1

FINANCIAL STABILITY OVERSIGHT COUNCIL

UPDATE ON REVIEW OF ASSET MANAGEMENT PRODUCTS AND ACTIVITIES

1. BACKGROUND 

1.1 Role of the Council and Engagement on Asset Management 

The financial crisis of 2007-2009 demonstrated the need for clear accountability for the stability 

of the U.S. financial system. The Dodd-Frank Wall Street Reform and Consumer Protection Act 

(Dodd-Frank Act) established the Financial Stability Oversight Council (Council) to bring 

together, for the first time, the financial regulatory community to identify and respond to 

emerging threats to financial stability. Consistent with its mandate, the Council monitors all 

sectors of the financial services marketplace to identify potential threats to U.S. financial 

stability and, where appropriate, takes steps to address those threats. Accordingly, as with other 

areas of the financial markets, the Council has actively reviewed potential risks to financial 

stability in the asset management industry. 

The asset management industry’s increasing significance to financial markets and to the broader 

economy underscores the need for the Council’s consideration of potential risks to U.S. financial 

stability from this sector. A number of different types of entities subject to varying regulatory 

frameworks engage in asset management activities, including but not limited to registered 

investment advisers, banks and thrifts, insurance companies, commodity trading advisors, and 

commodity pool operators. These entities provide a variety of asset management products, such 

as pooled investment vehicles and separately managed accounts (SMAs). Pooled investment 

vehicles include investment companies registered under the Investment Company Act of 1940 

(registered funds), private funds (including hedge funds), collective investment funds (CIFs), and 

commodity pools. 

In May 2014, the Council hosted a public conference on asset management that included a 

diverse group of stakeholders—including industry, regulatory, public interest, and academic 

participants—to help inform the Council’s analysis. Following this conference, at its July 2014 

meeting the Council directed staff to undertake a more focused analysis of industry-wide 

products and activities to assess potential risks across the asset management sector. This 

approach has sought to evaluate potential risks in a manner that reflects the characteristics that 

differentiate the asset management industry from other sectors of the financial system. 

In December 2014, the Council published a notice seeking public comment regarding whether 

and how certain asset management products and activities could pose potential risks to U.S. 

financial stability. The notice focused on liquidity and redemptions, leverage, operational 

functions (in particular, service providers and large account transitions), and resolution.

1

The 

Council’s notice also solicited information about existing industry risk management practices. 

The Council received letters from 49 commenters, representing individual companies, trade 

 

1 Council Notice Seeking Comment on Asset Management Products and Activities, 79 Fed. Reg. 77488 (Dec. 24, 

2014).
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associations, and public interest groups. Its analysis has been informed by the information and 

views presented in these comments, along with other sources of information detailed below. 

Additionally, the Securities and Exchange Commission (SEC) has issued several proposed rules 

since May 2015 affecting the asset management industry. Specifically, the SEC has proposed 

rules to: (1) enhance data reporting for registered investment companies and registered 

investment advisers of separately managed accounts; (2) strengthen liquidity risk management 

programs and disclosure for registered funds; and (3) limit the amount of leverage that registered 

investment companies may obtain through derivatives transactions.

2

 The SEC staff is also 

developing proposed rules covering transition planning for registered investment advisers and, 

pursuant to section 165 of the Dodd-Frank Act, stress testing for large registered investment 

advisers and registered investment companies. 

The Council is providing this public update on its review of potential risks to financial stability 

that may arise from certain asset management products and activities. As outlined below, the 

Council and staffs of its members and member agencies have carried out analyses and engaged 

in dialogue regarding these issues. Based on this work, the Council has identified certain areas 

of potential financial stability risk and is providing its views on key areas of focus and next steps 

to respond to these potential risks. A number of areas involve additional analysis, data 

collection, or monitoring. The Council welcomes ongoing engagement with stakeholders as this 

work moves forward. 

1.2 Framework for Review

Consistent with the questions highlighted in its December 2014 request for public comment, the 

Council’s subsequent review of risks to U.S. financial stability has focused on the following 

areas: (1) liquidity and redemption; (2) leverage; (3) operational functions, in particular service 

provider concentration; (4) securities lending; and (5) resolvability and transition planning.3

For each of these areas, the Council’s analysis has involved three primary components. First, the 

Council has reviewed potential risks to financial stability and considered the materiality of such 

risks. Second, the Council considered the extent to which market practices or regulations may 

mitigate the identified potential risks to financial stability and whether there are financial 

stability risks that those mitigants do not address. Finally, the Council is providing its views on

certain next steps to respond to or better understand the potential risks to financial stability 

highlighted by this review. As with the Council’s work generally, the members of the Council 

 

2

Proposed Rule: Investment Company Reporting Modernization, 80 Fed. Reg. 33590 (Jun. 12, 2015); Proposed 

Rule: Amendments to Form ADV and Investment Advisers Act Rules, 80 Fed. Reg. 33717 (Jun. 12, 2015); 

Proposed Rule: Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening of Comment

Period for Investment Company Reporting Modernization Release, 80 Fed. Reg. 62274 (Oct. 15, 2015); Proposed 

Rule: Use of Derivatives by Registered Investment Companies and Business Development Companies, 80 Fed. Reg. 

80844 (Dec. 28, 2015). 

3 The Council’s notice posed questions regarding securities lending throughout the notice, but for purposes of 

analysis, these questions have been consolidated and considered together. In addition, the notice posed questions 

about potential risks associated with large account transitions in the Operational Risk section, which are presented 

here in the Resolvability and Transition Planning section.
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have consulted extensively and have drawn on the expertise of their staffs and those of the 

member agencies. 

Throughout its review and consistent with its mandate, the Council has focused on identifying 

potential risks to financial stability, rather than investment risk. As discussed in the Council’s 

request for public comment, investment risk is a normal and necessary part of market 

functioning.4 The Council has sought to assess whether asset management products or activities 

could create, amplify, or transmit risk more broadly in the financial system in ways that could

affect U.S. financial stability. Financial stability risks may arise even where existing measures 

generally protect individual market participants (such as particular asset managers, investment 

vehicles, and investors) because these measures may not fully take into account the effects of 

possible stress on other market participants, market functioning, or other parts of the financial 

system. Further, some risks to financial stability might not flow from the actions of any one 

entity but could arise from the activities of a number of market participants. In addition, certain 

activities that do not pose risks to financial stability during normal times may do so during 

periods of stress at a particular firm or across markets more broadly. 

In conducting its analysis, the Council considered many sources of information, including 

publicly available data, data reported on the SEC’s Form PF, input from member agencies with 

supervisory authority, analyses from market participants, academic studies, and submissions in 

response to the Council’s request for public comment.

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 Because access to high-quality data and 

information is essential for the Council to carry out its mandate, the Council also assessed 

whether sufficient data and information are available to evaluate potential risks, or whether 

additional data and information would be helpful to the Council, regulators, or market 

participants and the public. Accordingly, this statement notes where additional data collection 

and analysis is needed to facilitate a better understanding of potential risks and inform next steps. 

The Council’s request for public comment inquired broadly about potential risks across the full 

range of investment vehicles and entities that make up the asset management industry, and it 

noted a particular focus on pooled investment vehicles.6 As of December 2014, U.S. pooled 

investment vehicles (excluding money market mutual funds) had approximately $25.8 trillion of 

assets.7 Mutual funds accounted for the largest share, with $13.1 trillion of assets, or 51 percent 

of the total.8 Hedge funds accounted for the second largest share, with $3.4 trillion, or 13 

 

4 Council Notice, 79 Fed. Reg. at 77489.

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Pursuant to section 404 of the Dodd-Frank Act, the SEC adopted Form PF as a reporting form for registered 

investment advisers to private funds to enable the Council to obtain data that will facilitate monitoring of systemic 

risk in U.S. financial markets.

6 Council Notice, 79 Fed. Reg. at 77489. 

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Investment Company Institute, Investment Company Fact Book (2015) (ICI Fact Book), p. 9, p. 207 (for registered 

funds and non-registered ETFs); SEC Division of Investment Management, Risk and Examinations Office, Private 

Fund Statistics, Fourth Calendar Quarter 2014 (Dec. 30, 2015) (for private funds); Federal Financial Institutions 

Examination Council Call Report data (Dec. 2014), estimates of the Office of the Comptroller of the Currency 

(OCC) and Board of Governors of the Federal Reserve System (Federal Reserve) (for CIFs); Federal Reserve,

Financial Accounts of the United States (for real estate investment trusts).

8

ICI Fact Book, p. 30.
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percent of total assets.9 CIFs have the third largest share, with at least $2.9 trillion, or 11 percent 

of total assets.

10

 Exchange-traded funds (ETFs) account for $2.0 trillion, or 8 percent of total 

assets.

11

As highlighted in the Council’s request for public comment, the Council intends to consider the 

impact that regulatory developments may have in reducing any risks to U.S. financial stability 

associated with the asset management industry. As noted above, the SEC has begun a series of 

rulemaking proposals related to the segments of the asset management industry under its 

jurisdiction. In its analysis, the Council has considered the potential implications of the proposed 

SEC rulemakings. However, because the SEC’s final rules may differ from what has been 

proposed, the Council’s analysis below does not evaluate specific provisions of the proposed 

rules. As the SEC rulemaking process progresses, the Council intends to monitor the effects of 

any regulatory changes and their implications for financial stability.

2. LIQUIDITY AND REDEMPTION RISK

2.1 Potential Risks to Financial Stability

The Council’s review of liquidity and redemption risks focused on pooled investment vehicles,

where investor redemption rights and underlying asset liquidity may not match. A particular 

focus of the review was on mutual funds because they are the largest category of pooled 

investment vehicles in the United States and offer daily redemptions to investors in vehicles that 

may invest in assets across a wide liquidity range. Funds invested in less-liquid assets, where the 

market impact and trading costs if the funds were to sell assets to meet redemptions may be 

greater than in other funds, could be more susceptible to the potential financial stability concerns 

described below. 

There are two primary features of pooled investment vehicles that raise potential financial 

stability concerns:

 Liquidity Transformation: Some pooled investment vehicles, in particular open-end funds,

provide liquidity transformation by allowing frequent (typically daily) redemptions by 

investors while investing in less-liquid assets. Investors in these vehicles may therefore 

require a lower liquidity premium than investors purchasing the underlying assets directly. 

This may increase the bid price of the underlying assets, depending on market dynamics and 

the behavior and importance of these investors. During a stress event, the price of assets held 

 

9 Hedge fund assets are reported as net assets under management. SEC Division of Investment Management, Risk 

and Examinations Office, Private Fund Statistics, Fourth Calendar Quarter 2014 (Dec. 30, 2015), p. 5. 

10 FFIEC Call Report data (Dec. 2014) (data limited to CIFs that are administered by FDIC-insured depository 

institutions, and limited purpose national trust banks and federal savings associations; excludes short-term 

investment funds and CIFs administered by state-chartered, non-depository, limited purpose trust companies); OCC 

and Federal Reserve estimates. 

11 ICI Fact Book, p. 60 (includes non-registered ETFs). The Council’s current analysis has focused on the 

investment vehicles described above due to their large market share or features of their structure or investment 

strategy. 
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by these funds may fall rapidly if large redemptions occur, as the investment vehicle may 

incur significant costs to sell these less-liquid holdings. 

 First-Mover Advantage: Redemption options and pricing methods offered by pooled 

investment vehicles may create a potential “first-mover advantage” if the costs of meeting 

investor redemptions are largely borne by remaining investors in the fund.

12

 This may create 

incentives for some investors to redeem shares ahead of other investors in times of market 

stress in order to avoid transaction costs associated with meeting redemptions and asset 

repricing. A first-mover advantage may also be created if funds sell their more liquid assets 

first to meet redemptions, leaving remaining investors with a less-liquid portfolio that is 

potentially costly to rebalance.13 A first-mover advantage may be compounded if investors 

act in anticipation of the liquidity of the remaining assets continuing to decline.

In a stress event, particularly an event affecting funds with less-liquid assets where the structural 

features discussed above are more pronounced, funds facing large redemptions may be forced to 

sell assets more quickly than expected. Such funds may incur significant costs that are likely to 

include not only immediate transaction costs, but also the costs associated with portfolio 

rebalancing and the market impact of selling less-liquid securities, which may be realized over 

several days. These costs may further impair performance and put downward pressure on the 

prices of the underlying assets, potentially leading to further fund outflows. Although 

destabilizing redemptions across mutual funds mostly invested in a less-liquid asset class have 

not occurred historically, in such an event, the resulting asset sales could lead to price declines 

across the asset class, transmit stress to previously unaffected market participants, and ultimately 

could create broader market disruptions.

14

The extent of these potential financial stability risks varies across pooled investment vehicles 

with differing fund characteristics, redemption structures, and regulations. In addition, the extent 

of such risks depends on a number of factors, including the liquidity of fund assets, and hence 

the degree of liquidity mismatch; the collective share of less-liquid asset classes held by funds 

providing liquidity transformation; the sensitivity of fund investors to first-mover advantage and 

fund performance; the liquidity risk management practices of funds; and the behavior of other 

investors. 

In particular, first-mover advantage amplifies liquidity transformation risk, and the extent of its 

significance depends strongly on fund investor and portfolio characteristics. For example, 

investors in funds with substantial holdings of less-liquid assets may have a greater incentive to 

redeem in periods of market stress, while for certain investors the adverse tax consequences of 

redeeming shares may counter the risk of a first-mover advantage. Other factors that may 

influence the risk of first-mover advantage include investor behavior, particularly of investors in 

 

12 See Qi Chen, Itay Goldstein, and Wei Jiang, Payoff Complementarities and Financial Fragility: Evidence from 

Mutual Fund Outflows, Journal of Financial Economics 97(2), pp. 239-262 (2010).

13 See Paul Hanouna, Jon Novak, Tim Riley, and Christof Stahel, Liquidity and Flows of U.S. Mutual Funds, SEC 

DERA White Paper (Sep. 2015); see, e.g., Matt Wirz, Waddell Fund’s Sales Leave Investors With Riskier Securities, 

The Wall Street Journal (Jun. 16, 2015). 

14 See Joshua Coval and Erik Stafford, Asset Fire Sales (and Purchases) in Equity Markets, Journal of Financial 

Economics 86(2), pp. 479-512 (2007).
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retirement accounts making long-term, life-cycle based allocations across asset classes;15 the 

management and investment mandate of a fund; and the internal investment processes of 

institutional investors.

The extent to which these dynamics have contributed to volatility or increased financial stability 

risks in past episodes is difficult to determine, especially given the complex nature of market 

interactions during stress events. 

2.1.1 Registered Funds: Mutual Funds

Mutual funds are open-end management investment companies that are registered with and 

regulated by the SEC under the Investment Company Act. Mutual funds allow investors to 

redeem shares daily at net asset value (NAV), with payment of redemption proceeds required 

within seven days.16 Under current regulations, mutual funds are required to use forward pricing 

when calculating the price that a redeeming shareholder receives for fund shares.

17

 However, 

funds do not customarily take into account transaction costs, including market impact and trading 

costs, which arise when they sell portfolio assets to meet redemption requests. Instead, 

transaction costs associated with meeting redemptions are generally passed on to the remaining 

investors in the fund. While the cost to meet redemptions is minimal for mutual funds investing 

in highly liquid assets, the cost to meet redemptions for mutual funds invested in relatively lessliquid assets could be more significant, and this structure could give rise to first-mover advantage 

risks. 

The magnitude of potential spillover effects from liquidity transformation in mutual funds is 

uncertain. However, potential risks would appear to be more significant in funds that invest in 

less-liquid asset classes, and under stress scenarios, when bid-ask spreads are widest and market 

illiquidity concerns are often more pressing. Existing SEC guidelines limit mutual funds’ 

acquisitions of certain illiquid assets to 15 percent of net assets.18 Mutual funds and registered 

advisers to mutual funds are both subject to SEC examinations that may include review of 

liquidity controls, particularly at funds with exposure to potentially illiquid securities.19 

However, the current 15 percent limit does not take into account the size of a fund’s position or 

potentially lengthy settlement times, which could delay a fund’s ability to convert securities into 

cash, and funds may invest in less-liquid securities that would not be subject to this limit.20

 

15 An estimated 50 percent of U.S. mutual fund assets are held in retirement-related accounts. Comment Letter of 

the Investment Company Institute to the Financial Stability Board (Apr. 7, 2014), p. F-18. Based on OCC and 

Federal Reserve staff estimates, approximately 80 percent of CIF assets are held in retirement-related accounts.

16 Section 22(e) of the Investment Company Act.

17 17 C.F.R. § 270.22c-1.

18 Revisions of Guidelines to Form N-1A, 57 Fed. Reg. 9828 (Mar. 20, 1992). 

19 SEC Office of Compliance and Inspections, Examination Priorities for 2016, p. 3 (Jan. 11, 2016).

20 See Proposed Rule: Open-End Fund Liquidity Risk Management Programs; Swing Pricing; Re-Opening of 

Comment Period for Investment Company Reporting Modernization Release, 80 Fed. Reg. at 62292 (“Although the 

15% guideline involves determining whether an asset can be sold or disposed of within seven days at approximately 

its stated value, it does not involve a fund considering whether it can actually receive the proceeds of any sale within 

seven days. The 15% guideline also does not involve a fund taking into account any market or other factors in 

considering an asset’s liquidity, or assessing whether the fund’s position size in a particular asset affects the liquidity 

of that asset.”).
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In general, the magnitude of these potential risks, and hence both the likelihood and impact of 

any forced selling by mutual funds on broader markets, likely increases as mutual funds’ overall 

market share of less-liquid assets increases. The share of corporate and foreign bonds, which are 

generally considered less liquid than some other major publicly traded assets,

21 held by mutual 

funds rose from 10 percent in 2009 to 22 percent in 2015.

22 Since the financial crisis, there have 

been large net inflows into mutual funds focused on sub-investment grade debt and emerging 

market assets, although these funds’ shares of the total mutual fund market has held relatively 

constant at 6 percent.23, 24

There are also indications that, in the aggregate, mutual fund investors may be more likely to 

redeem from less-liquid asset classes following poor performance.25 However, there is little 

historical evidence of widespread investor runs from floating-NAV mutual funds, even during 

times of market stress.26 For example, cumulative outflows from U.S. equity funds were 2 

percent of average assets under management (AUM) from September to December 2008, and 

monthly outflows from emerging market bond funds were 3 percent of AUM during the June 

2013 “Taper Tantrum.”27 

As noted, the potential for outflows to cause fund distress, and hence broader stress, may 

increase with the illiquidity of a fund’s investment portfolio. A recent event in the high-yield 

bond fund sector provides a useful example. On December 9, 2015, the Third Avenue Focused 

Credit Fund (FCF), a high-yield bond mutual fund, announced it could no longer “pay 

anticipated redemptions without resorting to sales at prices that would unfairly disadvantage

remaining shareholders.”28 On December 16, 2015, FCF received a temporary order from the 

SEC permitting the fund to suspend redemptions, subject to certain conditions, to protect the 

 

21 While the liquidity profile of corporate bonds is heterogeneous, they are generally considered less liquid than

agency mortgaged-backed securities, U.S. Treasury securities, other investment-grade sovereigns, and large-cap 

publicly traded equity securities. See Barclays, Liquidity Cost Scores Report (Mar. 2016).

22 Federal Reserve, Financial Accounts of the United States. 

23 ”Sub-investment grade debt” includes funds focused on high-yield corporate bonds, high-yield municipal bonds, 

and leveraged loans. “Emerging market assets” includes funds focused on emerging market equity (diversified 

emerging markets, China region, India equity, Latin America stock, Pacific/Asia ex-Japan stock) and emerging 

market bonds. From January 2010 to December 2015, these funds saw $258 billion in net inflows; flows to these 

less-liquid asset classes accounted for 19 percent of total industry inflows despite accounting for 6 percent of total 

assets under management (AUM) in December 2009, and a similar percent in December of 2015. Computations 

based on Morningstar Direct.

24 In some cases market share is down significantly from peak levels. For example, assets held by leveraged loan 

mutual funds rose from 3 percent of the leveraged loan market in December 2008 to 21 percent of the leveraged loan 

market in February 2014, but retreated to 12 percent of the market as of December 2015. Computations based on 

Morningstar Direct and S&P Leveraged Commentary & Data.

25 See Itay Goldstein, Hao Jiang, and David Ng, Investor Flows and Fragility in Corporate Bond Funds, Working 

Paper (Jun. 25, 2015); see also Joshua Coval and Erik Stafford, Asset Fire Sales (and Purchases) in Equity Markets,

Journal of Financial Economics 86(2), pp. 479-512 (2007); see also Luis Brandao-Marques, Gaston Gelos, Hibiki

Ichiue, and Hiroko Oura, Changes in the Global Investor Base and the Stability of Portfolio Flows to Emerging 

Markets, IMF Working Paper No. 15/277 (Dec. 28, 2015).

26 See, e.g., Comment Letter of PIMCO (Mar. 25, 2015), p. 10.

27 Computations based on Morningstar Direct.

28 Third Avenue FCF Management Letter to Shareholders (Dec. 9, 2015).
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fund’s investors.29 FCF’s portfolio, which was less liquid and invested in more distressed assets 

than other high-yield bond mutual funds, had become increasingly less liquid over the previous 

six months.30 For example, eight of its top ten holdings were in firms that had restructured over 

the previous two years.

31 Despite significant outflows across the sector during this period of 

market volatility, other high-yield bond mutual funds were able to meet redemption requests. 

The closure of FCF illustrates both liquidity and redemption risk in less-liquid mutual funds and 

raises questions about the implications for financial stability. If the problems that forced FCF to 

close had been widespread among other funds, or perceived to be widespread, its closure could 

have had spillover effects on other funds and asset markets. 

Appropriate liquidity risk management, including consideration of potential outflows in a stress 

event, can reduce the risk of forced asset sales and potential financial stability risks by providing 

for a sufficient base of liquid assets to meet redemptions. Several fund managers stated in their 

comment letters that they have a variety of liquidity sources to meet redemptions, including new 

inflows, cash and liquid asset buffers, internal cash flows, reverse repurchase agreements, 

external lines of credit, and interfund lending.32 Recent analysis by SEC staff, however, has 

shown that some mutual funds manage their liquidity in response to large redemptions by 

disproportionately selling their relatively more liquid assets, which might amplify first-mover 

advantage by leaving remaining investors with an increasingly illiquid portfolio.

33

 Such 

practices have been shown to contribute to contagion across asset classes.34

At present there is only limited data on mutual funds’ liquidity risk management practices and 

their portfolio composition as it relates to their liquidity profile. The lack of sufficient data 

hinders any assessment of the adequacy of funds’ ability to meet redemptions without the 

adverse spillover effects described above, or the magnitude of any potential risk of spillover. In 

particular, under the current regulatory framework, the liquidity risk profiles of outliers such as 

FCF are difficult to identify in a timely manner.

The extent to which fund redemptions might contribute to potential financial stability risks also 

depends on the behavior of various types of investors. The potential for large net outflows may 

be mitigated by the nature of mutual funds’ investor bases, which typically comprise retail 

investors with longer-term investment horizons and tax considerations that generally may make 

them less likely to redeem based on first-mover advantage dynamics.

35

 In addition, forced asset 

sales may not create a feedback loop if other investors step in to buy the assets. However, there 

is evidence that certain types of institutional investors, such as insurance companies and pension 

 

29 Third Avenue Trust et al., Investment Company Act Release No. 31943 (Dec. 16, 2015).

30 Third Avenue Trust and Third Avenue Management LLC, Application for an Order Pursuant to Section 22(e)(3) 

of the Investment Company Act of 1940 (Dec. 16, 2015). 

31 Third Avenue FCF, Portfolio Manager Commentary (Jan. 31, 2016).

32 See, e.g., Comment Letter of BlackRock (Mar. 25, 2015), pp. 34-35; see also Comment Letter of Vanguard (Mar. 

25, 2015), pp. 7-8; see also Comment Letter of Fidelity Investments (Mar. 25, 2015), pp. 18-21.

33 See Paul Hanouna, Jon Novak, Tim Riley, and Christof Stahel, Liquidity and Flows of U.S. Mutual Funds, SEC 

DERA White Paper (Sep. 2015).

34 Alberto Manconi, Massimo Massa, and Ayako Yasuda, The Role of Institutional Investors in Propagating the 

Crisis of 2007-2008, Journal of Financial Economics 104(3), pp. 491-518 (2007).

35 Comment Letter of Strategic Insight (Mar. 25, 2015), pp. 7-8, p.18.
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funds, tend to act in concert, and in a way similar to mutual funds, and their collective behavior 

can amplify price distortions in market stress.36

In addition to the two structural features discussed above, the Council is also focused on whether 

the use of external sources of borrowing—such as lines of credit and other means of financing, 

and to a lesser extent, interfund lending—could transmit liquidity stress to other entities or 

markets, particularly in times of broader market stress. The use of bank credit lines could 

potentially transmit financial stress to other parts of the financial system, as widespread draws on 

committed lines of credit could put additional pressures on bank liquidity during a financial 

stress scenario. Moreover, interfund lending and shared lines of credit may not be available 

during times of stress if mutual funds are experiencing broad redemptions, although interfund 

lending requires prior SEC exemptive relief and is typically subject to conditions that may 

restrict its use.37 However, these issues are difficult to assess because there is limited industrywide data readily available on funds’ use of these sources of borrowing and other financing. 

Similar concerns regarding these sources of borrowing, to the extent available, may apply to 

CIFs, which are discussed below.

2.1.2 Registered Funds: Exchange-Traded Funds

Due to their redemption structure, ETFs may not be subject to the same types of liquidity and 

redemption risks as some other pooled investment vehicles. Specifically, unlike mutual fund 

shares, which investors can redeem directly in exchange for cash, ETF shares can only be 

redeemed by authorized participants (APs), which are typically large broker-dealers that are 

members of clearing agencies. Furthermore, many ETFs only redeem their shares for in-kind 

baskets of securities, rather than cash, and, to the extent that ETFs redeem in cash, they often 

charge pre-determined transaction fees to the redeeming APs to reimburse the ETFs for the costs 

associated with the redemption.38 When ETF investors who are not APs wish to sell their shares, 

they must do so on secondary markets. Data indicates that the vast majority of purchases and 

sales of ETF shares are conducted in the secondary market and do not require share creation or 

redemption.

39 These features reduce the liquidity and redemption risks associated with ETFs

because investors who sell shares usually do not force the ETF to sell assets. Therefore, ETFs 

are less vulnerable to the first-mover advantage dynamic described above. 

Under normal circumstances, market makers (and other market participants) take advantage of 

any differential between an ETF’s share price and its intraday trading value, resulting in ETF 

 

36 See Fang Cai, Song Han, Dan Li, and Yi Li, Institutional Herding and Its Price Impact: Evidence from the 

Corporate Bond Market, Federal Reserve Working Paper (Mar. 1, 2016). 

37 The conditions, for example, include the lending fund being able to call a loan on one business day’s notice, the 

fund’s aggregate outstanding interfund loans being limited to 15 percent of its net assets, and the fund’s loans to any 

one fund being limited to 5 percent of the lending fund’s net assets. See, e.g., PNC Funds et al., Investment 

Company Act Release Nos. 31976 (Feb. 1, 2016) (Notice) and 32010 (Feb. 29, 2016) (Order).

38 APs create ETF shares by delivering securities or cash to the ETF in exchange for a block of ETF shares called a 

creation unit. They redeem ETF shares by delivering a creation unit of ETF shares to the ETF in exchange for 

securities or cash. 

39 See Comment Letter of the Investment Company Institute (Mar. 25, 2015), pp. A4-A5.
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share prices closely tracking the value of their underlying portfolios.40 However, the ETF 

arbitrage mechanism may break down in times of severe market stress if, for example, there is 

pricing uncertainty in an ETF’s underlying holdings and investors seek to quickly sell their ETF 

shares. In such a case, market makers arbitraging the ETF would widen their bid-ask spreads to 

compensate for market volatility and pricing errors. In addition, APs may choose to cease 

processing ETF orders.

41 These actions could result in a divergence between ETF share prices 

and the values of their portfolios.

42

 A recent short-lived event illustrated this potential 

vulnerability in the ETF arbitrage mechanism.43 Granular data on ETF investors is limited, but 

there is evidence that institutional investors are increasingly using ETFs rather than derivatives 

to gain or hedge market exposure.44 These investors may be exposed to this unanticipated basis 

risk if an ETF’s price does not track its value for a prolonged period of time. 

2.1.3 Collective Investment Funds

CIFs are prudentially regulated pooled investment vehicles that are operated by banks, savings 

associations, and federally insured and uninsured trust companies. CIFs are exempt from 

registration under the Investment Company Act, and they may be structured as common trust 

funds (which are limited to contributions by a bank in its capacity as a trustee, executor, 

administrator, or guardian) or collective investment trusts (which are limited to contributions by 

various employee benefit plans, such as 401(k) plans, and other trusts that are exempt from 

federal income tax), which are the most prevalent structure. CIFs are not generally marketed to 

investors in the same way that mutual funds are.

45

Many CIFs provide daily redemption to participants, although they are not required by statute or 

regulation to do so. For example, CIFs offered to participants in employee benefit plans may 

allow transfers to other funds offered by the plan. CIFs are available in a number of asset 

classes, including domestic equity, international equity, bonds, stable value, and alternatives. 

The risk management policies and practices of CIFs are subject to the relevant regulator’s 

guidance and are reviewed during periodic bank examinations.46 Although CIFs are not subject 

 

40 Share creation or redemptions typically happen when market makers (either through APs or APs themselves) 

enter the market and redeem (or create) shares when the ETF price is less (or greater) than the value of the 

underlying assets. The market maker’s or AP’s exercise of such an arbitrage opportunity generally results in an ETF 

share’s market price tracking its value.

41 During the June 2013 Taper Tantrum, Citigroup, a major AP, temporarily stopped processing ETF creation unit 

orders on an agency basis after reaching its internal prudential risk limits. See Comment Letter of the Investment 

Company Institute (Mar. 25, 2015), p. A4.

42 Less-liquid ETFs may trade at a premium or discount to their NAVs during the normal course of business. 

43 At the market open on August 24, 2015, some ETFs traded at substantial discounts to their value, in part due to 

heightened price uncertainty for underlying securities. See SEC Investor Advisory Committee Meeting (October 15, 

2015), available at: http://www.sec.gov/news/otherwebcasts/2015/investor-advisory-committee-101515.shtml; see 

also Staff of the Office of Analytics and Research in the SEC’s Division of Trading and Markets, Research 

Note: Equity Market Volatility on August 24, 2015 (December 2015). 

44 Greenwich Associates, Institutional Investment in ETFs: Versatility Fuels Growth (Q1 2016).

45 Common trust funds are expressly prohibited from advertising under section 3(c)(3)(B)(i) of the Investment 

Company Act, whereas collective investment trusts are typically not advertised directly to investors.

46 CIFs sponsored by national banks and federal savings associations are regulated by the OCC and must adhere to 

that agency’s CIF rules. See 12 C.F.R. § 9.18. Those administered by state member banks (for which the Federal 

Reserve is the primary federal regulator), state-chartered non-member banks (for which the FDIC is the primary 
11

to regulatory limits on investments in less-liquid securities, the primary federal regulators 

provide specific guidance to bank examiners and banks regarding adequate liquidity 

management practices.47 

Public data on CIFs is limited. Currently, Call Reports require banks to report total CIF AUM 

by investment strategy,48 but information such as funds’ redemption practices, external sources 

of liquidity, holdings of liquid assets, net flows, and employer plan type are not publicly 

disclosed. Because state-chartered, non-insured, non-depository limited purpose trust companies 

are not required to file a Call Report, aggregate information on the number and size of CIFs 

operated by such state-supervised trust companies is not readily available.

2.1.4 Hedge Funds

Unlike mutual funds, hedge funds are not subject to regulatory liquidity guidelines and therefore 

may invest in assets of varying liquidity profiles, consistent with their disclosures to investors. 

They may also restrict investors’ ability to redeem, and hence better ensure that investor liquidity 

is aligned with asset liquidity. In particular, most hedge funds require advance notice for 

redemptions, and some impose initial lockup periods for investors. Currently, large hedge fund 

advisers report on the SEC’s Form PF that 13 percent of their advised hedge fund shares can be 

redeemed with notice of seven days or less, and 26 percent in 30 days or less.49 Most hedge 

funds appear to largely match investor share liquidity and asset liquidity: funds with less-liquid 

assets typically have substantially longer redemption horizons.50 Further, many hedge funds use 

gates triggered by either investor or fund-wide redemption levels as a method of structuring 

redemptions over a particular time period. For example, a fund might not permit an investor or 

all investors to redeem more than 25 percent of their investment, individually or in the aggregate 

across all fund investors, during a particular redemption period unless the fund’s governing body 

waives this requirement. 

However, even in funds with redemption restrictions, managers may have difficulty selling lessliquid assets in an orderly manner to meet large redemption requests, particularly in times of 

stress. In such a situation, hedge funds could fall back on more extraordinary liquidity 

management measures to mitigate redemption difficulties and the potential for forced asset sales. 

For example, hedge funds often reserve the right to suspend redemptions, offer partial 

 

federal regulator), and non-depositary, limited purpose trust companies (supervised by the applicable state) are 

chartered and operate under state laws, which frequently reference the OCC’s rules as guidance or 

requirements. See OCC Collective Investment Funds Comptroller’s Handbook (May 2014) (OCC CIF Handbook); 

see also FDIC Trust Examination Manual, Section 7, Compliance – Pooled Investment Vehicles.

47 See OCC CIF Handbook, p.7 (“The fund manager should consider the structure and duration of the assets owned 

by the fund, redemption patterns, cash flow projections, and underlying assumptions. The fund should be stress 

tested, looking at changes in fund flows and the availability of liquidity, under various scenarios. Regular testing of 

any contingency financing sources is expected.”).

48 Insured depository institutions and federally chartered limited purpose trust companies are required to report this 

information on Schedule RC-T of the Call Report.

49 Large hedge fund advisers are advisers with at least $1.5 billion in hedge fund assets under management. Form 

PF, General Instructions, p. 2. SEC Division of Investment Management, Risk and Examinations Office, Private 

Fund Statistics, Second Calendar Quarter 2015 (Dec. 30, 2015), p. 26 (data based on quarterly filers).

50 Form PF data.
12

redemptions with less-liquid assets retained in “side pocket” funds, or offer in-kind 

redemptions.

51

 During the financial crisis, hedge funds may have amplified distress by engaging 

in significant deleveraging in response to redemptions that were due in part to investors 

anticipating the use of liquidity management measures.52 Discussion of the potential for liquidity 

issues in hedge funds continues below in Section 3. 

2.2 Council Views

The Council believes there are financial stability concerns that may arise from liquidity and 

redemption risks in pooled investment vehicles. To help mitigate these financial stability risks, 

the Council believes that the following steps should be considered:

1) Robust liquidity risk management practices for mutual funds, particularly with regard to 

preparations for stressed conditions by funds that invest in less-liquid assets. Robust liquidity 

risk management practices should mitigate the risks of a potential deterioration in the liquidity of 

fund assets to a degree that affects the fund’s ability to meet redemptions and of less-liquid asset 

classes coming under forced-selling pressure in stressed conditions. These practices should 

comply with guidelines from regulators that encourage adequate risk management planning and 

establish expectations regarding funds’ abilities to meet redemptions under a variety of extreme 

but plausible stressed market conditions.

2) Establishment of clear regulatory guidelines addressing limits on the ability of mutual funds 

to hold assets with very limited liquidity, such that holdings of potentially illiquid assets do not 

interfere with a fund’s ability to make orderly redemptions. Clear guidelines regarding the 

characteristics of such assets and limits on holding them should mitigate risks that may arise if 

funds hold assets that they have trouble disposing of in a size commensurate with potential 

redemptions, particularly in times of market stress.

3) Enhanced reporting and disclosures by mutual funds of their liquidity profiles and liquidity 

risk management practices. Additional reporting requirements regarding funds’ liquidity would 

allow regulators to better understand how funds are assessing liquidity. In addition, public 

disclosure of funds’ liquidity and their liquidity risk management practices could help improve 

liquidity risk management standards across the industry and enhance market discipline with 

respect to how funds manage and measure liquidity risk. Over time, such disclosures could 

reduce risks arising from liquidity transformation by providing better information to investors. 

4) Steps to allow and facilitate mutual funds’ use of tools to allocate redemption costs more 

directly to investors who redeem shares. Such tools should help reduce first-mover advantage 

and mitigate the risk that less-liquid asset classes would be faced with widespread sales under 

stressed conditions. Regulators should assess which tools could be effective in reducing firstmover advantage and determine the scope of application of such tools, especially in funds 

 

51 See Comment Letter of the Managed Funds Association (Mar. 25, 2015), pp. 12-14. 

52 See Itzhak Ben-David, Franzoni Francesco, and Rabih Moussawi, Hedge Funds Stock Trading During the 

Financial Crisis of 2007-2009, Review of Financial Studies 25(1), pp. 1-54 (2012).
13

holding less-liquid assets. If there are significant operational challenges to implementing these 

tools, regulators should consider approaches to alleviate such challenges.

5) Additional public disclosure and analysis of external sources of financing, such as lines of 

credit and interfund lending, as well as events that trigger the use of external financing. 

Currently, granular information on the use of these sources of financing is not available, limiting 

the ability to assess the extent to which they could transmit liquidity strains to broader markets. 

6) Measures to mitigate liquidity and redemption risks that are applicable to CIFs and similar 

pooled investment vehicles offering daily redemptions. While there are differences described 

above between mutual funds and other pooled investment vehicles such as CIFs, due to the 

potential for similar investment strategies and redemption practices, regulators should consider 

whether any aspects of the measures listed above, or other measures, may be appropriate for 

reducing potential liquidity risks in CIFs and similar pooled investment vehicles subject to their 

respective jurisdictions. 

While ETFs are not subject to the same types of liquidity and redemption risks as other open-end 

funds, the Council will continue to monitor other risks that could arise, such as the potential for 

ETFs to disconnect from the price of their underlying securities for an extended period, and 

whether such risks could raise financial stability concerns. The Council notes that the SEC is 

currently reviewing exchange-traded products with respect to a broad variety of issues.

In May 2015, the SEC proposed rules, forms, and amendments to modernize and enhance the 

reporting and disclosure of information by registered investment companies and registered 

investment advisers. In September 2015, the SEC issued proposed rules for mutual funds and 

ETFs designed to enhance liquidity risk management by funds, provide new disclosures 

regarding fund liquidity, and allow funds to adopt swing pricing to pass on transaction costs to 

entering and exiting investors. The Council welcomes the SEC’s policy initiatives in this area 

and understands the SEC is currently reviewing public comments on its proposed rules. 

 

To the extent that these or any other measures are implemented by the SEC or other regulators, 

the Council intends to review and consider whether risks to financial stability remain. This 

review will take into account how the industry may evolve in light of any regulatory changes, 

whether additional data is needed to comprehensively assess liquidity and redemption risk, and 

the differences and similarities in risk profiles among mutual funds and other pooled investment 

vehicles.
14

3. LEVERAGE RISK

3.1 Potential Risks to Financial Stability

The Council has considered potential risks arising from the use of leverage in certain investment 

vehicles, including mutual funds, hedge funds, CIFs, and SMAs.53 In particular, the Council has 

explored ways in which the use of leverage by investment vehicles could increase the potential 

for direct or indirect losses to counterparties and other market participants, and the extent to 

which these risks may have implications for U.S. financial stability. 

Leverage can be a useful component of an investment strategy, and its use can imply widely 

varying levels of risk depending on the activities and strategies of the investment vehicle. 

Leverage may be obtained through borrowings or securities financing transactions (referred to as 

financial leverage), or may be embedded in financial products such as derivatives (referred to as 

synthetic leverage). 

While actual risk exposure depends on a number of factors, leverage can magnify the impact of 

asset price movements on a fund’s net assets and performance. In the event that a leveraged

investor is faced with collateral or margin calls due to significant changes in asset prices, the 

investor may be forced to sell assets to satisfy those demands. Assets purchased with borrowed 

short-term funds may be particularly vulnerable to selling pressure in stress conditions if shortterm borrowing becomes unavailable and positions need to be unwound quickly. A disorderly 

liquidation of positions could in turn have a significant price effect on assets, and potentially 

impact previously unaffected market participants.54 Additionally, the exposures created by 

leverage establish interconnections to other market participants through which financial stress 

could be transmitted to the broader financial system.55

3.1.1 Hedge Funds

Hedge funds are not subject to the leverage restrictions imposed on funds registered under the 

Investment Company Act. Although hedge funds are not subject to direct regulatory restrictions, 

their use of leverage may be constrained indirectly through requirements on their broker-dealer

counterparties, such as Regulation T and FINRA margin rules for securities transactions,

56 and 

newly adopted requirements under the Dodd-Frank Act, including increased central clearing of 

 

53 SMAs are accounts managed by a registered investment adviser, in which the client (e.g., a pension fund, 

sovereign wealth fund, or other entity or individual) retains direct and sole ownership of the assets under 

management, and which are typically held at an independent custodian on behalf of the client. SMAs are not 

considered pooled investment vehicles but are included in this leverage discussion because of their ability to obtain 

significant leverage and because of the limited data available regarding these vehicles.

54 See Markus Brunnermeier and Lasse Pedersen, Market Liquidity and Funding Liquidity, The Review of Financial 

Studies 22(6), pp. 2201-2238 (2009).

55 See Zeno Adams, Roland Fuss, and Reint Gropp, Spillover Effects Among Financial Institutions: A StateDependent Sensitivity Value at-Risk Approach, Journal of Financial and Quantitative Analysis 49(3), pp. 575-598

(2014).

56 See 12 C.F.R. Part 220; FINRA Rule 4210.
15

derivatives and the introduction of margin requirements for uncleared swaps.57 Further, rules 

implementing the Basel III capital standards may limit access to leverage for hedge funds by 

increasing the costs to some prime brokers of certain trading activities. Hedge funds are also 

subject to ongoing reporting requirements imposed by lending counterparties, which may limit 

the amount of leverage funds may obtain. 

The relationship between a hedge fund’s level of leverage and risk, and whether that risk may 

have financial stability implications, is highly complex. Leverage is not a perfect proxy for risk, 

but there is ample evidence that the use of leverage, in combination with other factors, can 

contribute to risks to financial stability.58 These risks are likely to be greater if an elevated level 

of leverage is employed; borrowing counterparties are large, highly interconnected financial 

institutions; counterparty margining requirements are limited or lax and positions are 

infrequently marked to market; the underlying assets are less liquid and price discovery is poor; 

or other financial institutions with large positions are involved in similar trading strategies.59, 60

For example, a given value of a leverage metric might represent a prudent level of risk for a 

strategy involving committed funding in a highly liquid, centrally cleared market; the same value 

of that metric under different circumstances might warrant closer examination. Also, many 

strategies simultaneously take long and short positions in similar instruments with different 

liquidity profiles, and a simple leverage metric will not capture the potential differences in risk 

across these strategies.61 Abrupt shifts in market volatility or liquidity may have very different 

effects across strategies or markets. 

While additional information is needed to better assess any financial stability risk, the Council 

used data reported on Form PF as a starting point to assess the amount and nature of hedge 

funds’ leverage. The Council used a number of metrics for measuring leverage based on existing 

data, though each metric has certain shortcomings, as described below:

 

57 Dodd-Frank Act §§ 723, 731, 763(a), 763(c), and 764(a). In addition, sections 728, 763(i) and 766 of the DoddFrank Act require that information regarding all swaps and security-based swaps be reported to swap data 

repositories and security-based swap data repositories.

58 See Viral Acharya, Lasse Pedersen, Thomas Philippon, and Matthew Richardson, Measuring Systemic Risk, 

Technical Report, NYU Department of Finance (2010).

59 See Nicholas Chan, Mila Getmansky, Shane Haas, and Andrew Lo, Systemic Risk and Hedge Funds, The Risks of 

Financial Institutions, ed. Mark Carey and Renee Stulz, University of Chicago Press, Chicago, IL, pp. 235-338 

(2007); see also Amir Khandani and Andrew Lo, What Happened to the Quants in August 2007?: Evidence from 

Factors and Transactions Data, Journal of Financial Markets 14(1), pp. 1-46 (2011).

60 The failure of Long Term Capital Management (LTCM) in 1998 and the liquidation of Amaranth Advisors in 

2006, both large and highly leveraged hedge funds that came under significant stress over short periods of time with 

different outcomes, illustrate the interplay between leverage, size, and other factors. See President’s Working Group 

on Financial Markets, Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management (1999); see also

Roger Ferguson and David Laster, Hedge Funds and Systemic Risk, Banque de France Financial Stability Review: 

Special Issue on Hedge Funds, pp. 45-54 (2007); see also Mila Getmansky, Peter Lee, and Andrew Lo, Hedge 

Funds: A Dynamic Industry In Transition, NBER Working Paper No. 21449 (Aug. 2015).

61 See Comment Letter of the Managed Funds Association (Mar. 25, 2015), p. 35. 
16

 Borrowing divided by net asset value (borrowing/NAV): Provides a measure of credit 

exposure relative to shareholder assets but does not measure synthetic leverage obtained 

through derivative investments.

 Gross asset value divided by net asset value (GAV/NAV): Provides a measure of 

financial leverage obtained through the use of cash borrowings (including repo, prime 

brokerage borrowing, and other secured and unsecured borrowing) but only includes the 

market value of derivatives and thus may understate synthetic leverage.62

 Gross notional exposure divided by net asset value (GNE/NAV): Provides the summed 

absolute values of long and short notional positions. The measure incorporates financial 

and synthetic leverage, but has limitations. First, the summing of long and short 

positions ignores favorable effects of hedging or offsetting positions, which may reduce 

risk.63 A related shortcoming is that it treats all notional derivative values equally when 

calculating leverage levels, so it does not capture differences in risk exposure across 

different classes of derivatives.

64 However, notional exposure on Form PF is adjusted for 

certain derivative instruments; funds report delta-adjusted values for options and 10-year 

bond equivalent values for interest rate derivatives.65

These metrics are helpful for identifying potential areas for further analysis, but they are not 

sufficient to identify whether the use of leverage by hedge funds may present financial stability 

risks. In particular, aggregating notional derivative amounts to measure synthetic leverage is 

likely to overstate leverage. Evaluating risks from the use of leverage by hedge funds requires 

an analysis of other factors, which could include the nature of investment positions, trading and 

hedging strategies, financing arrangements, counterparties, margin requirements, and the effects 

of central clearing.

In the context of these data limitations, Form PF offers an initial high-level view on the extent of 

hedge funds’ use of leverage.66 The Council’s analysis confirmed that many hedge funds use 

relatively small amounts of leverage. However, disaggregated data show that larger hedge funds, 

as measured by GAV, tend to be more leveraged than smaller hedge funds. For instance, as of 

the second quarter of 2015, for all qualifying hedge funds (QHFs), the weighted averages for the 

three ratios—GAV/NAV, GNE/NAV, and borrowing/NAV—were approximately 1.8x, 5.5x, 

and 0.7x, respectively. In contrast, for the 10 largest hedge funds, the weighted averages for the 

three ratios were 6.1x, 23.3x, and 4.6x.

67

 This relationship between leverage and size is also true 

 

62 The vast majority of hedge fund borrowing is secured, which is the focus of this statement. 

63 See Comment Letter of the Alternative Investment Management Association (Mar. 25, 2015) p. 20.

64 For example, foreign exchange and interest rate derivatives tend to have higher notional amounts compared to 

credit default swaps or equity options for the same amount of volatility. 

65 Standardization of notional variables to comparable measures (e.g., delta adjusting option exposures) helps to 

clarify the comparisons, although such adjusted notional measures do not typically account for differences in 

liquidity, funding risk, cleared status, collateralization, or other potentially relevant characteristics.

66 See Comment Letter of Americans for Financial Reform (Mar. 27, 2015), pp. 4-5.

67 Data reported on Form PF as of 2Q 2015. A QHF is defined on Form PF as “any hedge fund that has a net asset 

value (individually or in combination with any feeder funds, parallel funds and/or dependent parallel managed 
17

for median and simple averages; in each case, the larger funds measured by GAV tend to have 

higher leverage ratios. When hedge funds are ranked by NAV, there is no clear pattern of 

leverage ratios and fund size.68 However, the Council has focused on GAV as a better proxy for 

exposure. 

Additionally, the use of leverage appears to be concentrated among a small number of hedge 

funds. The top 10 funds sorted by NAV represent less than 10 percent of the NAV of all QHFs. 

However, when sorted by GNE, borrowings, and notional value of derivatives, the top 10 funds 

represent 28, 35, and 49 percent, respectively, of all QHFs.69 When sorted by NAV, the top 100 

funds account for 39 percent of the NAV of all QHFs, but when sorted by GNE, borrowings, and 

notional value of derivatives, the top 100 funds represent 66, 73, and 83 percent of GNE, 

borrowings, and notional value of derivatives, respectively, of all QHFs. 

The data suggests that some of the largest (by gross assets) and most leveraged funds are relative 

value, fixed-income arbitrage funds that use repo and derivatives—primarily interest rate swaps 

and foreign exchange—to obtain leverage. These funds’ leveraged positions generally appear to 

be offsetting—that is, their market exposures appear to be largely hedged on a long/short basis—

but there are limitations to these reported metrics, requiring further analysis.

70

 As a result, it is 

difficult at this time to assess fully the potential for the liquidation of leveraged assets by a 

distressed fund, or by several funds pursuing similar strategies, to disrupt key financial markets.

Hedge fund leverage varies depending on strategy. Some funds rely on substantial amounts of 

borrowing, and those that are heavily reliant on short-term borrowing may be more affected by

financing constraints in times of market stress. Financial stress may result in worsening credit 

terms or reduced repo availability, and this stress could be transmitted to financial markets if 

hedge funds are forced to reduce their leverage.71 

With respect to counterparty exposures, QHFs report on Form PF the sum of mark-to-market net 

counterparty exposures for each of their top five counterparties.72 Of the $1.1 trillion of net 

 

accounts) of at least $500 million as of the last day of any month in the fiscal quarter immediately preceding [the 

fund’s] most recently completed fiscal quarter.” See Form PF, Glossary of Terms, p. 8.

68 In particular, as of 2Q 2015, the weighted averages for the three ratios were approximately 1.9x, 5.3x, and 0.8x for

the top 10 hedge funds sorted by NAV.

69 For all QHFs, aggregate borrowing was approximately $2.0 trillion ($1.1 trillion in borrowing from prime 

brokers, $649 billion in repo, and $255 billion in other secured borrowing), and the aggregate gross notional value of 

derivatives was approximately $12.7 trillion. Derivatives data is based on Form PF question 44; unlike GNE, this 

aggregated notional number does not include an adjustment for interest rate derivatives to 10-year bond equivalents, 

or any delta-adjustment for options. 

70 Form PF can be used to estimate the level of market risk to which the funds are exposed, including reporting of 

value at risk (question 40), and the results of stress tests (question 42); however, there are limitations to these 

reported metrics. For example, value at risk is not uniformly calculated or reported by filers, and stress tests do not 

reveal the effect of non-parallel shifts in the yield curve. 

71 See Adam Copeland, Antoine Martin, and Michael Walker, Repo Runs: Evidence from the Tri-Party Repo 

Market, Journal of Finance 69(6), pp. 2343-2380 (2014); see also Arvind Krishnamurthy, Stefan Nagel, and Dmitry 

Orlov, Sizing Up Repo, Journal of Finance 69(6), pp. 2381-2417 (2014).

72 Form PF question 23 requires filers to report the five counterparties that have the greatest mark-to-market net 

counterparty credit exposure to the fund. 
18

counterparty exposures reported by all QHFs, seven counterparties accounted for $843 billion, or 

75 percent of the total. Given the limitations of the data, however, the extent to which net 

counterparty exposure and the proportion attributable to these seven counterparties represent a 

significant portion of total net mark-to-market counterparty exposure of qualifying hedge funds 

is unknown. While financial stability risks can be transmitted through direct and indirect 

exposures of large financial institutions, the risk of direct losses to counterparties is reduced by 

collateral posted by the hedge funds. The reported value of collateral posted for the $1.1 trillion 

of exposures was $1.4 trillion. However, the data also shows that the ratio of posted collateral to 

counterparty exposures varies across the largest funds, and there is limited detailed information 

regarding collateral type.73

The market reforms discussed above, including margin requirements and increased use of central 

clearing for derivatives, are significant structural changes that should mitigate certain risks to 

financial stability. However, these changes do not apply equally to all markets or products, and 

their effect has not yet been tested during a period of severe market stress. For example, to the 

extent that margin requirements are procyclical, they could contribute to forced liquidations that 

could amplify price volatility in times of market stress.74

In addition, although some market participants have stated that counterparty risk management 

has improved in the wake of the financial crisis,75 individual counterparties may lack a complete 

picture of a fund’s exposures, as many hedge funds have relationships with multiple prime 

brokers and derivatives dealers.76 These counterparties are also supervised or regulated by 

agencies across various jurisdictions. Accordingly, no single regulator has a complete window 

into the risk profile of hedge funds. 

In summary, the Council’s ability to fully assess these risks and potential mitigants is constrained 

by limitations in the available data. While the reporting of data on Form PF has increased 

transparency to regulators, the leverage metrics and broad strategy classifications available in 

Form PF do not provide sufficient insight into relevant risks, limiting the Council’s ability to 

assess potential risks to financial stability from the activities of leveraged hedge funds.

 

73 On Form PF question 37, hedge funds report the value of collateral posted to the counterparties listed in question 

23. Of the $1.4 trillion in collateral reported on question 37, 35 percent was cash and cash equivalents (which 

includes Treasury and agency securities), 63 percent was securities other than cash and cash equivalents, and 2 

percent was reported as other collateral and credit support.

74 A number of studies suggest that margin requirements for certain derivatives and securities lending transactions 

may have procyclical effects. See Markus Brunnermeier and Lasse Pedersen, Market Liquidity and Funding 

Liquidity, The Review of Financial Studies 22(6), pp. 2201-2238 (2009); see also David Murphy, Michalis Vasios, 

and Nick Vause, An Investigation into the Procyclicality of Risk-Based Initial Margin Models, Bank of England, 

Financial Stability Paper No. 29 (2014); see also Committee on the Global Financial System, The Role of Margin 

Requirements and Haircuts in Procyclicality, Bank for International Settlements CGFS Papers No. 36 (2010).

75 See e.g., Deloitte Touche Tohmatsu Limited, Global Risk Management Survey, Eighth Edition, Setting a Higher 

Bar, p. 25.

76 See Comment Letter of the Alternative Investment Management Association (Mar. 25, 2015), p. 5. 
19

3.1.2 Registered Funds: Mutual Funds and ETFs

The Investment Company Act restricts the amount of financial leverage that may be used by 

mutual funds and other investment companies registered with the SEC. The Investment 

Company Act limits mutual funds’ bank borrowings to 50 percent of net assets; SEC guidance 

has limited leverage obtained through reverse repurchase agreements and certain other financing 

transactions such that funds’ obligations under these transactions cannot exceed 100 percent of 

net assets.77 As a result, most mutual funds and ETFs have low levels of financial leverage. 

However, some funds’ current practices enable them to obtain a higher degree of leverage than 

was contemplated under previous SEC guidance.

78

 This is particularly true for alternative 

strategy funds, such as nontraditional bond funds and leveraged ETFs. For example, according 

to SEC staff analysis, which was based on a 10 percent random sample of all funds, most 

traditional mutual funds and ETFs obtain little to no exposure through derivatives, and only 1 

percent of the AUM of the traditional funds included in the sample was invested in funds with 

derivatives exposure relative to NAV above 3.0x.79 In contrast, SEC staff analysis found that 

some alternative strategy funds appear to use derivatives substantially. While only 8 percent of 

alternative strategy funds included in the SEC’s sample had derivatives exposure relative to 

NAV greater than 3.0x, these funds accounted for 52 percent of alternative strategy AUM in the 

staff’s random sample.80 Alternative strategy funds represent only 3 percent of total industry 

AUM; however, they have recently experienced significant growth and have received a 

disproportionate share of industry net inflows. 

3.1.3 Collective Investment Funds

The extent of the use of leverage is reviewed as part of the regular examination process at 

federally supervised institutions operating CIFs, and these banks are required to monitor leverage 

 

77 Sections 18(a)(1) and 18(f)(1) of the Investment Company Act; Investment Company Act Release No. 10666, 44 

Fed. Reg. 25128 (Apr. 27, 1979); see Registered Investment Company Use of Senior Securities – Select 

Bibliography, available at: https://www.sec.gov/divisions/investment/seniorsecurities-bibliography.htm (listing 

staff guidance analyzing the application of section 18 of the Investment Company Act to certain financial 

transactions).

78 See Use of Derivatives by Registered Investment Companies and Business Development Companies, 80 Fed. Reg. 

80844, 80893 (Dec. 28, 2015) (“Together, funds’ use of the mark-to-market segregation approach with respect to 

various types of derivatives, plus the segregation of any liquid asset, enables funds to obtain leverage to a greater 

extent than was contemplated in Release 10666.”).

79 Daniel Deli, Paul Hanouna, Christof Stahel, Yue Tang, and William Yost, Use of Derivatives by Registered 

Investment Companies, SEC DERA White Paper (Dec. 2015) (analysis of 2014 Form N-CSR filings with a 10 

percent random sample of all funds). In the white paper, derivatives exposure is defined as the gross notional 

amount of derivatives that involve potential future payment obligations. “Alternative strategy funds” refers to 

alternative funds, nontraditional bond funds, and commodity funds. AUM refers to the percent of assets that are 

invested in traditional (alternative strategy) funds according to derivatives exposures/NAV. A total of 54 percent of 

AUM in traditional funds that were included in the staff’s sample was invested in funds with no derivative 

exposures, and 95 percent of AUM in traditional funds that were included in the staff’s sample was invested in funds 

with derivatives exposure/NAV below 1.0x.

80 Due to data limitations, “derivatives exposure” in the SEC staff analysis is not precisely comparable to the gross 

notional exposure metrics used in the Form PF analysis. For example, the SEC staff analysis does not delta adjust 

option exposures and does not represent fixed income exposures in 10-year equivalents.
20

risk to the CIF.

81

 However, there is no express regulatory limit on CIFs’ leverage, and there is 

limited public data available on CIFs’ use of borrowing and synthetic leverage.

3.1.4 Separately Managed Accounts 

There is currently limited regulatory data available to assess the extent to which SMAs use 

leverage. An industry survey suggests that leverage levels within SMAs are low and that the 

majority of SMAs do not employ leverage.

82

 However, this information does not represent the 

total SMA universe. Additionally, those that do use leverage are typically limited in their ability 

to do so by their governing investment management agreements. 

3.2 Council Views

3.2.1 Hedge Funds

While the regulatory reforms and market practices described above indirectly limit certain risks 

from the use of leverage at hedge funds, data reported on Form PF shows that, based on certain 

metrics, there appears to be a concentration of leverage in a small number of large hedge funds. 

Form PF does not provide complete information on the economics and corresponding risk 

exposures of hedge fund leverage or potential mitigants associated with reported leverage levels. 

In addition, hedge funds’ major counterparties are regulated by various regulators with different 

jurisdictions. Currently, therefore, no single regulator has all the information necessary to 

evaluate the complete risk profiles of hedge funds.

The Council’s review of the use of leverage in the hedge fund industry suggests a need for 

further analysis of the activities of hedge funds. The Council is creating an interagency working 

group that will share and analyze relevant regulatory information in order to better understand 

whether certain hedge fund activities might pose potential risks to financial stability. In 

particular, the working group will: 

1. Use regulatory and supervisory data to evaluate the use of leverage in combination with 

other factors—such as counterparty exposures, margining requirements, underlying 

assets, and trading strategies—for purposes of assessing potential risks to financial 

stability; 

2. Assess the sufficiency and accuracy of existing data and information, including data 

reported on Form PF, for evaluating risks to financial stability, and consider how the 

existing data might be augmented to improve the ability to make such evaluation; and

 

81 See OCC CIF Handbook, pp. 13-14 (“To the extent a fund uses leverage with the objective of enhancing returns, 

the bank must have processes in place to calculate the leverage risk in the fund’s portfolio. The bank must monitor 

that leverage risk and, where appropriate, incorporate risk mitigation and diversification strategies to reduce that 

risk.”). 

82 See Comment Letter of the Asset Management Group of SIFMA and the Investment Adviser Association to the 

Financial Stability Board and SEC (Apr. 4, 2014), p. 2, p. 6. 
21

3. Consider potential enhancements to and the establishment of standards governing the 

current measurements of leverage, including risk-based measures of leverage.

This group will seek to report its consolidated findings to the Council by the fourth quarter of 

2016. If risks to financial stability are identified, the Council will: (1) consider what actions 

regulators can take using existing authorities; (2) assess whether existing regulatory and 

supervisory tools are sufficient to address risks; and (3) evaluate whether additional authorities 

may be needed for market regulators or other supervisory agencies.

 

3.2.2 Registered Funds: Mutual Funds and ETFs

In December 2015, the SEC issued a proposed rule on the use of derivatives by registered 

investment companies, including mutual funds, ETFs, and business development companies. 

The SEC’s proposed derivatives rule would generally limit the leverage that registered

investment companies may obtain through derivatives that impose a conditional or unconditional 

obligation on the fund to make a payment or to deliver assets to a counterparty. The 

requirements under the proposed rule are intended to impose a limit on the amount of leverage 

registered funds may obtain through these derivatives and certain other senior securities 

transactions; address concerns that registered investment companies may be unable to meet their 

obligations, including in times of stress, by limiting derivatives exposures and strengthening 

asset segregation requirements; and require funds with substantial or complex derivatives 

exposures to implement a formalized risk management program.

The Council welcomes the SEC’s efforts to limit the amount of leverage that registered 

investment companies such as mutual funds and ETFs may obtain through derivatives 

transactions, strengthen their asset segregation requirements, and require derivatives risk 

management programs for certain funds. The Council intends to monitor the effects of any 

regulatory changes and their implications for financial stability.

3.2.3 Collective Investment Funds

Regulators should consider whether aspects of any SEC rules regarding derivatives and data 

reporting modernization, or other measures, may be appropriate for CIFs subject to their 

respective jurisdictions. Regulators should consider how the industry may evolve as a result of

any final SEC rules, whether additional data is needed comprehensively to assess leverage risk at 

CIFs, and differences in regulatory regimes.

3.2.4 Separately Managed Accounts

In May 2015, the SEC issued a proposed rule requiring registered investment advisers to provide 

annual data on the SMAs they manage. The SEC has proposed important enhancements that 

would increase data available to monitor the use of leverage in SMAs. The Council welcomes 

these efforts and understands that the SEC is currently reviewing public comments on the 

proposed rule. The Council intends to monitor the effects of any regulatory changes and their 

implications for financial stability.
22

4. OPERATIONAL RISK

4.1 Potential Risks to Financial Stability

The Council has considered whether operational risks within the asset management industry 

could have broader implications for U.S. financial stability.83 Specifically, the Council has 

considered whether a disruption or failure of a service provider, or the provision of a flawed 

service, could result in a transmission of risk to the broader financial system. Historical 

operational risk incidents highlight the potential for such events to cause significant losses and 

disrupt market functioning. Additionally, new risks continue to arise in this space, such as 

cybersecurity risks. 

The potential for more far-reaching effects is likely to be greater when multiple asset managers 

rely on one or a small number of providers for certain services.84 If a sufficiently protracted or 

large-scale disruption, failure, or error were to occur at a widely used service provider, this could 

potentially create disruptions to core business functions. While not rising to the level of financial 

stability concerns, recent examples of operational issues, including a disruption to the NAV 

pricing service for hundreds of mutual funds provided by a third-party vendor, highlight the 

importance of service providers to the industry and demonstrate the potential for disruptive 

incidents.85 The Council’s initial review has focused on areas that appear to feature a relatively 

high level of outsourcing to external service providers, and potential concentrations in a small 

group of service providers, particularly across middle and back office functions. However, 

additional information and analysis are necessary to fully assess potential risks. 

Operational risk is an important area of focus for companies in many industries and, while 

operational risks cannot be wholly prevented, companies take important steps to plan for and 

respond to operational issues. As with other areas of risk, operational risks may be mitigated by 

appropriate risk management programs and control environments. Regulators set expectations 

for the management of risks from the use of service providers and in some cases have regulatory 

authority over service providers themselves. For example, the SEC requires funds and advisers 

 

83 In its request for public comment, the Council indicated an interest in any areas of operational risk within the asset 

management industry that could present risks to U.S. financial stability, but expressed a particular interest in risks 

that may arise when multiple asset managers rely on one or a limited number of third parties to provide important 

services. Council Notice, 79 Fed. Reg. at 77493.

84 Asset managers, like other types of financial services firms, may use affiliated or third-party service providers and 

specialized information technology systems for key functions and may provide such services to other asset managers 

or financial institutions. The Council’s review thus far indicates key front-office functions include portfolio 

decision making, trading, and marketing; middle office functions typically include trade processing, asset pricing,

fund valuation, services provided by prime brokers, and portfolio risk management; and back office functions 

include custody services, fund administration, fund accounting, transfer agency and shareholder record keeping, and 

facilitation of securities lending. Asset managers of registered funds employ a wide range of insourcing and 

outsourcing models, with some fulfilling both middle and back office functions internally, some fully or largely 

outsourcing, and some using a hybrid approach. See, e.g., Comment Letter of BlackRock (Mar. 25, 2015), pp. 70-

71; see also Comment Letter of the Investment Company Institute (Mar. 25, 2015), pp. 59-60.

85 See, e.g., Press Release, SunGard Financial Systems, BNY Mellon InvestOne Production Environment Issue (Aug.

27, 2015), available at: https://www.bnymellon.com/us/en/_locale-assets/pdf/newsroom/sungard-bny-melloninvestone-external-statement.pdf.
23

to have written compliance policies and procedures and expects that such policies and 

procedures should address certain issues, including business continuity plans to the extent they 

are relevant.

86

 The Federal Reserve, Office of the Comptroller of the Currency (OCC), and 

Federal Deposit Insurance Corporation (FDIC) have guidance requiring bank-owned or bankaffiliated asset managers to maintain sound risk management processes with respect to thirdparty relationships.87

 In addition, regulators have various mechanisms through which they may 

obtain information about service providers, though they may vary across regulatory 

jurisdictions.88

Finally, as noted above, another important area of operational risk is cybersecurity, which many 

commenters on the Council’s notice highlighted in their letters. As with other types of 

operational risk, cybersecurity is a key focus for firms across all sectors of the financial system. 

Some commenters cited the Council’s potential to play a coordinating role in helping the 

industry prepare for and respond to cyber threats.89

4.2 Council Views

The use of service providers and reliance on technology within the asset management industry 

calls for greater understanding of potential risks. While the asset management industry, as with 

the financial industry as a whole, has placed increasing emphasis on business continuity 

planning, and individual market participants have information on their own service provider 

relationships, there is limited information available to enable regulators to assess operational 

risks across the industry, including service provider risks. Although the incidents to date have 

not raised financial stability concerns, this does not preclude the potential for future incidents to 

pose more serious threats. 

 

86 See Compliance Programs of Investment Companies and Investment Advisers, 68 Fed. Reg. 74714 (Dec. 24, 

2003). 

87 See Federal Reserve SR 13-19, Guidance on Managing Outsourcing Risk (Dec. 5, 2013), available at:

https://www.federalreserve.gov/bankinforeg/srletters/sr1319.htm; see also OCC Bulletin 2013-29, Third-Party 

Relationships: Risk Management Guidance (Oct. 30, 2013), available at: http://www.occ.gov/newsissuances/bulletins/2013/bulletin-2013-29.html; see also FDIC FIL-44-2008, Guidance for Managing Third Party 

Risk (Jun. 6, 2008), available at: https://www.fdic.gov/news/news/financial/2008/fil08044.html; see also FFIEC 

Information Technology Examination Handbook: Outsourcing Technology Services Booklet (Jun. 2004), available 

at: http://ithandbook.ffiec.gov/ITBooklets/FFIEC_ITBooklet_OutsourcingTechnologyServices.pdf, and Supervision 

of Technology Service Providers Booklet (Oct. 2012), available at:

http://ithandbook.ffiec.gov/ITBooklets/FFIEC_ITBooklet_SupervisionofTechnologyServiceProviders(TSP).pdf.

88 The Federal Reserve, OCC, and FDIC have authority under the Bank Service Company Act to examine certain 

third-party service providers directly. The SEC can obtain information and documents maintained by third-party 

service providers that perform work for, or whose activities have a material impact on, a registered entity and may 

obtain access to service providers’ records if they have custody of the securities of an advisory client. Additionally, 

certain service providers are regulated by the SEC directly. Some other service providers are bank holding 

companies supervised by the Federal Reserve that may be subject to enhanced prudential standards under section 

165 of the Dodd-Frank Act. 

89 See, e.g., Comment Letter of the Asset Management Group of SIFMA and the Investment Adviser Association 

(Mar. 25, 2015), pp. 47-48; see also Comment Letter of the Investment Company Institute (Mar. 25, 2015), pp. 71-

72.
24

As a result, the Council will continue its analysis of potential service provider risks, including by 

engaging with relevant industry participants and other stakeholders, which may also be useful in 

better understanding potential service provider risks within the financial industry as a whole. 

The Council’s analysis is expected to cover key functions performed by service providers to 

asset managers, including, among other things, a review of the concentration of service 

providers, the level of outsourcing of particular services, and the complexity of the infrastructure 

and activities supported by such providers. The Council will consider whether there is the 

potential for operational disruptions or problems to cause significant losses and disrupt market 

functioning. The Council also intends to further evaluate industry practices for managing these 

risks, such as business continuity and disaster recovery planning for disruptions. As part of this 

analysis, the Council will consider tools already available to mitigate risks from service 

providers, as well as potential ways to enhance information sharing among regulators to help 

evaluate the extent of these risks.

Additionally, the Council will continue to work with the asset management industry and other 

components of the financial services industry to promote information sharing, best practices, and 

efforts to improve planning, response, and recovery from cyber incidents. 

5. SECURITIES LENDING RISK

5.1 Potential Risks to Financial Stability

Securities lending transactions involve the temporary transfer of a security by one party (the 

lender) to another (the borrower) in exchange for collateral, which may be cash or other 

instruments. The primary borrowers are hedge funds and broker-dealers, as well as their clients. 

The primary lenders are large institutional investors, such as pension plans, insurance companies, 

sovereign wealth funds, and endowments, as well as mutual funds and other pooled investment 

vehicles. Lenders generally use a securities lending agent to facilitate loans, although some may 

lend securities directly to a borrower. Custodian banks are the most common lending agents, and 

some asset managers also perform this function. A thorough evaluation of potential risks to 

financial stability from securities lending activities must include entities across the financial 

system.

A potential risk to financial stability from securities lending activity arises from the reinvestment 

of cash collateral by securities lenders. Some securities lenders, including registered funds, are 

subject to regulatory limits on cash collateral reinvestment. Other lenders that are not subject to 

these limits may invest cash collateral in pooled investment vehicles with weighted average 

portfolio maturities significantly greater than the terms of their securities loans, which can result 

in liquidity and maturity mismatches. Widespread borrower terminations of securities loans 

could result in significant, unexpected lender redemptions from cash collateral reinvestment 

vehicles in order to repay collateral. Such unexpected redemptions from vehicles with 

insufficient liquidity could result in rapid asset sales to meet redemptions, which in a period of 

market stress could accelerate declines in asset prices and potentially lead to losses in cash 
25

collateral pools more broadly, additional redemptions, and further outflows.90 Because cash 

collateral is sometimes reinvested in repo markets, such a scenario could have negative 

consequences for other types of short-term wholesale funding and the market participants that 

rely on them.91 

At the same time, there are significant mitigants to cash collateral reinvestment risks arising from 

securities lending. In particular, many securities lenders reinvest cash collateral in money 

market mutual funds and certain short-term investment funds, which have become more resilient 

as a result of post-crisis reforms by the SEC and OCC, respectively.92 These reforms include 

more stringent investment limits, tools to address investor runs in periods of market turmoil, 

improved stress-testing procedures, and more detailed disclosures. 

Another area for potential further analysis is the activities involved with indemnification against 

borrower default.93 While there have not been historical examples of borrower default 

indemnification creating financial stability risks, regulators lack reliable data on the various 

lending agent activities across this market.

5.2 Council Views

Without comprehensive information on securities lending activities across the financial system, 

regulators cannot fully assess the severity of potential risks to financial stability in this area. 

Current estimates of the total size of the securities lending market differ widely, and greater 

transparency is needed. Therefore, the Council encourages enhanced and regular data collection 

and reporting, as well as interagency data sharing, regarding securities lending activities. 

The Council welcomes the efforts of the Office of Financial Research, Federal Reserve, and SEC 

on their recently completed joint securities lending data collection pilot, which surveyed major 

securities lending agents to collect data covering a wide array of lenders and borrowers. This 

data collection is critical to better understand securities lending activities across different types 

of institutions. The Council encourages efforts to propose and adopt a rule for a permanent 

collection.94 Data collection efforts should be expanded to include a greater number of market 

participants. In addition, regulators should continue to monitor cash collateral reinvestment 

vehicles and explore ways to gather information on reinvestment practices occurring outside of 

the regulatory perimeter. The Council encourages relevant agencies to report back to the 

 

90 See Robert McDonald and Anna Paulson, AIG in Hindsight, The Journal of Economic Perspectives 29(2), pp. 81-

105 (2014).

91 See Arvind Krishnamurthy, Stefan Nagel, and Dmitry Orlov, Sizing Up Repo, Journal of Finance 69(6), pp. 2381-

2417 (2014).

92 Short-term investment funds are a type of CIF subject to certain regulatory requirements. See 12 C.F.R. §

9.18(b)(4)(iii). 

93 Securities lenders’ investment policies often require them to obtain an indemnification from their lending agent, 

under which the agent typically guarantees replacement value of a lent security in case the securities borrower fails 

to return the security and the value of pledged collateral is insufficient to replace it. 

94 While the Council’s review did not consider secured financing transactions more generally, it notes that the 

securities lending data collection could be integrated with a similar pilot initiated to collect data on the bilateral repo 

market to allow for more complete analysis of secured financing transactions. 
26

Council on their assessment of potential risks arising from securities lending activities based on 

these enhanced data gathering initiatives. 

With regard to other data enhancements, the SEC issued a proposed rule in May 2015 to require

funds to report monthly on their securities lending activities, including certain counterparty 

information and position-level information on Form N-PORT. The Council welcomes proposals 

by the SEC to collect more detailed information on the characteristics of securities lending 

activities undertaken by registered funds, including data on principal, collateral, counterparties, 

reinvestment practices, and indemnification agreements. 

Finally, the extent to which particular market participants operate across national boundaries is 

not clear from available data, so it is difficult for regulators to determine how stresses in a 

foreign jurisdiction may affect securities lending activities in the United States. As current 

estimates suggest that half of global securities lending activities take place outside of the United 

States, the Council encourages member agencies to work with key foreign counterparts on 

enhanced data collection across jurisdictions.

6. RESOLVABILITY AND TRANSITION PLANNING

6.1 Potential Risks to Financial Stability

The Council has evaluated and continues to examine potential challenges and risks to financial 

stability that may arise in a resolution or liquidation of an entity in the asset management 

industry, particularly in circumstances of market stress, or involving an entity with a high degree 

of complexity and multi-jurisdictional operations. While there are limited precedents for the 

rapid failure or closure of a large, global asset manager, the Council considered potential 

implications from stress scenarios that could impact asset managers or pooled investment 

vehicles, as well as mitigants to such risks.95 

Although they do not typically represent independent sources of risk, resolvability and transition 

challenges could exacerbate the risks arising from the stress or failure of an asset manager or 

investment vehicle. In the case of a disorderly liquidation or abrupt failure of an investment 

vehicle, resolution challenges could amplify the transmission of risks related to liquidity and 

redemption or leverage, which are addressed above in Sections 2 and 3. Challenges include the 

disruption or termination of critical service provider relationships, complications arising from 

affiliate insolvencies, the liquidation and re-establishment of over-the-counter derivative

positions, and obstacles associated with the transfer of foreign assets. The Council’s analysis 

considered how advance planning efforts in these areas could mitigate such risks. 

 

95 See Comment Letter of BlackRock (Mar. 25, 2015), p. 76, pp. 88-89 (providing examples of asset management 

fund closures, failures, transfers, mergers, and acquisitions). These examples provide evidence of how funds and 

asset managers have addressed such events without raising financial stability concerns, although there are limited 

examples of the rapid failure of large, global asset management firms or funds, particularly in times of overall 

market stress. 
27

6.2 Council Views

As noted in the discussions above of liquidity and redemption risk and leverage risk, the Council 

has identified certain potential risks associated with stress scenarios affecting asset management 

entities and has identified steps to consider in addressing such risks. With respect to 

resolvability more generally, advance planning by asset managers for certain stress scenarios 

may provide important risk-mitigation benefits. SEC staff is working to develop a proposed rule 

for SEC consideration to require registered investment advisers to create and maintain transition 

plans that address, among other things, a major disruption in their business. The Council 

welcomes the SEC’s efforts in this area and will monitor the effects of any regulatory changes 

and their implications for financial stability.