The Asset Management Industry And Financial Stability by IMF
Summary
Financial intermediation through asset management firms has many benefits. It helps investors diversify their assets more easily and can provide financing to the real economy as a “spare tire” even when banks are distressed. The industry also has various advantages over banks from a financial stability point of view. Nonetheless, concerns about potential financial stability risks posed by the asset management industry have increased recently as a result of that sector’s growth and of structural changes in financial systems. Bond funds have grown significantly, funds have been investing in less liquid assets, and the volume of investment products offered to the general public in advanced economies has expanded substantially. Risks from some segments of the industry—leveraged hedge funds and money market funds—are already widely recognized.
However, opinions are divided about the nature and magnitude of any associated risks from less leveraged, “plain-vanilla” investment products such as mutual funds and exchange-traded funds. This chapter examines systemic risks related to these products conceptually and empirically.
In principle, even these plain-vanilla funds can pose financial stability risks. The delegation of day-to-day portfolio management introduces incentive problems between end investors and portfolio managers, which can encourage destabilizing behavior and amplify shocks. Easy redemption options and the presence of a “first-mover” advantage can create risks of a run, and the resulting price dynamics can spread to other parts of the financial system through funding markets and balance sheet and collateral channels.
The empirical analysis finds evidence for many of these risk-creating mechanisms, although their importance varies across asset markets. Mutual fund investments appear to affect asset price dynamics, at least in less liquid markets. Various factors, such as certain fund share pricing rules, create a first-mover advantage, particularly for funds with high liquidity mismatches. Furthermore, incentive problems matter: herding among portfolio managers is prevalent and increasing.
The chapter does not aim to provide a final verdict on the overall systemic importance of the potential risks or to answer the question of whether some asset management companies should be designated as systemically important. However, the analysis shows that larger funds and funds managed by larger asset management companies do not necessarily contribute more to systemic risk: the investment focus appears to be relatively more important for their contribution to systemic risk.
Oversight of the industry should be strengthened, with better microprudential supervision of risks and through the adoption of a macroprudential orientation. Securities regulators should shift to a more hands-on supervisory model, supported by global standards on supervision and better data and risk indicators. The roles and adequacy of existing risk management tools, including liquidity requirements, fees, and fund share pricing rules, should be reexamined, taking into account the industry’s role in systemic risk and the diversity of its products.
The Asset Management Industry And Financial Stability – Introduction
In recent years, credit intermediation has been shifting from the banking to the non-bank sector, including the asset management industry.1 Tighter regulations on banks, rising compliance costs, and continued bank balance sheet deleveraging following the global financial crisis have contributed to this shift. In advanced economies, the asset management industry has been playing an increasingly important role in the financial system, especially through increased credit intermediation by bond funds.2 For emerging markets, portfolio flows—many of which are channeled through funds – have shown steady growth since the crisis. Globally, the industry now intermediates assets amounting to $76 trillion (100 percent of world GDP and 40 percent of global financial assets; Figure 3.1).
The larger role of the asset management industry in intermediation has many benefits. It helps investors diversify their assets more easily and can provide financing to the real economy as a “spare tire” even when banks are distressed. The industry also has advantages over banks from a financial stability point of view. Banks are predominantly financed with short-term debt, exposing them to both solvency and liquidity risks. In contrast, most investment funds issue shares, and end investors bear all investment risk (see Figure 3.2, and see Annex 3.1 for a primer on the industry). High leverage is mostly limited to hedge funds and private equity funds, which represent a small share of the industry.3 Therefore, solvency risk is low in most cases (see October 2014 Global Financial Stability Report). Intermediation through funds also brings funding cost benefits and fewer restrictions for firms compared with bank financing—it does, however, also expose firms to more volatile funding conditions, so the advantages have to be weighed against the risks.
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