The Financial Stability Board, in consultation with the International Organization of Securities Commissions (IOSCO), released a consultative paper suggesting revised methodologies for identifying non-bank non-insurer global systemically important financial institutions (NBNI G-SIFIs) based on commentary received from the original consultative paper released in January 2014. The paper describes a general framework that would apply to NBNI G-SIFIs, as well as a specific framework that would be applied based on the type of entity, including separate frameworks for asset managers and investment funds.
The general framework proposed in the paper identifies five “impact” factors to be considered in designating a NBNI G-SIFI: size, interconnectedness, substitutability, complexity, and global activities. Due to lack of public information available regarding financial firms compared to what is available for banks or insurers, the FSB suggests the analysis would be conducted primarily by national authorities using the impact factors as guidance. The FSB and IOSCO would form an International Oversight Group (IOG) to ensure consistency across jurisdictions, and final determinations would be assigned in consultation between the IOG and national authorities.
While the paper notes that regulations affecting investment funds aim to address systemic issues, “the distress or forced liquidation of an investment fund that has extensive exposures and liabilities in the financial system or that provides a critical role in certain markets could have a destabilising impact on other market participants or counterparties in a cascading manner that could lead to broader financial system instability.” As with the last paper, the current iteration identifies three channels where failure of NBNIs are most likely to transmit their distress to the financial markets and thereby threaten financial stability:
- Exposure of creditors, counterparties, investors, and other market participants to the NBNI;
- Liquidation of assets trigger a decline in asset prices that significantly disrupts trading or causes significant losses or funding problems for similar firms; and
- Inability or unwillingness to provide a critical function or service to market participants or clients where there are no ready substitutes in the market.
Regarding the first channel, the paper acknowledges that many public funds are limited in their use of leverage by legal and regulatory provisions, but the FSB remains concerned that certain funds can nonetheless be highly leveraged when using non-centrally cleared derivatives, particularly those with inadequate margin requirements. With regard to the liquidation of assets, responses to the first consultation paper “generally disagreed with the relevance of asset liquidation/market channel for investment funds and argued that fire sales by investment funds do not pose a global systemic risk.” While several jurisdictions allow funds to impose fees, gates, or redemption limits, the paper calls for further investigation into the efficacy of these tools due to the infrequency of use. The FSB also cites recent research that focuses on less liquid markets (such as fixed income) and the corresponding ability for pricing pressures to spread easily. The document seeks feedback on the impact that individual funds may play in an event of distress. Lastly, the paper asks whether the third channel (critical functionality) is a significant factor for investment funds, noting that the comments received from the last iteration indicated that the industry is “highly competitive with numerous substitutes existing for most investment fund strategies.”
To determine the materiality threshold for funds that warrant further analysis, the FSB and IOSCO propose that “traditional investment funds” (non-hedge funds) that fall into the following categories warrant further analysis:
- Net Assets Under Management of greater than $100 billion, or $30 billion in NAV and a balance sheet leverage of 3 times NAV; or
- $200 billion in Gross Assets Under Management, “unless it can be demonstrated that the investment fund is not a dominant player in its markets” (such as through showing that the fund’s daily trading volume is less than 0.5% of the total trading volume of the asset class, or by showing that the Net Assets Under Management could be absorbed in a stressed market).
Comments on the consultative paper are due by May 29, 2015, and the FSB expects that the methodologies will be completed by the end of 2015. The next step will be for the FSB to work with other relevant international bodies to develop “the incremental policy measures needed to address the systemic and moral hazard risks posed by NBNI G-SIFIs,” and subsequently to form an IOG to oversee the identification process and maintain consistency.