Fund managers globally could face new liquidity and leverage stress tests, according to Bank of England governor, Mark Carney, as regulators delve deeper into non-bank systemic risk management.
Carney issued the warning in a speech to the Institute of International Finance (IIF) in Tokyo last week just as a liquidity crisis engulfed a high-profile UK investment manager.
Former star UK investment manager, Neil Woodford, shuttered his flagship £3.7 billion Woodford Equity Income Fund last week following a flood of redemption requests.
Woodford has blocked withdrawals from the poorly-performing income fund for at least 28 days as the manager attempts to unravel a number of illiquid holdings.
A former high-ranking politician in the UK financial services ministry, Lord Myners, criticised both the UK regulator, the Financial Conduct Authority (FCA), and administrator, Link Fund Solutions, for failing to spot the Woodford issues earlier.
“The people losing out here are the end investors,” Myners told the BBC. “The professionals are OK, the regulator will give itself two years to carry out a review of what went wrong, and the same risks will continue of allowing illiquid assets to be put in portfolios that are treated as if they are liquid.”
While the Woodford affair did not feature explicitly in his IIF speech, Carney said more than half of investment funds globally have a “structural mismatch between the frequency with which they offer redemptions and the time it would take them to liquidate their assets”.
“Under stress they may need to fire sell assets, magnifying market adjustments and triggering further redemptions – a vicious feedback loop that can ultimately disrupt market functioning,” he said.
Investment vehicles domiciled in the US and Europe represent about two-thirds of all liquidity-mismatched funds with many investing across jurisdictions, Carney said, which suggested better regulatory oversight of those risks “is both a national asset and a global public good”.
He said the Bank of England, and other financial regulators, were developing “system-wide stress simulations” to measure fund liquidity and leverage risks.
“And authorities are beginning to consider macroprudential policy tools to guard against the build-up of systemic risks in non-banks,” Carney said.
“Regulators currently have far less sight of risks within funds compared to the core banking system, particularly synthetic leverage arising from funds’ use of derivatives.”
The International Organisation of Securities Commissions (IOSCO) – of which the Financial Markets Authority (FMA) is a member – is currently consulting on a global set of standard leverage metrics for investment funds.
“To be most decision-useful, these need to be consistent and comprehensive across countries,” Carney said.
He said the IOSCO proposals could create new “best practice” benchmarks such as better-aligning fund redemption periods with underlying asset liquidity.
“We are mindful that these decisions could have global as well as local implications,” Carney said.