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FSOC Meeting

Financial Stability Oversight Council (FSOC)

Open Meeting
Friday, February 4, 2022

Top Line

  • FSOC voted favorably to issue a public statement to reaffirm its commitment to addressing the vulnerabilities and financial stability risks of non-bank financial intermediaries.
  • FSOC staff, SEC staff, and regulators discussed reforms and financial stability risk posed by hedge funds, open end funds, and MMFs.

Non-Bank Financial Intermediation Presentation
Janet Yellen, Secretary, U.S. Department of Treasury

Yellen discussed her identification of vulnerabilities in non-bank financial intermediation as a key area of focus for FSOC. She stated that market stress in 2020 demonstrated how vulnerabilities in non-bank financial intermediation, especially with hedge funds, open end funds, and money market funds, can amplify existing stress in the financial system and concluded that FSOC has made progress on addressing these risks.

Alexandra Summer, Policy Analyst, FSOC

Summer updated the Council on hedge fund working group progress and next steps. She stated that the  group’s analysis found two channels through which hedge funds use of leverage could pose risks to financial stability: (1) by causing or contributing to market disruption through forced asset liquidations and (2) by transmitting risk to counterparties that are large, highly interconnected financial institutions. She then explained that the working group also considered an additional channel, that a reduction in hedge fund intermediation could, under certain conditions, potentially impair market functioning. Summer explained the working group’s attention to two case studies, including hedge funds’ role in the March 2020 treasury market turmoil and the 2021 Archegos failure. She explained that Archegos’ failure illustrated how leveraged investment managers can transmit stress to the other parts of the financial system. She added that hedge funds contributed to market disfunction but were not the sole cause and were among the largest liquidators of Treasury securities alongside open end funds and foreign investors.

Summers highlighted a main conclusion of the working group, which said that Archegos’ failure revealed shortcomings in counterparty risk management practices and margin models sometimes employed at global financial institutions. She outlined four staff-identified areas for future work, including: (1) coordinating with the interagency working group on treasury market surveillance in examining the important role hedge funds play in the treasury market and their implications for market resiliency, (2)

considering initiatives to improve data on hedge funds and the markets in which they operate, (3) establishing an inter-agency risk monitoring system to identify potential emerging financial stability risks posed by hedge funds, and (4) considering options to mitigate risks identified in the two case studies.

Kelsey Pristach, Senior Policy Advisor, FSOC

Pristach discussed two channels identified by the Council’s open fund working group’s 2016 asset management statement that give rise to financial stability concerns. These include liquid transformation and first mover advantage. She described open end fund activity during the early pandemic and how the working group’s findings support continued focus on open end funds. She added that the size of open fund asset liquidation means they contributed to stress at the beginning of the pandemic.

William Birdthistle, Director of Investment Management, Securities and Exchange Commission (SEC)

Birdthistle explained the SEC’s proposed money market fund (MMF) reforms and the goals of the reforms, which are to eliminate incentives to runs, enhance resilience to MMFs during stress periods, and to require investors to bare the costs of their redemption activity more fairly.

Council Comments

Jerome Powell, Chairman, Federal Reserve Board of Governors

Powell welcomed FSOC’s work on hedge fund, MMF, and open fund risk and applauded the SEC’s money market reform package. He stated that, if adopted, these reforms could meaningfully reduce structural vulnerabilities in MMFs and that open end mutual funds can also amplify liquidity strains. He closed by welcoming continued analysis of the vulnerabilities associated with these funds.

Michael Hsu, Acting Comptroller, Office of the Comptroller of the Currency (OCC)

Hsu said the OCC supports the initiatives discussed and those related to hedge fund data gaps and commended the SEC for addressing open fund resiliency.

Gary Gensler, Chairman, Securities and Exchange Commission (SEC)
Gensler explained that the fund industry’s nature, scale, and interconnectedness poses financial stability risk, like during the 2008 crisis, the start of the Covid crisis, and back in 1998 when the hedge fund Long-Term Capital Management collapsed. He stated that MMFs and open funds by their design have a potential liquidity mismatch and that in times of stress, these funds’ liquidity mismatches cause issues. He added that hedge funds cause stability issues as well and that the SEC has a responsibility to address these issues. Gensler said he asked staff for recommendations to address these issues to bolster resiliency, including through MMF reforms, and asked staff about improvements around fund liquidity, pricing, and resiliency for possibly future stress events. Concerning hedge fund issues, he highlighted the SEC’s Form PF and securities swap position reporting proposals and expressed his support for FSOC’s statement.

Todd Harper, Chairman, National Credit Union Administration (NCUA)

Harper expressed support for the council continuing to monitor risks in the fund space and reforms offered by his colleagues.

Dino Falaschetti, Director, Office of Financial Research, U.S. Department of Treasury (OFR)
Falaschetti discussed how data gaps can prevent regulators from identifying and addressing risk to financial stability and said that new data may need to be collected from firms and markets. He added that FSOC’s hedge fund working group identified gaps in data on uncleared bilateral repurchase agreements and that OFR is laying the groundwork to address this critical data need through a pilot data collection program. He concluded by saying that he looked forward to beginning the rulemaking process to establish a permanent collection as soon as OFR has sufficient information from the pilot.

For more information on this hearing, please click here.

For an archive of past SIFMA hearing coverage, please click here.