Point of View

Group Calls on Central Banks To Manage Systemic Risk

A new working paper calls for charging central banks in each country with the responsibility of preserving the stability of the overall financial system rather than the health of individual institutions. This approach would help not only manage systemic risk, but also prevent financial crises.

The paper, “A Systemic Regulator for Financial Markets,” was authored by the Squam Lake Working Group on Financial Regulation of the Council on Foreign Relations (CFR). The group argues financial regulations in almost all countries are designed to ensure a focus on institutions, principally commercial banks. This focus has two dangerous consequences. First, this focus on individual firms ignores critical interactions between institutions. Second, a focus on individual firms can cause regulators to overlook important changes in the overall financial system. The working paper makes five recommendations for correcting the situation:

• The regulatory structure for financial markets and financial institutions should include a systemic regulator that oversees the health and stability of the overall financial system in each country and limit systemic shocks.
• The central bank should be the systemic financial regulator because of its independence, daily market interactions, focus on macroeconomic stability and role as lender of last resort.
• The systemic regulator should not be involved in consumer protection and business-practices regulation. Those roles should be given to one or more separate agencies.
• The systemic regulator must be given adequate resources to identify systemic risks and craft needed regulations.
• The central bank should be given an explicit mandate for stability of the financial system.

The Squam Lake Working Group is a nonpartisan, nonaffiliated group of 15 academics that offers guidance on financial regulation reforms. This is the fourth in a series of working papers distributed by the CFR’s Center for Geoeconomic Studies. To download the complete series of Squam Lake working papers, go to cfr.org.

Hedge Fund Survival May Hinge on Ability to Change

Hedge funds will need to alter their business and operating models if they are to reverse the outflow of assets that began in 2008, according to research by management consulting firm Casey Quirk.

In its April 2009 research paper, “The Hedge Fund of Tomorrow: Building an Enduring Firm,” the firm states hedge funds’ recovery and future prosperity depends on successfully aligning the interests of investors, firms and investment teams. “Future alignment structures will match investor liquidity needs, portfolio liquidity, investment horizon, performance measurement and payout periods,” the paper concludes.

Casey Quirk forecasts hedge fund assets will reach almost $2.6 trillion in 2013, with North American institutions the greatest source of growth. The firm also expects funds of hedge funds will remain the primary hedge fund distribution channel, receiving about 60% of net asset flows between 2010 and 2013.

For more information and a copy of the research paper, go to caseyquirk.com/knowledge_center.

Global Responses to Money Market Fund Upheaval

The tumultuous events in the money market fund (MMF) industry during September and October 2008 have sparked calls for regulatory changes worldwide. In the United States, the Investment Company Institute formed an MMF working group that published recommendations for the industry in March. Those recommendations were:

• An MMF should hold a minimum of 5% of net assets for daily liquidity and a minimum of 20% of net assets in securities accessible within seven days.
• The maximum weighted average maturity should be reduced to 75 days from 90 days to protect against interest rate risk.
• MMFs should implement “know our client” procedures to understand expected redemption practices and liquidity needs of investors.
• MMFs should review and, if appropriate, revise the risk disclosure they provide investors and markets.
• A non-public regime should be implemented to facilitate the provision of information to an appropriate government entity to allow adequate and effective financial markets oversight.

The Securities and Exchange Commission has proposed amendments to the rules governing MMFs under the Investment Company Act. The SEC is accepting comments on its proposals until Sept. 8.

In Europe, the Institutional MMF Association (IMMFA), which represents variable net asset value funds, also has formed a working group to study the future structure of those products.

For more information on the ICI’s recommendations, ici.org. Information on the IMMFA group can be found at immfa.org.

Participants Use DC Assets to Weather Storm

U.S. defined contribution (DC) plan participants have been using their retirement savings as a funding source during the current financial crisis, but that activity appears to be tapering off, a survey by Watson Wyatt Worldwide finds.

The survey of human resource executives at 179 U.S.-based companies found 35% of employers saw an increase in hardship withdrawals taken in June 2009, down from 44% in April 2009 and the same level of activity as February. The percentage of employers seeing an increase in hardship withdrawals was 16% in December 2008 and 15% in October of that year.

Similarly, the number of loans from 401(k) and 403(b) plans seems to be leveling off. About half of the employers surveyed, 47%, saw an increase in loan activity in June, the same percentage as in April of this year. That is up slightly from the 45% of employers in February and still significantly higher than the 27% reported for this past December 2008 and 19% for October 2008.

The most recent update of the survey, “Effect of the Economic Crisis on HR Programs, Update: June 2009,” can be found at watsonwyatt.com.

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