We wrote in our April 19 Link of the Day on a press release titled, "Austrian, French, Italian and Spanish financial market authorities give their key priorities for a macro-prudential approach to asset management," but today we quote from the full publication, "A macro-prudential approach to asset management." It says, "The risks stemming from non-bank financial intermediation (NBFI) have been subject to scrutiny from regulators worldwide since the Global Financial Crisis. The banking regulation tightening that followed, the desire to reduce the economy's dependency on bank financing in a number of jurisdictions, as well as the low (including negative) interest rates policy, have resulted in an increase of the share of NBFI in the global financial system. In addition, several recent events have illustrated the fact that shocks that either spread through or originate from the NBFI world may have a potentially significant negative effect on the real economy, which amounts to say that they are of potential systemic relevance."
The paper tells us, "Those concerns warrant some nuances in two ways. First, although parts of the NBFI ecosystem might indeed offer products that have bank-like features and would then call for bank-like regulation -- in the spirit of the well-known same activity, same risk, same regulation principle -- the NBFI world, overall, is extremely diverse and generally, much different from banks. Asset management, in particular, follows an agency business model. Asset managers do not take risk as principals."
It explains, "This paper focuses on the asset management industry. The international work so far has focused on liquidity risk of money market funds on the one hand, and open ended funds on the other (there is currently a work stream dedicated to leverage in NBFI, which is another fundamental aspect of macro-prudential stability). Despite the heterogeneity of the wide array of products in the asset management industry, two main takeaways have emerged from these works: First, investment funds need to be acknowledged and understood as investment products, in the sense that investors carry the economic risks associated with the underlying assets. Any contractual feature that generates a different expectation from investors is likely to result in excessive volatility due to arbitrage by investors."
The piece states, "This is the case in particular for NAV smoothing techniques ('amortised cost accounting') of certain types of money market funds, which create a confusion by making investments products contractually comparable to demand deposits, even though the contractual promise is not internally consistent (as investors are still supposed to bear all the risks of the assets). More broadly, any mechanism that may create a first mover advantage by not adequately passing on to investors the full cost of their own decisions, including redemption demands, is conducive to such problems. Second, investment funds must ensure that the promises they make to investors are consistent with their investment policy and suited to their investors. In particular, funds that invest in illiquid assets should be structured in a way that reflects that illiquidity. In addition, a large range of tools should be available to manage liquidity stress, to ensure that managers have the capacity to act in the best interest of their investors at all time."
It continues, "These themes are not new to securities market regulators as they are crucial to protect investors. A major breakthrough was made by the FSB in its 2022 Progress Report with the concept of repurposing existing tools. The idea behind this concept is that ex-ante requirements aim at ensuring that investors are treated fairly and are offered a contractual promise that is internally consistent -- a principle that should be familiar to all securities market regulators -- and addresses financial stability concerns to a large extent. The FMA, AMF, CONSOB and CNMV, therefore, strongly support that concept."
The update also says, "There are four priorities that stand out in our view: The first one is to ensure a wide availability and greater use of LMTs in all kinds of open-ended funds. The recent AIFMD-UCITS review will allow for a significant progress in this respect making most common LMTs available across Member States, although level 2 measures as regards the use of those tools are still in the making. Given the strong reluctance of asset managers to adopt LMTs, one key issue is to make sure that LMTs are appropriately calibrated so they are effectively used. Nevertheless, the use of LMTs cannot substitute the need to offer appropriate redemption conditions aligned with the liquid nature of the fund's assets. To this end, the recent FSB recommendations on the redemption conditions of open-ended funds should be fully implemented, in particular regarding ELTIF funds."
It comments, "The second relates to the review of Money Markets Funds Regulation (MMFR). The key priority of this review should be to remove any first mover advantage and any confusion with on-demand/bank deposits by banning amortised cost accounting (for Low Volatility Net Asset Value/LVNAV and Constant Net Asset Value/CNAV alike). These NAV smoothing techniques are intrinsically detrimental to financial stability and amount to making false claims to investors who are led to believe that they enjoy a contractual commitment to a stable NAV, whatever the value of the underlying assets might be. If that were the case, then the fund would act as a deposit and should be regulated as such. The other key area should be to review liquidity requirements upwards. Such an increase should remain moderate for VNAV funds, as price adjustments will create a natural incentive to limit redemption pressure. Liquidity requirements should remain expressed in terms of cash and not be mixed up with less liquid assets such as government bonds."
The piece adds, "In a more strictly macro-prudential fashion, two key priorities should be explored: The EU would strongly benefit from the introduction of a truly consolidated supervisory approach for large cross border asset management groups. The structure of such groups has evolved and it is now common that the portfolio management teams, the risk management teams, and the funds are supervised by different NCAs in different countries, which creates coordination issues. This is particularly relevant in times of stress where there needs to be a close dialogue between supervisory authorities and asset managers. In addition, it is also relevant outside the context of a crisis. For instance, asset managers that have a large market footprint can be expected to display correlation in their investment behaviour across different funds -- even though those funds are managed for investors with different investment profiles. From a supervisory standpoint, there would be a strong benefit in being able to assess risk exposure at the level of all the funds managed by a given asset manager."
Finally, they write, "In practical terms, a consolidated supervisory approach should rely on a supervisory college gathering relevant NCAs and ESMA (and possibly the ECB as an observer). The primary responsibility of this supervisory college would be i) to understand the group's overall risk exposures; ii) to assess the robustness of risk management frameworks within the group; and iii) to perform stress tests against economic stress scenarios to assess the resilience of the asset management group and each of its funds. The stress tests could be defined by ESMA, who could recommend using ex-ante powers -- such as those of Article 25 of AIFMD regarding leverage limits. To ensure that crosscutting decisions taken by the supervisory college are effectively implemented, a 'lead NCA' for each group should be nominated (e.g. the licensing authority or the authority in which jurisdiction is the highest AUM for that group). The coordination actions would not interfere with the powers granted to each NCA by European legal texts. To provide asset managers with some benefits in return, that consolidated approach would need to be grounded in some regulatory requirements, e.g. acknowledging intragroup service provision arrangements."
For more, see the website IPE.com, which recently published the piece, "European financial market authorities set priorities for macro-prudential approach." They state, "As the European Commission prepares to launch its consultation on the macro-prudential treatment of risk in asset management, four major European market authorities, have set out their views on the priorities in the debate on a macro-prudential approach to asset management. The authorities -- Austrian Finanzmarktaufsicht (FMA), Italian Commissione Nazionale per le Società e la Borsa (CONSOB), Spanish Comisión Nacional del Mercado de Valores (CNMV) and French Autorité des marchés financiers (AMF) -- said the risks stemming from non-bank financial intermediation have been subject to scrutiny from regulators worldwide over the past years, especially as its share in the global financial system has been increasing since. In addition, concerns have been raised about potential significant negative effects that shocks, either spreading through or originating from non-bank financial intermediation, may have on the real economy, the quartet added."
