SEC’s White Feels BlackRock’s Pain Over Systemic LabelDave Michaels and Christopher Condon
Asset managers trying to forestall stricter U.S. oversight appear to have found an ally in the chairman of the Securities and Exchange Commission.
SEC Chair Mary Jo White took up their arguments yesterday, lending support to firms including BlackRock Inc. and Fidelity Investments which are fighting efforts to officially label them sources of “systemic risk” to the financial system.
“I don’t think you are overreacting to the process,” White told industry executives at a conference sponsored by their trade group, the Investment Company Institute.
Asset managers sponsor products such as mutual funds and hedge funds that invest $53 trillion for individuals saving for retirement and institutions such as pension funds. They argue that some proposals under consideration by a council of regulators would make mutual funds more expensive and hurt their ability to make the best decisions for investors.
Traditionally regulated by the SEC, the largest firms could come under Federal Reserve oversight if the Financial Stability Oversight Council, an umbrella group of U.S. regulators, decides they require tougher scrutiny because their collapse could trigger broader instability. The council was established by the 2010 Dodd-Frank Act, which sought to prevent a repeat of the 2008 financial crisis.
White, who has a seat on the 10-member council, hasn’t said how she’d vote. Two firms are currently under review: BlackRock, which manages $3.8 trillion worldwide, and Fidelity Investments, which manages $1.9 trillion.
In a letter released yesterday, BlackRock said regulators should focus on systemic risk fostered by the structure of different funds “rather than targeting a small group of large asset managers or a small group of large hedge funds.”
Regulation should be coordinated across countries to reduce the “first-mover advantage” that investors have to exit a fund at the first sign of stress, which taxes a fund’s liquidity and can lead to losses for other shareholders.
If all collective funds “were broadly structured to make sure that asset owners associated with net flows bore their full cost, whether that be in terms of ‘herding’ into an asset class or rushing out, systemic risks would be mitigated,” the company wrote.
Bureaucratic turf is also at stake. A designation would partly take those firms out of the SEC’s ambit and allow the Federal Reserve to impose new rules, including bank-like requirements for capital and liquidity to help a firm survive a loss of funding and prevent the need for a government bailout.
The council’s actions have provoked a surge of lobbying by the industry and opened a rift between the SEC and other regulators that appears to be widening.
White has echoed the industry’s points for a while, arguing that unlike banks, money managers don’t accumulate large risky positions on their own balance sheets. She has pointed out that banking regulators constitute a plurality on the oversight council, while arguing the SEC is the expert when it comes to overseeing the markets for stocks and bonds.
“We do have that expertise, and it’s something we are constantly putting in play before all the other regulators, some of whom do have that capital markets expertise but for the most part are banking regulators,” White said at an event sponsored by the U.S. Chamber of Commerce in March.
The disagreement was also evident in reactions to a study issued in October by a research arm of the Treasury Department that concluded that money managers could endanger the financial system when reaching for higher returns. Soon after the report was finished, White released it for public comment, giving the industry a chance to fight back. A top Treasury official, Mary Miller, said on May 19 that the industry overreacted; White said yesterday the industry’s response is justified.
“It is enormously important for FSOC, before it takes any decision, to make certain it has the requisite expertise,” White said. “A lot of it has come and needs to come from the industry.”
White is under pressure from other SEC commissioners, whose votes she needs to advance rules, to protect the SEC’s authority. Commissioner Daniel M. Gallagher said in a letter this month that the council’s efforts are “fatally misguided” and driven by “blatant regulatory creep” as banking regulators seek more control over the firms.
“I suspect that Dan Gallagher isn’t that far from Mary Jo’s position, and the real gap is between Mary Jo and the Fed and the Treasury,” said Richard Breeden, a former SEC chairman and hedge fund manager. “Because it’s the Fed and the Treasury behind a bureaucratic turf grab, and it’s not an issue of legitimate substance.”
Behind closed doors, White should be trying to slow down the council’s deliberations by “laying as many studies from the SEC and as much outside evidence on the table and saying, ‘What about this?’” Breeden said. In public, White has said the SEC is developing a plan to boost oversight of asset managers, including requiring mutual funds to provide more monthly data on their portfolios.
The industry lobbying has forced the council to accept more input on the issue. This week, it hosted a public hearing at which executives from BlackRock, the world’s largest money manager, and Pacific Investment Management Co. said designation would be misguided because fund investors, not asset managers, decide when to move in and out of funds.
The council is justified in examining whether asset managers create or spread risk that the SEC hasn’t adequately addressed, said Jeffrey N. Gordon, co-director of the Richman Center for Business, Law and Public Policy at Columbia Law School. The SEC still hasn’t adopted, for instance, structural changes to money-market mutual funds to address the role some funds played in accelerating the 2008 credit crisis.
“The SEC’s track record as a systemic risk regulator does not inspire confidence,” Gordon said in a phone interview.
Outside of money funds, losses experienced by mutual funds didn’t trigger wider problems during the crisis, according to ICI data. During October 2008, when the Standard & Poor’s Index of U.S. large-cap stocks plunged 17 percent, mutual-fund investors withdrew less than 2 percent of aggregate U.S. stock fund assets.
On the other hand, risk could be building up in other types of funds or activities. The SEC warned in January about the build-up in assets in bond mutual funds and exchange-traded funds, which reached $3.64 trillion in March, according to ICI data. A move by the Fed to raise interest rates would increase volatility in the bond market and could stress bond funds’ sources of liquidity, the SEC said.
“You can’t sit here today and say there is no potential systemic risk that ought not be the subject of forward-looking consideration,” Gordon said.