In 2014, the US Office of Financial Research (OFR) suggested that asset management firms, on account of the enormous capital flows they facilitate, should be designated as systemically important financial institutions (SIFIs). Although the focus of regulators seems to have shifted away from investment firms and towards better understanding market liquidity risks, the question of the investment industry’s association with financial stability, or lack thereof, remains relevant.
In an address to the CFA Society, Bob Jenkins (Adjunct Professor of Finance at the London Business School) argued that, in order to safeguard the stability and sustainability of our industry, investment managers need to act against financial practices that they consider to be destabilising. He points to three compelling reasons why the investment industry should adopt an active stance on this matter, namely:
- It is in the investment industry’s interests (certain speculators aside) to maintain a stable financial system
- Financial instability erodes trust in the financial services industry as a whole
- The investment industry is next on the list as a target for regulatory attention
Jenkins singles out persistently high levels of leverage in the banking sector as the biggest potential contributor to another financial meltdown. Banks have, he contends, successfully either diluted or delayed regulation that seeks to limit their capital margins (Basel III and Dodd-Frank). There has so far been no coordinated response to counter the banks’ position – ie to insist on reduced potential to engage in leverage as a means of improving financial stability. Jenkins encourages investment organisations to speak out against this and support tighter constraints on permitted leverage. To do nothing, he suggests, is a failing in the investment industry’s responsibilities to the people who entrust it with managing their money.
Jenkins stops short of saying what form the industry’s stance on this issue might take, but his argument raises some questions regarding responsibilities associated with ownership. For starters, we might ask whether asset managers/owners should have been more aware and/or vocal regarding financial practice that led to the GFC. And, given what we have learnt about the dangers of leverage, what action might a responsible owner take? Should they disinvest, in which case ownership would revert to less engaged, less scrupulous investors? And what are the consequences of investors staying invested but upping their stewardship standards? What scope is there for owners to collaborate to make a difference?
There is another unanswered question implicit in this address: what has stopped investment organisations from taking action to date? Clearly, there are some conflicts in the case of bank-owned asset managers, but this doesn’t explain the silence of the rest of the industry. Is there a general reluctance to take on the responsibilities of engagement as owners? And if so, what needs to change for investors to become more involved?