The topic of whether or not Australian banks are well capitalised has been running hot. However the asset management sector has largely gone unnoticed when talking about financial system stability. In Australia, total assets held by asset managers (including superannuation funds, insurers and units trusts) are 75% of the assets held by banks. In fact the burning question at the moment when talking about asset management seems to be whether or not you need $1m to have a comfortable retirement. In addition, industry professionals vent plenty of frustration when talking about the apathy the Australian population seems to have towards saving for retirement. However this apathy could be one of the factors that mitigate the systemic risk from the asset management sector, according to this informative article from the RBA.
Since the GFC, the asset management sector globally has grown strongly. This has been driven by a combination of factors, such as the pursuit of yield by investors. The sector has also stepped in to fill part of the void left by banks as they scaled down their market making or trading activities in response to regulations introduced after the GFC.
Asset managers operate very differently to banks and face different risks. Importantly the returns from assets held by asset managers are passed to a diverse range of investors, whereas the bank holds all the risks on its assets. However asset managers still pose risks to financial stability. A key risk is the potential for “fire sales” when asset managers face heavy and sudden redemptions in a crisis. This is a risk primarily for open ended funds and is equivalent to a bank run. There is also counter party risk. Asset managers are clients of banks and other financial services firms. Some funds (and hedge funds in particular) can be heavily leveraged. Other linkages can exist through derivative transactions, collateral and repo arrangements. Finally many large asset management companies are owned by banks leading to intragroup contagion risk.
Internationally a number of regulatory and standards setting bodies have taken actions to help mitigate against this risk. Actions include publishing principles for liquidity management, introducing tools for liquidity management by regulators, other policy recommendations, and the Financial Stability Board policy framework for shadow banking.
The assets held by superannuation funds, ordinary investment funds and insurance companies are around 75% of the assets held by banks. This is projected to grow over time in line with superannuation contributions entering the system. Should we be concerned by the threat to financial stability from asset managers? And should the government and regulatory bodies do more to put in place measures to mitigate this risk?
Thankfully there are a couple of structural features in the Australian context which provide some safety. Firstly superannuation savings cannot be accessed until preservation age (i.e. retirement ) is reached. This means that it is not possible for investors to cash out their savings. However there is still the possibility that investors will switch to cash funds during a crisis resulting in funds rapidly selling off assets such as equities. This is where the apathy of superannuation investors could be a blessing in disguise. During the GFC, there was limited evidence of switching between funds by investors. If you wish to learn more, the RBA article is great source with further facts, figures and references.