United States: Treasury Department Urges Principles-Based Regulation Of Money Managers; Delay Of Implementation Of Liquidity Risk Management And Fiduciary Rules

The U.S. Department of the Treasury's report on asset management and insurance recommends, among other things, a delay in implementation of the SEC's liquidity risk management rule and the Department of Labor's fiduciary rule.

The October 2017 report is the third of four that address the president's Core Principles to regulate the U.S. financial system, signed by executive order in February 2017. The report recommends that the Financial Stability Oversight Counsel (FSOC), which broadly oversees systemic risks to the U.S. financial system, back off on entity-based systemic risk evaluations of asset managers, and that the SEC focus on potential risks that arise from asset management and on strengthening the asset management industry as a whole.

This alert summarizes the provisions of the report that directly affect regulation of investment companies and investment managers. We do not address other provisions of the report relating to the Volcker Rule and insurance companies.

To start, the report includes a helpful, plain-English primer on how the U.S. regulates money managers and investment funds, summarizing the maze of regulations and regulators that apply to money managers, including the SEC, the IRS, the CFTC, and the DOL, not to mention state regulators. It highlights protections built in to the Investment Company Act of 1940, as amended, and the Investment Advisers Act of 1940.

The report then sets the stage for rethinking regulation of investment managers in a manner that favors principles-based regulation instead of detailed, rules-based regulations that Treasury believes are overly burdensome.

General Approach to Regulation of Money Managers

Treasury noted that, despite disruptive market events, mutual fund complexes have remained resilient in their ability to maintain total returns and meet redemptions.

The report also notes that, as assets under management (AUM) have continued to increase, so has the cost of regulatory compliance. Citing a Duff & Phelps report, the report says that money managers expect their cost of compliance to increase from four percent of total revenue to 10 percent of total revenue by 2022, and that many of these costs ultimately will be passed on to investors.

The report signals a likely change in direction by FSOC on prudential regulation of asset managers. In widely criticized reports, FSOC has suggested that asset managers present systemic risks to the financial system, and thus additional prudential regulation (e.g., capital and operating restrictions that are applied to banks and bank holding companies) would be appropriate. With regards to prudential regulation, Treasury emphasizes the difference between asset managers and banks, noting that "asset managers and investment funds, in contrast to banks, are not highly leveraged and do not engage in maturity and liquidity transformation to the same degree that banks do through the use of bank deposits and other forms of credit."

Treasury notes that, over the past 20 years, expense ratios for stock and bond funds have decreased, while "substantial asset flows are going to fewer asset managers and global competition has placed downward pressures on margins," especially for smaller investment advisers. The report notes that increased regulation, particularly implementation of compliance programs, has increased the downward pressure on margins, disproportionately affecting smaller asset managers and "reduc[ing] the ability of asset managers to reinvest for innovation and long-term growth."

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Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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Julian E. Hammar
 
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