the experience of insurers has demonstrated, the designation process is driven by worst-case scenarios based on the flexible standard of what “could” happen during market shocks.
Given the Council’s discretion, and our understanding of the Council’s rationale for designating insurers, it continues to be our view as stated in a prior brief that a few large asset managers will ultimately be proposed for SIFI designation – the clock has started ticking.
We do not believe these designations will occur before 2015 though, for the following reasons:
The asset management industry has pointed out the Study’s limitations. Beyond removing little from the menu of potential industry risks, the Study does not elaborate on what “combination of ... activities” could pose risk (or amplify or transmit risk), nor does the Study detail the “riskier activities” by a “significant number” of asset managers that could cause a similar threat. Also, the Study does not address the broader policy question of whether potential threats to financial stability from asset managers can best be mitigated by designating a firm as a nonbank SIFI (i.e., subjecting it to supervision by the Federal Reserve Board and enhanced prudential standards under Dodd-Frank), or whether these threats are better addressed by other regulatory measures as referred to in the Rule’s preamble.
As a final point, the Securities and Exchange Commission (“SEC”), the primary regulator of the asset management industry, has asked for public comment on the Study (comments are due by November 1st). The fact that the SEC has taken this action demonstrates an assertion of its traditional authority and expertise in asset management (perhaps in light of the SEC’s experience last year with the Council’s initiative regarding money market funds) – expect the SEC to be a strong voice at Council meetings.
This FS Regulatory Brief provides the highlights of the Study, explains what the Study means for asset managers as a practical matter, analyzes its key themes, and provides our view that a few asset managers will be proposed for SIFI designation.