Mutual funds are not systemic threats to financial markets, investment industry body ICI will argue in a letter to be submitted later today to the Financial Stability Board (FSB). ICI contends that proposals by the supranational body would in fact be harmful for investors.

As part of efforts by regulators to identify ‘global systemic financial institutions’ (G-Sifis), the FSB proposed methods in January for assessing which entities fit this description. Today is the deadline for comments.

Designating mutual funds as G-Sifis would allow regulators to apply capital standards, prudential supervision and other forms of bank-like regulation that are inappropriate for mutual funds, says Dan Waters, London-based managing director at ICI Global. He was giving AsianInvestor an advance outline of ICI’s comments on behalf of US and global funds.

Forcing funds to hold a few percent of their assets in capital is unworkable, as funds don't hold capital, so they may become more expensive for investors as a result, adds Waters. “It’s quite an astonishing proposal.”

The FSB’s methodology for assessing investment funds is “fundamentally flawed” and ignores characteristics of US mutual funds that make designation inappropriate and unnecessary, he says. These include that:

  • regulated funds make little use of leverage – the essential fuel of financial crises;
  • the structure and comprehensive regulation of mutual funds and their managers – including daily valuation of fund portfolios and liquidity requirements – not only protect investors, but limit systemic risks and the transmission of risk;
  • these funds simply do not “fail” the way other financial companies do; and
  • concerns about “systemic risk transmission” through counterparties or liquidity concerns are not supported by historical evidence and ignore fundamental factors in place, such as the fact that funds have a very stable investor base.

Another problem, notes Waters, is that the FSB proposes selecting funds for assessment based solely on a size threshold, set at an “arbitrary level” of $100 billion or more in assets under management. Only 14 funds worldwide currently fall in this category, and all are US-regulated.  

That said, if these proposals are agreed, national regulators would apply the methodology domestically, and will be able to look below the $100 billion threshold, he says. “There must be concerns for large funds currently below the threshold that local authorities may decide they are systemically significant.”

“Size alone reveals very little about whether a fund could pose risk to the global financial system,” notes Waters. Any threshold should also take into account factors such as leverage and a fund’s interconnections with other financial institutions.

The potential cost of Sifi designation for funds could be great – and would be borne by fund shareholders, he explains. A fund might have to hold substantially more cash than it planned for in setting its investment objectives, impeding its ability to deliver its investment objectives and reducing investors’ returns.

In addition, under US law, Sifi designation could put investors of those funds on the hook to be assessed to help pay for a failing institution. That goes against regulators' goal of ending US taxpayer bailouts of financial institutions, says Waters.

Alternative investment funds such as hedge and private equity vehicles are also included in the FSB’s consultation, but these are not within ICI’s area of coverage.