Applying a 'too big to fail' designation to major US fund groups would risk seriously affecting their operations in Asia, regulators have been warned.

Such a move would hit Hong Kong particularly hard, with the city’s reliance on foreign aset managers making it vulnerable to systemic risk classifications coming from the US.

However, the US body that determines which firms are too big to fail has pledged to boost transparency in its operations after criticism from lawmakers.

The US Financial Stability Oversight Council (FSOC) is currently considering whether some asset management firms should be deemed too big to fail, just as many of the big US banks were classified following the collapse of Lehman Brothers in 2008.

The subsequent stringent regulations for banks may now be extended to the asset management industry. Financial institutions, in particular non-bank groups considered, in official parlance, to be 'systemically important financial institutions' (Sifi), have railed against the move. US life insurer MetLife has gone so far as to launch a lawsuit against the FSOC for having labelled it as a Sifi last month.

Some groups have expressed concern that being labelled too big to fail would negatively impact their competitive position, as well as subjecting them to greater regulatory scrutiny and higher capital requirements.

If some of the largest US fund houses do become categorised as Sifis, those with bases in Asia could suffer collateral damage, in that they would, as a result, have fewer resources to aid their expansion in the region.

“I think Sifi fund designation would be bad news for those fund managers," said Karl Egbert, Hong Kong-based partner at law firm Dechert. "To the extent that you’re increasing cost and capital requirements on a major fund manager, then it will have an impact in Hong Kong.”

Asian jurisdictions such as Hong Kong have long relied heavily on overseas-domiciled funds, such as Ucits, to help funds gain scale efficiency to keep costs low. “It will be a terrible thing for Hong Kong because Hong Kong is already a relatively small market,” Egbert said.

“Hong Kong needs more variety of funds, not less … that’s a problem that can only be solved right now by piggybacking off other markets that are large [through cross-listing, for example],” he added. “A Sifi label is going to implicate one of those larger managers.”

One of the biggest concerns in the market is the lack of ETF varieties in Hong Kong, with almost half of funds listed on Hong Kong’s stock exchange (67 out of 99) currently tracking China equities, and 30 having launched since 2012 through the use of renminbi qualified institutional investor (RQFII) quota to physically replicate an index.*

While concern remains, one small glimmer of hope, at least for fund managers, is that the FSOC has vowed to increase transparency and improve the way it communicates its decisions, after having come under fire from lawmakers, as reported.

The council has also voted to extend until March 25 the deadline for its consultation on Sifi designation of fund houses.

The consultation is part of a wider enquiry globally as to whether to designate asset managers and other non-bank financial institutions as Sifi, including one currently under way by the Financial Stability Board, an international body that monitors and makes recommendations about the global financial system, in conjunction with the International Organisation of Securities Commissions (Iosco).

Hong Kong authorities are also looking into the decision, with the government warning the funds industry that “authorities consider that it would be premature to conclude that asset managers …  should be excluded from the scope of the regime, since their systemic relevance is still under consideration by the FSB/Iosco”.

Alan Ewins, Asia special counsel for Allen & Overy, noted that by themselves most Hong Kong entities regulated by the Securities and Futures Commission, were not large enough to count as systemically important for the market. But if they were part of a major global banking group, it would make sense for their position to be factored into any resolution arrangements in the event of bankruptcy hitting the parent group.

Hong Kong’s own consultation will end on April 20.

*Read the February 2015 issue of AsianInvestor for the full feature on Hong Kong's ETF market