One of the largest unanswered regulatory questions following the global financial crisis is what, if anything, should be done to rein in asset managers. The Financial Stability Oversight Council (FSOC) has been looking at BlackRock, Inc. (NYSE:BLK) and Fidelity National Financial Inc (NYSE:FNF) specifically to better understand their role in the market, but there is still no indication whether they will designate either as a systemically important financial institution (SIFI). Even though Blackrock CEO Larry Fink has made it clear that his company isn’t deadest against regulation, the company argues that conflating asset managers with investment banks won’t have the impact on fund flows that regulators are hoping for.
BlackRock: Asset owners ultimately control fund flows
“Given the long history of micro-prudential regulation, it is natural that the vast majority of regulators now pondering how to design appropriate macro-prudential regulation for the financial system have assimilated the banking model deeply into their thinking,” BlackRock, Inc. (NYSE:BLK) writes in a recent white paper Who Owns the Assets? “Yet, it is precisely on this axis that banks and asset managers are fundamentally different.”
Banks invest their equity capital and deposits in an assortment of balance sheet assets that are owned by the bank. Even though depositors are at risk if the bank goes into default, they don’t own the bank’s assets and they don’t have any control over how the money is invested, and people don’t generally choose where to make deposits based on a bank’s investment strategy.
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Asset managers, on the other hand, act as agents for their clients. They don’t own the assets they manage and they aren’t really the counterparties to the trades they make. Assets that are being managed under a separate account are subject to an investment management agreement (IMA), and collective investment vehicles (CIV) such as hedge funds and mutual funds are similarly constrained by the mandate that establishes the fund.
BlackRock, Inc. (NYSE:BLK) argues that in both cases large scale fund flows are determined by asset owner allocations to specific strategies, not by tactical decisions made by individual asset managers. With $19 trillion in gross flows last year, it’s hard to argue that asset owners are the driving force behind asset re-allocations.
BlackRock wants to limit first-mover advantage
Instead of applying regulations aimed at the banking industry, BlackRock, Inc. (NYSE:BLK) would like to see FSOC and other regulators try to address the first-mover advantage that can cause a run on asset managers. The principal is that if redemption force a fund to sell into a bear market, or otherwise creates inordinate transaction costs that the remaining investors will bear, then a market shift can force everyone to run for the exit, even those who would rather wait it out.
Forcing investors to bear the real cost of their own redemptions would remove one of the major pro-cyclical accelerants that drives fund flows. Different types of CIVs would need different sets of rules to put this into practice, but BlackRock, Inc. (NYSE:BLK) argues that using this as a guiding principle will do more to limit pro-cyclic flows than trying to bend banking sector regulations to fit very different business model.
Readers can find the full report from BlackRock here