Asset Management and Financial Stability: Financial Stability Oversight Council Publishes Statement on Asset Management; Focuses on Liquidity, Leverage; Creates “Interagency Working Group” on Hedge Fund Leverage

Sullivan & Cromwell LLP - April 25, 2016

On April 18, 2016, the Financial Stability Oversight Council (“FSOC”) held an open meeting during which it unanimously approved a public statement on its review of potential risks to U.S. financial stability that may arise from asset management products and activities (the “Statement”).  The Statement follows the 2013 report by the Office of Financial Research (the “OFR”) on systemic risk in the asset management industry (the “OFR Report”) and FSOC’s subsequent announcement that it would undertake a thorough review of asset management products and activities, including a request for public comments on such products and activities.

The Statement focuses on two main topics: (i) liquidity and redemption risk, especially financial stability concerns that may arise from liquidity transformation and “first-mover” advantage, particularly in mutual funds; and (ii) the use of leverage, particularly by mutual funds and hedge funds.  The Statement, citing the proposition that “no single regulator has all the information necessary to evaluate the complete risk profile of hedge funds,” also announces the creation of an “interagency working group” to further study whether use of leverage by hedge funds may pose a risk to financial stability, with a report expected in the fourth quarter of 2016.  In addition, the Statement addresses operational risk (including service provider risk), securities lending (including the need for enhanced data collection) and resolvability and transition planning.

The Statement received notable public support from FSOC members.  Most prominently, on April 20, 2016, U.S. Treasury Secretary Jacob J. Lew, who chairs FSOC, authored an op-ed in the Wall Street Journal explaining the Statement and defending the initiative, stating: “[FSOC’s] unanimous approval of the [Statement] issued this week is an important step toward improving the stability of our financial system.”  U.S. Securities and Exchange Commission (“SEC”) Chair Mary Jo White and Commodities Futures Trading Commission (“CFTC”) Chairman Timothy Massad also made public statements.  These actions may be a response in part to previous criticism of the OFR Report and FSOC’s procedures, as well as to the March 30, 2016, decision by the U.S. District Court for the District of Columbia rescinding FSOC’s designation of MetLife, Inc. as a systemically important non-bank financial company.