The timing could hardly have been more apt. On June 22, the Financial Stability Board published proposals for dealing with redemption runs in asset management. The next day the UK's vote to leave the European Union triggered a real-world example of just what the FSB was worried about.
By early July, in response to redemption requests after the vote on June 23, UK property funds representing about two-thirds of assets in the sector had suspended trading. The speed with which they did so surprised some in the industry. But what does the UK experience say about the regulation of systemic risk in asset management?
In a sense, the Brexit vote provided an unexpected field test for some of the FSB's ideas. Firms acted quickly to prevent a feedback loop in which redemptions would force cut-price asset sales and spook more investors into pulling money from funds.
"It did feel like we were not long after the Brexit vote and suddenly property funds were suspending," says a partner at a leading UK law firm. "That is very different from the experience during the financial crisis. Then, suspensions were seen as a last resort with managers trying to do all that was possible to avoid suspending because of the risk to their reputation."
In doing so, firms were interpreting Financial Conduct Authority (FCA) rules on suspensions differently from the past. Those rules say firms may suspend if "due to exceptional circumstances [doing so] is in the interest of all the unitholders in the authorised fund".
As a second UK law firm partner puts it, suspending so quickly after the Brexit vote required firms to be pessimistic – in her words "super cautious" – in assessing how exceptional the circumstances were in early July.
"I always viewed suspension powers as exceptional meaning exceptional – something like the market shutting or the 7/7 terrorist attacks in London. Here it was a judgement as to what you thought Brexit might mean. Different people took different views.
"For most of the equity and bond market, June 24 was a bad day at the office but not exceptional. But there is no absolute line about what is exceptional," she says.
Regulators seem, though, to have welcomed this super-cautious approach. "They have lauded us for suspending," says one UK asset management chief risk officer. "The main thing they are worried about is forced selling of assets."
He sees the regulator playing a proactive role going forward, specifically because of concerns about systemic risk: "I think the FCA is going to be very involved [in plans about reopening suspended funds] because this is both a market stability issue and a customer fairness issue."
FCA guidance to the industry on July 8 in reaction to the suspensions further supports this impression, with the authority telling firms not to sell assets in a way that disadvantages investors still in the fund.
That appears to give leeway for funds to stay suspended while they seek buyers for slow-to-sell commercial properties. The chief risk officer thinks some suspensions will likely remain in force for several months.
All this matches the approach advocated in the FSB's proposals. There, the authors note that funds have been slow to suspend in the past because of worries about reputational damage, while supervisors might also fear suspensions spreading panic among wider investors.
The proposals call for the International Organization of Securities Commissions (Iosco) to provide guidance on use of "extraordinary risk management tools" – including fund suspensions – to clarify how they might be used without "spillover effects" and how asset managers can overcome "reputational or competitive reluctance to use [them] where clearly appropriate".
The FSB is consulting on its proposals until September 21, with Iosco to implement much of the plans through guidance that should be finalised by the end of 2017.
One of the FSB's aims is to remove the stigma of such extraordinary measures if they are employed in the right circumstances. A useful lesson from the Brexit vote is that suspensions can be used – at times and for certain types of funds – without necessarily triggering wider panic.
- People moves: SocGen adds in prime services, Deutsche fills new rates hole, HSBC makes model move, and more
- Quant Finance Master’s Guide 2019
- Credit risk quants are hitting the tech gap
- Princeton tops inaugural Risk.net quant master’s ranking
- Does credit risk need an expected shortfall-style revamp?