IMF U.S. review urges more risk oversight of asset managers and insurance, AML reforms

An International Monetary Fund (IMF) review of the U.S. economy adds to international calls for stricter regulations of the asset management industry, including stress testing.

The IMF's June 22 report also expresses concern over the clarity of U.S. anti-money laundering enforcement policies, insurance regulation and identification of the true owners of commercial entities. Its call for stricter oversight of asset management comes on the heels of a similar call from the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO).

The FSB, which coordinates regulation for the G20 economies published policy recommendations to address structural vulnerabilities from asset management activities that could potentially present global financial stability risks. 

IOSCO, the international body of the world's securities regulators, develops, implements, and promotes adherence to internationally recognized standards for securities regulation. IOSCO works closely with the G20 and the FSB on the global regulatory reform agenda. An IOSCO statement this month points out data gaps in the asset management industry and how the body is working with the FSB in this area

As the six-year anniversary of the passing of the Dodd–Frank Wall Street Reform and Consumer Protection Act nears, U.S. financial services firms are experiencing a touch of regulatory fatigue as the industry continues to digest the massive industry regulatory overhaul. However, industry participants are aware that when international financial regulatory or governing bodies such as ISOCO, the FSB and IMF push their initiatives, the U.S. frequently falls into line. 

Furthermore, the international focus is echoed by domestic U.S. regulators including the Securities and Exchange Commission (SEC) and the inter-agency Financial Stability Oversight Council (FSOC). Therefore, the IMF call for stress testing of asset management is unlikely to be ignored.

The IMF report on the U.S.

The IMF report urged the United States to build "a more complete and transparent data landscape in the asset management industry." The effort "should go hand in hand with a structured effort to implement comprehensive stress testing programs for the asset management industry that focus on liquidity and counterparty risks."

The IMF report also criticized the absence of harmonized national standards or a consolidated supervisor in the U.S. life insurance industry. The current structure under state regulation makes any assessment of risks in the industry incomplete. According to the report, "a coordinated nationally consistent approach to regulation, supervision, and stress testing is needed with regulatory oversight assigned to an independent agency with a nation-wide mandate, operational independence, and appropriate powers and accountability." 

The report credited Dodd-Frank for stimulating regulatory intensity particularly in the areas of banks' capital planning, stress testing and corporate governance. It also praised The Federal Reserve's Comprehensive Capital Analysis and Review stress-testing process as particularly valuable.

Anti-money laundering and combating the financing of terrorism (AML/CFT) was another concern in the report. It noted that a number of U.S. banks had withdrawn from correspondent banking relationships. It cited broad factors including "insufficient regulatory clarity, reputation concerns of the banks, possible conflicts in regulations (e.g. with data privacy laws), and economies of scale in compliance," and suggested that in the United States "the risk-based regulatory approach should strive to provide more clarity."

Lastly, the IMF report said, "A more structured, uniform and complete solution is needed to the current lack of transparency in beneficial ownership in the U.S." It recommended federal legislation to make beneficial ownership information, now subject to a patchwork of state regulations, more readily available to regulators and law enforcement. 

With the added media attention because of the "Panama Papers" and concerns over beneficial ownership transparency, and AML, look for this to be a continued top priority with regulators.

The IMF report is a somewhat general, and macro overview of the U.S. economy that briefly touches on some structural and political topics. The IMF call for tighter regulation, stress testing, and more data in the asset management industry is noteworthy as the timing of the report was nearly simultaneous to the FSB and IOSCO reports calling for the same

FSB and IOSCO recommendations for asset managers

The FSB's policy recommendations identified four important structural vulnerabilities in the asset management industry. The following vulnerabilities are seen to pose potential stability risks and should be addressed:
    • Liquidity mismatch between fund investments and redemption terms and conditions for fund units;.

    • Leverage within funds;.

    • Operational risk and challenges in transferring investment mandates in stressed conditions; and.

  • Securities lending activities of asset managers and funds..

The FSB's concern with liquidity mismatch and leverage as significant risks on which to focus are also shared at the Securities and Exchange Commission and the FSOC. The SEC has proposed new rules and restrictions on the use of derivatives which will likely limit leverage in funds. FSOC also recently published a report voicing the same concerns.

The FSB proposed recommendations are to be implemented over two years from the end of 2017. They are designed to provide national regulators and asset management entities with the tools and data to effectively detect and address the identified risks. The recommendations call for national regulators to collect more data on the sector, monitor leverage, and ensure that funds have the right set of tools to use in stressed markets, such as swing pricing, redemption fees and other anti-dilution methods. They also recommend that national regulators provide guidance or requirements on stress testing for funds.

The FSB initially planned to include pension and sovereign wealth funds in their recommendations but has decided to address them separately. The comment period closes September 21, 2016. The FSB intends to finalize the policy recommendations by the end of 2016.

IOSCO set out their priorities and recommendations for reducing data gaps in the asset management industry and has suggested that data in the following areas should be obtained on a priority basis; Open-ended regulated Collective Investment Schemes (CIS), Separately managed accounts, and Alternative funds.

IOSCO recommends that regulators encourage the use of internationally agreed standards.. The use of standards will enable regulators and organizations to measure, manage and monitor more effectively counterparty exposure on a global level.

With the IMF report following the FSB and IOSCO, the international bodies are now clearly on board with the SEC and FSOC when it comes to voicing concerns about risk in the asset management industry whether in hedge funds, mutual funds, or private separate accounts. 

The SEC has been on top of the liquidity concern in mutual funds. In its annual exam priorities going back to 2014 the agency set its sights on the fixed-income sector and the underlying liquidity in fixed-income mutual funds. In September 2015 it unveiled proposed new liquidity risk management rules for mutual funds just as the high yield credit markets were experiencing a significant decline leading to the closure of a number of private funds and the collapse of a well-known mutual fund. 

All of these regulators are generally suggesting that large asset managers are likely to be hit with additional reporting, planning and disclosure requirements, and perhaps stress tests, in the coming months. 

Many of the issues raised by IMF, FSB and IOSCO are already in the SEC's crosshairs. One thing is certain, all regulators will continue to warn of a need for more oversight, rules and regulations in keeping with their purpose.
Todd Ehret is a Senior Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence. He has more than 20 years' experience in the financial industry where he held key positions in trading, operations, accounting, audit, and compliance for broker-dealers, asset managers, and hedge funds.