Funds industry set for fresh regulatory wave amid questions of 'systematic importance'

The 2008 Global Financial Crisis was primarily the result of failings in the regulation of the investment banking industry.

It has since led to banks being forced to carry out regular stress-testing, the birth of three new supervisory bodies to oversee regulation and, more recently, the introduction of mandatory ring-fencing to protect the assets of their end customers.

Over the course of the 11-year bull market, which has been supported by ultra-loose central bank policy, the investment industry has become increasingly multi-faceted and offers a wider range of mandates, often investing in complex and higher-risk assets. 

According to research from the Financial Times, assets managed outside of the global banking industry now amount to more than $180trn - which is 20% more than is currently being held by banks.

While the asset management industry has been hit with waves of new regulation since the last crisis, its rapid growth in assets over that period has moved regulators to increasingly flirt with the idea of imposing the label of "systemically importance" on the sector. This label would require the imposition of far more stringent controls as seen in the banking industry.

In 2015, the Financial Stability Board considered making such a move, but were pushed back from doing so thanks in no small part to a concerted industry lobbying effort led by BlackRock.

A 2016 paper authored by Claude Lopez, Donald Markwardt, and Keith Savard of the Milken Institute explained the sector is unlikely to "create" systemic risk as it does not take "nearly the same level of leverage as banks and does not guarantee balances on customer accounts, as banks do".

However, the paper explained, asset managers "have the potential to transmit or amplify systemic risk".

More recently, pan-European regulator ESMA has signalled its intention to hit the asset management industry with further stress testing, and testing of liquidity management tools and leverage. Head of asset management, regulatory change at KPMG UK Julie Patterson said the growing regulatory focus of leverage in the funds sector is misguided.

She explained: "There is some confusion among banking policymakers, who are looking to apply banking policy thought to funds. Banks are very unique when it comes to their scale of leverage."

Instead, Patterson argued regulators post-crisis are most likely to focus on liquidity within the funds world, particularly if we see wide-scale redemptions.

Saker Nusseibeh, CEO at Federated Hermes, said investors must separate systematic and asset management risk. 

"I can see how asset managers might themselves suffer in this downturn. But should an asset manager essentially blow up, nothing happens to the underlying assets because the underlying assets do not belong to the asset manager, they belong to the client," he said.

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