Top mutual funds try to limit growing regulatory scrutiny

Mon Apr 7, 2014 12:13pm EDT

* Funds complain they are unfairly viewed through banking lens

* Funds warn that capital requirements would hit hard

* Central bankers muscle in on securities regulator territory

By Huw Jones

LONDON, April 4 (Reuters) - Top mutual funds face extra scrutiny in the United States and Britain, regardless of whether global regulators push ahead with new rules based on a consultation that closed on Monday.

The consultation by the Financial Stability Board (FSB), the regulatory arm of the world's leading economies (G20), raised hackles by proposing that funds with more than $100 billion in assets are systemically important. That would mean they face extra supervisory requirements that have yet to be spelt out.

Mutual funds invest in shares and bonds, typically to generate income for investors in old age. They argue that tougher regulation will raise costs that will be passed on to investors in higher fees. They also say they don't take risks like banks, so using size as a criterion is misleading.

"Size does not equate to risk," Barbara Novick, vice chairman of BlackRock, the world's biggest asset manager, told Reuters. "If they are going to look for risk, they should look for it in the right place."

The $87 trillion mutual funds industry insists it poses no threat to financial stability and played no part in the 2007-09 financial crisis. That crisis saw taxpayers bailing out banks and the G20 pledging to leave no part of the financial system unsupervised again.

Consequently, securities regulators such as the FSB are showing more interest in the big funds. And no matter what the regulators decide, central banks like the U.S. Federal Reserve and the Bank of England are paying more attention as well.

Based on a $100 billion threshold, about 12 to 14 funds would be affected, all based in the United States. Among them are Vanguard, PIMCO, American Funds, SPDR S&P, Fidelity and JPMorgan, though not BlackRock, as none of its individual funds reaches the proposed threshold. Britain and the rest of Europe would not figure at all.

"There is a sense in Europe that the FSB plans are less likely to bite," said Richard Metcalfe, a director of regulatory affairs at Britain's Investment Management Association. "We believe that no collective funds in the UK would trigger whatever measures it is that the FSB ... might have in mind."

NEXT FRONTIER

The FSB has not set a deadline for deciding on criteria for selecting funds, or for fleshing out the extra requirements. A similar exercise for top banks means they will have to hold extra capital from 2016. Capital rules for top insurers are due to be finished by year end.

The aim is to end so-called "too big to fail" institutions, meaning a fund, bank or insurer so large taxpayers would always save it from collapse, to avoid the turmoil in global markets that occurred when Lehman Brothers bank went under in 2008.

The FSB is expected to update G20 leaders on progress at their summit in Brisbane, Australia, in November. Given the sector's hostility, it could decide to consult further before turning to what extra measures would be imposed on top funds.

One concern for regulators is the potential risk from funds that offer customers an indemnification or guarantee that they and not the investor would bear losses. A basic capital framework is one potential solution for such funds, a person familiar with the FSB project said.

Submissions from the fund industry's trade bodies to the FSB on Monday were adamant that funds bear no resemblance to leveraged banks. But funds in Britain and the United States are likely to feel the heat no matter what the FSB comes up with, industry officials on both sides of the Atlantic say.

The Investment Company Institute, or ICI, a U.S. body that lobbies on behalf of funds and their shareholders, said many regulators see the world through a banking lens.

The FSB is chaired by Bank of England Governor Mark Carney, and central banks are seen to be muscling in on what had been securities supervisors' territory, which looked at products and fees rather than systemic risks. Central bankers usually favour capital requirements for increasing safety at financial firms.

"This would immediately penalise shareholders and probably make the funds uncompetitive and unsustainable," ICI chief executive Paul Schott Stevens told Reuters.

IMA's Metcalfe said it was unclear who would hold the capital, the fund or its manager, and what impact that would have on investment.

Industry insiders say top funds hope that by influencing the FSB they can in turn push back against national central banks like the Federal Reserve and Bank of England, which are also starting to look at mutual funds.

Any recommendations from the FSB will be for regulators like the Fed and BoE to apply nationally.

The Fed is keen to monitor mutual funds, industry officials say. The U.S. Financial Stability Oversight Council (FSOC), which includes the Fed, will host a conference next month on asset management activities.

In Britain, the Bank of England's head of financial stability, Andy Haldane, said in a speech on Friday that major funds can be too big to fail in some circumstances as the sector is set to grow hugely, fed by a rising population of older and richer people.

"The speech raises various issues that, whatever their merit, are simply not recognizable in the case of U.S. mutual funds," Schott Stevens said.

It was the first time the UK central bank had spoken about mutual funds that way, and Haldane said the sector was the "next frontier" for the BoE's Financial Policy Committee, Britain's equivalent to the FSOC.

Haldane estimates that global funds assets could quadruple to $400 trillion by 2050 with big funds already comparable in size to top banks. (Reporting by Huw Jones; Editing by Larry King)