SIFI Designation is Unnecessary for Regulated Funds—and Would Be Harmful to Funds, Investors, and the Capital Markets

1. SIFI designation of regulated funds or their managers is unnecessary

  • The Financial Stability Oversight Council (FSOC) has acknowledged that regulated funds use little to no leverage [page 13].
  • Regulated funds don’t fail like banks do—investment losses are absorbed by fund investors, so there’s no need for a government bailout.
  • Unlike banks, fund managers act as agents [page 3]. Fund investors—not fund managers—bear the risks of any portfolio losses, or the benefits of any gains.
  • U.S. regulated stock and bond funds have stable investor bases. Even for the largest U.S. regulated stock and bond funds, and even during times of market stress, there is no historical evidence to warrant “herding” or fire-sale concerns.
    • History demonstrates that U.S. regulated stock and bond fund investors show muted responses to even severe financial market shocks.
    • Even when investors do sell their fund shares, they often reinvest the proceeds in similar funds.
  • Regulated fund structure and regulation limit risk and risk transmission [page 7].
    • Funds and their managers are comprehensively regulated under the Investment Company Act of 1940, other federal securities laws, and related SEC regulations.
      • These regulations require daily mark-to-market valuation, liquidity to support redemptions, limits on leverage and borrowing, a simple, transparent capital structure, and more.

2. SIFI designation would impose new costs on investors, including possibly paying to bail out another failing institution

  • Designation would mean new fees and added costs.
    • Based on the Dodd-Frank Act and the FSOC’s actions to date with SIFI firms, it’s expected that the FSOC would impose bank-like regulation—including capital and liquidity requirements—and new fees and assessments, possibly including assessments to help shoulder the costs of bailing out a large, failing financial institution.
    • As fund expenses, the costs of those fees and assessments ultimately would be borne by fund investors.
    • American Action Forum research from May 2014 showed that fund investors would bear the costs of SIFI designation and capital requirements.
      • The research found that, in some cases, investors could see their returns reduced by as much as 25 percent (approximately $108,000) over the long term, forgoing several multiples of their initial principal in lost returns over the course of a working life.
    • The precise impact on any investor would depend on the investor’s investment objective, fund choice, and time horizon. But an FSOC SIFI designation must justify the fact that any designation, and the resulting capital requirements and other bank-like regulation, would have noticeable effects on investors’ returns.
  • SIFI designation could harm a fund’s ability to serve its investors.
    • The goals of the Federal Reserve’s prudential supervision could conflict with the fiduciary duty of a fund manager to act in the best interests of the fund.
    • For example, the Federal Reserve could require a designated fund to hold more cash or cash-equivalent securities than contemplated by its investment objectives and policies. This could make it challenging for the fund to deliver the investment strategy and performance that its investors expect.
  • Designation could distort the competitive landscape.
    • Investors are highly sensitive to fees and their effect on investment returns. The higher costs imposed on designated funds would make them less attractive to investors and thus could distort the competitive landscape and limit investor choice.

3. SIFI designation would be harmful to regulated funds and the capital markets

  • Bank-style capital requirements are fundamentally incompatible with the regulated fund business model.
    • Designated funds would fall under “prudential supervision” by the Federal Reserve, despite the fact that funds already are extensively regulated by the U.S. Securities and Exchange Commission, whose mission includes protecting investors.
    • A designated fund could be required to meet bank-level capital requirements of as much as 8 percent of fund assets.
    • Regulated funds have neither the need for capital nor the ability to meet capital requirements.
  • Imposing bank-like regulation on regulated funds would damage U.S. capital markets, which are the envy of the world and the engine of growth for our economy.
    • Regulators’ recent emphasis on “macroprudential” regulation could impose highly prescriptive bank-like regulations that could push fund managers toward a common set of “approved” investments—just as the Basel standards pushed banks toward a standard portfolio of “lower-risk” assets, and thus helped usher in the financial crisis of 2008.
    • This shift could undermine, rather than enhance, the resiliency of U.S. and global financial markets by:
      • diminishing diversification in financial services and financing for economic activity;
      • increasing correlation and herding;
      • exacerbating volatility;
      • increasing the probability of shocks to the financial system; and
      • amplifying—rather than muting—the impact of such shocks.
  • Capital markets and banking have existed side by side since the Great Depression, and the healthy competition between these two forms of finance has spurred growth and innovation for both savers and users of capital.

4. Data and empirical evidence—not conjecture—must drive asset management review

  • Any regulatory inquiry of asset management should be based on empirical evidence and data; ICI has and will continue to respond to questions in great detail.
  • Good government requires that regulators listen; pay attention to the analysis, the data, and the historical record; and weigh the costs of their remedies against actual benefits in realistic scenarios.
  • To date, the FSOC and the Financial Stability Board (FSB)—an international regulatory body—have approached the review of asset management based on theory, not data and experience.
    • In their consultations and requests for information, the FSOC and the FSB do not point to any actual events in which regulated stock and bond funds raised systemic threats, even in the greatest financial crisis since the Great Depression.
    • Instead, they repeatedly assume hypothetical situations where funds and their investors could pose systemic risk through “herding” and “run risk,” which are unrealistic and for which there is no evidence, based on the 75-year history of U.S. regulated stock and bond funds.

5. FSOC’s transparency and process must be improved

  • There’s widespread support for improving the FSOC transparency and SIFI process.
  • While ICI supports preliminary steps taken by FSOC to increase communications and interaction with firms under review, further improvements are necessary, including:
    • a path for a company to eliminate risk rather than being designated;
    • a greater role for the primary financial regulator;
    • greater transparency; and
    • periodic comprehensive review of whether designated companies should remain designated.
  • ICI supported the bipartisan FSOC reform bill sponsored by Representatives Dennis Ross (R-FL) and John Delaney (D-MD) that would establish in law a number of FSOC transparency and process reforms to ensure that FSOC operates with adequate due process and consistency, and is truly focused on reducing systemic risk.
    • Giving the primary regulator and a targeted firm the opportunity to address identified systemic risks prior to final designation achieves regulators’ goals over designating a fund to be regulated by the Federal Reserve with yet to be determined “heightened prudential supervision.”

6. An activity-based approach, led by the SEC, is a better way to address regulators’ concerns about potential risks in capital markets

  • ICI supports an activity-based regulatory approach that draws on the expertise of primary regulators.
    • Under a marketwide activity-based approach, regulators use their considerable rulemaking authority to determine whether specific activities or practices could pose risks to the financial system—and to address those risks if necessary.
    • Regulators’ rulemaking authority was substantial before the financial crisis, and has been further strengthened by the Dodd-Frank Act.
  • Targeting activities and practices will engage primary regulators that have deep experience and expertise with specific industries and markets.