The Securities and Exchange Commission is in the early states of creating new rules to monitor the risk that mutual funds and hedge funds pose to the larger economy in the event of a market shock, according to the Wall Street Journal.
Specifically, fund companies such as Fidelity and BlackRock will be subject to stress tests to determine how their funds would react to a sudden rise in interest rates.
The Financial Stability Oversight Council recently announced that it will not tag Fidelity and BlackRock as Systemically Important Financial Institutions, as it had been considering.
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The SIFI designation would have brought the fund companies under the regulation of the Federal Reserve, and would have required them to increase their capital reserves. The FSOC was created by the Dodd-Frank legislation, and is charged with assessing the systemic risk in financial institutions. Mary Jo White, chairwoman of the SEC, sits on the FSOC.
The Investment Company Institute, the primary lobbying association of the mutual fund industry, was a vocal opponent of the FSOC's proposal to bring heightened regulation to fund companies.
But on Monday, ICI's president, Paul Schott Stevens, said in a statement that he welcomes the SEC's inspection of the potential systemic risks in the fund industry.
"Any risks that may arise in asset management are best addressed by the SEC, which has a highly successful track record of regulating funds and advisers under statutory authority for almost 75 years," said Schott Stevens.
The Wall Street Journal said the SEC has concerns with mutual funds using derivatives to boost returns.
The agency is considering ways to reign in alternative mutual funds, which use hedging strategies and increase leverage with futures and derivatives contracts, the paper said.
Leveraged Exchange Traded Funds, which have struggled to gain footing in defined contribution plans, are also being reviewed. According to the Journal, leveraged ETFs use derivatives to double, and sometimes triple, the daily performance of the indexes the funds track.
Proposed regulations would require ETFs that leverage derivatives to have enough cash and stock reserves to meet investors' redemptions in the event of a market shock.
The SEC is reportedly also considering requiring fund companies to create a "living will," much as the FSOC has required of the biggest banks, to outline how the companies could be sold off in an orderly fashion were they to go out of business.
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
