1 

This document has been submitted to the Office of the Federal Register (OFR) for publication 

and is currently pending placement on public display at the OFR and publication in the Federal 

Register. The document may vary slightly from the published document if minor editorial changes 

have been made during the OFR review process. Upon publication in the Federal Register, the 

regulation can be found at http://www.gpoaccess.gov/fr/, www.regulations.gov, and at 

www.fsoc.gov. The document published in the Federal Register is the official document. 

Billing code 4810-25-P 

FINANCIAL STABILITY OVERSIGHT COUNCIL

Notice Seeking Comment on Asset Management Products and Activities

Docket No. FSOC-2014-0001 

AGENCY: Financial Stability Oversight Council. 

ACTION: Notice. 

SUMMARY: Consistent with its responsibility to identify risks to the financial stability

of the United States, the Financial Stability Oversight Council (Council) is issuing this 

notice seeking public comment on aspects of the asset management industry (Notice), in 

particular whether asset management products and activities may pose potential risks to 

the U.S. financial system in the areas of liquidity and redemptions, leverage, operational 

functions, and resolution, or in other areas. The Council is inviting public comment as 

part of its ongoing evaluation of industry-wide products and activities associated with the 

asset management industry. 

DATES: Comments must be received no later than [INSERT DATE 60 DAYS FROM 

THE DATE OF PUBLICATION]. 

ADDRESSES: Interested persons are invited to submit comments on all aspects of this 

Notice. All submissions must refer to docket number FSOC-2014-0001. 
2 

 Electronic Submission of Comments: Interested persons may submit comments 

electronically through the Federal eRulemaking Portal at http://www.regulations.gov. 

Electronic submission of comments allows the commenter maximum time to prepare and 

submit a comment, provides for timely receipt, and enables the Council to make the 

comments available to the public. Comments submitted electronically through 

http://www.regulations.gov can be viewed by other commenters and interested members 

of the public. Commenters should follow the instructions provided on that site to submit 

comments electronically. 

Mail: Comments may be mailed to Financial Stability Oversight Council, 

Attn. Patrick Pinschmidt, Deputy Assistant Secretary for the Financial Stability Oversight 

Council, 1500 Pennsylvania Ave., NW, Washington, DC 20220. 

 Public Inspection of Comments: Properly submitted comments will be available for 

inspection and downloading at http://www.regulations.gov. 

Additional Instructions: In general, comments received, including attachments and 

other supporting materials, are part of the public record and are available to the public. 

Do not include any information in your comment or supporting materials that you 

consider confidential or inappropriate for public disclosure. 

FOR FURTHER INFORMATION CONTACT: Patrick Pinschmidt, Deputy Assistant 

Secretary for the Financial Stability Oversight Council, Department of the Treasury, at 

(202) 622-2495; Lyndsay Huot, Senior Policy Advisor, Office of the Financial Stability 

Oversight Council, Department of the Treasury, at (202) 622-5874; or Eric Froman, 

Office of the General Counsel, Department of the Treasury, at (202) 622-1942. 
3 

SUPPLEMENTARY INFORMATION: The Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank Act) established the Council to identify risks to 

the financial stability of the United States, promote market discipline, and respond to 

emerging threats to the stability of the U.S. financial system. Consistent with those 

purposes, the Council continually monitors the financial marketplace to identify potential 

risks to U.S. financial stability. 

The Council has been engaged in work over the past year to analyze risks 

associated with the asset management industry and whether any such risks could affect 

U.S. financial stability. The Council recognizes that asset management is an important 

component of the financial services industry and that there are meaningful differences 

within the asset management industry, with diverse investment strategies, corporate 

structures, regulatory regimes, and customers. To further the Council’s work, in May 

2014, the Deputies Committee of the Council hosted a public conference on the asset 

management industry and its activities, at which practitioners—including CEOs, 

treasurers, and risk officers—as well as academics and other stakeholders discussed a 

variety of topics related to the industry. The Council subsequently directed staff to 

undertake a more focused analysis of industry-wide products and activities to assess 

potential risks associated with the asset management industry. Based on that and other 

work, certain areas of interest have been highlighted by the Council as warranting further 

review and analysis. 

The Council is now seeking public comment in order to understand whether and 

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

financial stability. Specifically, this Notice requests information about whether risks 
4 

associated with liquidity and redemptions, leverage, operational functions, and resolution 

in the asset management industry could affect U.S. financial stability.1 The Council also 

welcomes input on other areas associated with asset management products and activities 

that could affect U.S. financial stability. 

The Council recognizes that investment risk is inherent in capital markets, 

representing a normal part of market functioning. The Council’s focus on the asset 

management industry is directed at assessing 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 protect individual market participants (including 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, markets 

themselves, or the broader economy. Similarly, risks to financial stability might not flow 

from the actions of any one entity, but could arise collectively across market participants. 

Further, the Council notes that certain activities that do not pose risks to financial 

stability during normal times may do so during periods of financial market stress or stress 

at a particular firm. 

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 

 

1

 In this regard, the Council is acting consistent with the purposes described in section 112(a)(1) of the 

Dodd-Frank Act, see, e.g., 12 U.S.C. 5322(a)(1)(A) (“identify risks to the financial stability of the United 

States that could arise from the . . . ongoing activities, of . . . nonbank financial companies”), as well as 

pursuant to specific duties of the Council. See, e.g., 12 U.S.C. 5322(a)(2)(C) (requiring the Council to 

“monitor the financial services marketplace in order to identify potential threats to the financial stability of 

the United States”).
5 

commodity pool operators.2

 These entities provide a variety of asset management 

products, herein referred to as “investment vehicles,” such as separately-managed 

accounts (SMAs) and “pooled investment vehicles.”3 Pooled investment vehicles include 

investment companies registered under the Investment Company Act of 1940 (Investment 

Company Act) (registered funds), private funds (including hedge funds), bank collective 

investment trusts, and commodity pools. The Council is interested in obtaining 

information on potential risks to the U.S. financial system that may arise from the asset 

management activities of any entities or investment vehicles. 

The Council recognizes that the Securities and Exchange Commission (SEC) is 

undertaking several initiatives that would apply to investment companies and investment 

advisers regulated by the SEC and may address some of the risks described in this 

Notice.4 While the SEC’s initiatives are not specifically focused on financial stability, 

the Council intends to consider the impact these initiatives may have in reducing any 

risks to U.S. financial stability associated with the asset management industry. 

The Council’s analytical process will depend importantly on the existence and 

availability of high-quality data and information, which are essential to the ability of the 

Council to carry out its statutory purposes. The Council notes that information is 

 

2

 Many of these entities provide a range of financial services. For the purposes of this Notice, the Council 

is interested in the asset management activities of these entities and any risks that they could present to the 

broader financial markets. As discussed in Sections III and IV, the Council is also exploring the existence 

of potential risks that could arise from interconnections with affiliated companies.

3

 SMAs are accounts managed by a registered investment adviser, in which the client, which could be 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. 

For purposes of this Notice, SMAs are included in the term “investment vehicles.” 4

 See Unified Agenda of Regulatory and Deregulatory Actions (Fall 2014) (initiatives relating to 

derivatives use by investment companies, fund liquidity management programs, transition plans for 

investment advisers, stress testing for large asset managers and large investment companies, and 

information reporting by SEC-regulated entities).
6 

available in varying degrees about different asset management products and activities. A 

core component of the Council’s review is an evaluation of the extent to which sufficient 

data are available to monitor and assess potential risks in the asset management industry 

and whether there are areas where additional data and information would be helpful to the 

Council, as well as to market participants. 

The Council has not made any determination regarding the existence or nature of 

any potential risks to U.S. financial stability discussed in this Notice. Throughout this 

Notice, the Council asks questions regarding areas of potential risk in the asset 

management industry and will consider the input received in each case in evaluating 

whether any of these areas might present potential risks to U.S. financial stability. In the 

event the Council’s analysis identifies risks to U.S. financial stability, the Council will 

consider potential responses. 

I. Liquidity and Redemptions 

Liquidity risk generally refers to the risk that an investor will not be able to buy or 

sell an asset in a timely manner without significantly affecting the asset’s price.5 Most

financial assets expose investors to some degree of liquidity risk, whether they invest 

directly in the assets or indirectly through a pooled investment vehicle. While the 

Council welcomes broader input on liquidity risks that may be associated with investment 

vehicles generally, the Council is focused on exploring whether investments through 

pooled investment vehicles that provide redemption rights, as well as their management 

 

5

 The term “liquidity risk” is used herein to describe market liquidity risk, as opposed to funding liquidity 

risk. Funding liquidity risk, which involves the risk that an entity is unable to meet its cash or other 

obligations in a timely manner, is a means through which leverage may contribute to financial market 

stress, a subject discussed in Section II.
7 

of liquidity risks and redemptions, could potentially influence investor behavior in a way 

that could affect U.S. financial stability differently than direct investment. 

In particular, the Council is interested in exploring the ways in which investors in 

some pooled investment vehicles could have greater incentives to redeem than if they 

were to sell a direct investment in the financial assets comprising the vehicle’s portfolio. 

Investors in pooled investment vehicles that offer near-term access to redemptions could 

face increased redemption incentives, especially during periods of financial market stress, 

because the costs associated with redemptions are shared and, as a result, partially borne 

by remaining shareholders.6

 As a result, investors could have an incentive to redeem 

before other investors to avoid sharing the costs associated with other investors’ 

redemptions. This incentive to redeem from pooled investment vehicles may be 

magnified for vehicles invested in less-liquid asset classes. Managers of such vehicles 

might need to sell assets at a discount to meet redemptions, particularly during times of 

stress, and the cost would have to be borne by remaining investors in the vehicle. If a 

manager of such a vehicle were to sell more-liquid portfolio assets in order to minimize 

the price impact of early redemptions, liquidity risk could be concentrated on investors 

redeeming later. As a result, investor perceptions of how liquidity and redemption risk 

are managed in pooled investment vehicles could potentially heighten redemption 

incentives and increase the likelihood of asset sales. 

The Council seeks input on whether these issues affect redemption behavior from 

pooled investment vehicles in a way that could ultimately affect financial stability. 

Specifically, the Council is interested in whether such redemption incentives could make 

 

6

 In contrast, because SMAs impose the full cost of asset sales on the redeeming investor, SMAs are 

unlikely to create the same incentives for the investor to redeem. 
8 

fire sales more likely in the asset markets in which the pooled investment vehicles invest, 

as well as in correlated or broader asset markets. 

The Council also is interested in redemption incentives associated with pooled 

investment vehicles in which lenders reinvest cash collateral received to secure a loan of 

securities.7

 Such a pooled investment vehicle may experience redemptions triggered by 

terminations of securities loans, and the related requirement to repay cash collateral. The 

Council seeks input on whether such redemptions might increase during times of 

financial stress and whether this may result in the potential broader market impacts 

discussed above. 

The Council understands that pooled investment vehicles may employ a variety of 

techniques to manage liquidity risks.8

 For example, some investment vehicles maintain a

portion of assets in cash or highly-liquid assets to meet redemption requests and may 

modify their portfolio composition based on market conditions to manage redemption 

requests.9

 Many exchange-traded funds (ETFs) redeem in kind as a matter of course, and 

those that allow authorized participants (APs) to redeem in cash frequently impose 

transaction or liquidity fees that force the AP to bear the liquidity-related costs of its own 

 

7

 Securities lending is a transaction involving the temporary transfer of a security by one party (the lender) 

to another (the borrower) in exchange for cash or non-cash collateral. Securities loans generally are 

collateralized by an amount exceeding the value of the securities loaned, and the required collateral amount 

is marked-to-market daily. Most securities lending in the United States is secured by cash collateral, and 

lenders generally reinvest cash collateral to earn additional income. 8

 Regulatory requirements regarding liquidity in pooled investment vehicles and redemption practices are 

also critical to understanding risks and risk management. The Council is aware of existing regulations in 

this area and, while the discussion notes some relevant regulatory constraints, this Notice is not intended to 

provide a comprehensive discussion of regulatory requirements. 

9

 In addition, SEC guidance provides that mutual funds and exchange-traded funds (ETFs) generally may 

not invest more than 15 percent of their net assets in “illiquid securities.” Illiquid securities are defined as 

securities that cannot be sold or disposed of in the ordinary course of business within seven days at 

approximately the price at which the fund has valued the investment. Revisions of Guidelines to Form N1A, Investment Company Act Release No. 18612 (Mar. 12, 1992) 57 FR 9,828 (Mar. 20, 1992). 
9 

redemption.10 Hedge fund investors often are subject to an initial “lock up” period and 

thereafter may only redeem their interests on a periodic basis. Insurance separate 

accounts may serve as funding vehicles for life insurance policies or annuity contracts 

that provide deferred benefit payments and redemption disincentives (such as earlysurrender charges and loss of economic and tax benefits).11 Some private funds may 

have additional redemption restrictions that may be imposed during times of stress, such 

as size limits on redemptions (partial “gates”) or temporary suspension of redemptions. 

The Council is interested in the effectiveness of these measures during periods of overall 

market stress, as well as the potential impact on broader financial markets from the 

exercise of such measures. 

The Council is also interested in the extent to which asset managers may not 

always manage investment vehicles in a way that prevents or fully mitigates the risks to 

the investment vehicle and to the broader financial system. For example, investor 

preferences regarding an investment vehicle’s investment strategy and portfolio 

allocation may generally encourage the vehicle to remain fully, or almost fully, invested 

in particular asset classes and limit the vehicle’s holdings of cash or highly-liquid assets. 

Similarly, competitive pressures to increase returns and outperform benchmarks may 

provide disincentives to holding cash or highly-liquid assets. The Council also seeks 

 

10 ETF shares are traded on an exchange. Investors (other than APs as discussed below) do not transact in 

shares directly with the ETF, but instead buy and sell shares in the secondary market (and do not have a 

right of redemption). ETF shares may only be redeemed by (or issued to) certain broker-dealers or other 

institutions that have contractual arrangements to act as APs for the ETF. ETF shares are issued and 

redeemed in block-size aggregations (e.g., 50,000 shares) referred to as creation units, typically in an inkind transaction in which an AP delivers or receives a specified portfolio of securities, other assets, and 

cash. Whereas mutual funds typically redeem their shares in cash but reserve the right to redeem in kind, 

ETFs typically redeem in kind but reserve the right to redeem in cash.

11 Insurance separate accounts often are registered under the Investment Company Act as unit investment 

trusts. 
10 

input on the degree to which the risk management practices of asset managers sufficiently 

account for the possibility of simultaneous asset sales by multiple investors or the 

likelihood of significantly larger price effects in times of stress. 

 Questions for public comment 

The Council requests comment on the questions below. The Council also 

welcomes input on other areas relating to liquidity and redemption risks in the asset 

management industry that could potentially present financial stability concerns.12

1. How does the structure of a pooled investment vehicle, including the 

nature of the redemption rights provided by the vehicle and the ways that such 

vehicles manage liquidity risk, affect investors’ incentives to redeem? Do particular 

types of pooled investment vehicles, based on their structure or the nature of their 

redemption management practices, raise distinct liquidity and redemption concerns 

(e.g., registered funds, private funds, or ETFs)? 

2. To what extent do pooled investment vehicles holding particular asset 

classes pose greater liquidity and redemption risks than others, particularly during 

periods of market stress? To what extent does the growth in recent years in assets in 

pooled investment vehicles dedicated to less liquid asset classes (such as high-yield 

bonds or leveraged loans) affect any such risks? 

3. To what extent might incentives to redeem shares in a pooled investment 

vehicle or other features of pooled investment vehicles make fire sales of the portfolio 

 

12 There may also be interconnections between liquidity and leverage risks, or between liquidity risk and 

activities such as securities lending. For example, leveraged investment vehicles whose posted collateral 

assets decline in value may need to sell other assets to obtain the liquidity required to meet margin calls. 

With respect to securities lending, if cash collateral is invested in assets with longer maturities than the loan 

terms, lenders could face liquidity risks that result in lender losses. See Section II for a discussion of risks 

associated with leverage. 
11 

assets, or of correlated assets, more likely than if the portfolio assets were held 

directly by investors? 

4. To what extent does the potential for terminations of securities loans that 

would trigger redemptions from cash collateral reinvestment vehicles or other asset 

sales pose any distinct financial stability concerns? To what extent do investment 

vehicles reinvest cash collateral in assets with longer maturities relative to the

lender’s obligation to repay the collateral, which may increase liquidity risk? How 

much discretion do lending agents have with respect to cash collateral reinvestment? 

To what extent do lending agents reinvest cash collateral in vehicles managed by the 

same firm that manages the investment vehicle lending the securities?

5. How do asset managers determine whether the assets of a pooled 

investment vehicle are sufficiently liquid to meet redemptions? What liquidity and 

redemption risk management practices do different types of pooled investment 

vehicles employ both in normal and stressed markets, and what factors or metrics do 

asset managers consider (e.g., the possibility that multiple vehicles may face 

significant redemptions at the same time, availability of back-up lines of credit) in 

managing liquidity risk? 

6. To what extent could any redemption or liquidity risk management 

practices (e.g., discretionary redemption gates in private funds) used in isolation or 

combination amplify risks? 

7. To what extent can competitive pressures create incentives to alter 

portfolio allocation in ways that may be inconsistent with best risk management 
12 

practices or do not take into account risks to the investment vehicle or the broader 

financial markets?

8. To the extent that liquidity and redemption practices in pooled investment 

vehicles managed by asset managers present any risks to U.S. financial stability (e.g., 

increased risks of fire sales or other spillovers), how could the risks to financial 

stability be mitigated? 

9. What additional information would help regulators or market participants 

better assess liquidity and redemption risks associated with various investment 

vehicles, including information regarding the liquidity profile of an asset class or of a 

particular type of investment vehicle? 

II. Leverage 

Leverage is created when an investor (e.g., investment vehicle) enters into 

transactions resulting in investment exposures that exceed equity capital. Leverage can 

be financial (i.e., borrowings reflected on the balance sheet), or synthetic (i.e., exposures 

embedded in the structure of financial instruments such as derivatives). While the use of 

leverage with appropriate controls and risk management can be a useful component of an

investment strategy, high degrees of leverage can present risks to investment vehicles by 

magnifying the impact of asset price or rate movements. 

In this Notice, the Council is interested in exploring ways in which the use of 

leverage by investment vehicles could increase the potential for forced asset sales, or 

expose lenders or other counterparties to losses or unanticipated market risks, and the 

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

example, during periods of financial market stress, declines in asset prices could lead to 
13 

collateral or margin calls, requiring leveraged investors to meet those demands through 

asset sales that could in turn result in further declines in asset prices. Additionally, the 

exposures created by leverage establish interconnections between borrowers and 

lenders—and possible further interconnections between lenders and other market 

participants—through which financial stress could be transmitted to the broader financial 

system. 

The Council understands that the use of leverage by investment vehicles can vary

significantly depending on the type of investment vehicle and type of investment 

strategy. In particular, the Council is interested in the extent and full variety of ways that 

private funds and SMAs obtain leverage.13 While the Council recognizes that registered 

funds are generally limited in their use of leverage, it is nonetheless also interested in the 

nature and extent of leverage obtained by registered funds, including through the use of 

derivatives. 

Leverage can be obtained by investment vehicles through a variety of secured 

financings, including margin credit, repurchase agreements (repos), prime brokerage 

financing arrangements, securities lending transactions, or bank loans. Investment 

vehicles may also obtain leverage through derivative transactions. Entering into 

numerous derivative contracts or having large directional exposures through derivatives 

may significantly increase the complexity of risk management and the associated level of 

risk within the investment vehicle. Some private fund strategies rely extensively on the 

 

13 While an SMA represents a direct investment by a client and investment management agreements may 

specify limitations relating to leverage, the Council is interested in whether, and how, the use of leverage 

by investors is affected when the investors’ assets are managed through SMAs.
14 

use of derivatives to obtain leverage. Registered funds may also use derivatives, subject 

to certain limitations.

14 

The Council recognizes that derivatives are also used by investment vehicles for 

purposes other than obtaining leverage, such as establishing hedges against market risks. 

The Council is interested in better understanding whether and how derivatives are used 

by various types of investment vehicles to obtain leveraged market exposures, as opposed 

to hedging risks relating to other investment positions. 

U.S. regulations restrict leverage for certain types of investment vehicles. For 

example, the Investment Company Act constrains the amount of leverage that may be 

employed by mutual funds and other registered funds. Mutual funds may only incur 

indebtedness through bank borrowings with 300 percent asset coverage.15 Registered 

funds may engage in repos, but must segregate liquid assets equal to the repurchase price 

of the securities. Registered funds may also use derivatives, for hedging purposes or to 

enhance returns, subject generally to a requirement to segregate liquid assets for their 

derivatives transactions.

16 

 

14 A number of regulations apply to derivatives transactions. For example, exchange-traded and centrallycleared derivatives are subject to specific margin rules and clearinghouse protocols to support payment of 

potential counterparty obligations. For certain swap and security-based swap transactions, rules (or 

proposed rules will) require mandatory clearing and execution on trading platforms, collection of margin, 

and data reporting and recordkeeping. Over-the-counter derivatives that are not centrally cleared may be 

more difficult to value, transfer, or liquidate, potentially exposing contracting parties to greater

counterparty credit risk. 

15 Closed-end registered funds are also subject to the 300 percent asset coverage requirement on their 

indebtedness. Closed-end funds may borrow both from banks and nonbank lenders, and closed-end funds 

are permitted to issue preferred stock subject to a 200 percent asset coverage requirement. 16 The amount of liquid assets to be segregated varies depending on the transaction and would generally 

either be the full obligation due at the end of the contract or, with respect to certain cash-settled derivatives, 

the daily mark-to-market liability, if any, of the fund under the derivative. In certain cases, registered funds 

may cover their derivatives transactions by holding a fully offsetting position. The SEC issued a concept 

release on the use of derivatives by registered funds in August 2011. See Use of Derivatives by Registered 

Investment Companies Under the Investment Company Act of 1940, Investment Company Act Release 
15 

By contrast, private funds, including hedge funds and other unregistered funds, 

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

Investment Company Act. In addition, certain publicly offered products other than 

registered funds, such as exchange-traded commodity pools, may provide investors with 

more highly leveraged investment exposures than would be available through registered 

funds. SMAs may also employ leverage.

17 Because regulators currently do not collect 

data on SMA portfolio positions on a systematic, industry-wide basis, information 

regarding the types of assets held in these accounts, their counterparty and other 

exposures, and amounts of leverage are not routinely available to regulators for 

assessment and monitoring purposes. 

Questions for public comment 

The Council requests comment on the questions below. The Council also 

welcomes input on other areas relating to the risks of leverage in the asset management 

industry that could potentially present financial stability concerns. 

1. How do different types of investment vehicles obtain and use leverage? 

What types of investment strategies and clients employ the greatest amount of 

leverage? 

2. To what extent and under what circumstances could the use of leverage by 

investment vehicles, including margin credit, repos, other secured financings, and 

derivatives transactions, increase the likelihood of forced selling in stressed markets? 

 

No. 29776 (Aug. 31, 2011). Among other things, the concept release requested comment on the benefits 

and shortcomings of the asset segregation approach and potential alternatives. 

17 Because SMAs are not collective investment vehicles, they are not subject to restrictions on leverage 

under the Investment Company Act. The investment management agreement between the client and asset 

manager, however, may specify limitations relating to the use of leverage. 
16 

To what extent could these risks be increased if an investment vehicle also offers 

near-term access to redemptions? 

3. How do asset managers evaluate the amount of leverage that would be 

appropriate for an investment strategy, particularly in stressed market conditions? 

To what extent do asset managers evaluate the potential interconnectedness of 

counterparties? How do lenders or counterparties manage their exposures to 

investment vehicles? 

4. What risk management practices, including, for example, widely-used

tools and models or hedging strategies, are used to monitor and manage leverage risks

of different types of investment vehicles? How do risk management practices in 

investment vehicles differ based on the form of leverage employed or type of 

investment vehicle? How do asset managers evaluate the risk of potential margin 

calls or similar contingent exposures when calculating or managing leverage levels? 

How are leverage risks managed within SMAs, and to what extent are such risks 

managed differently than for pooled investment vehicles? 

5. Could any risk management practices concerning the use of leverage by 

investment vehicles, including hedging strategies, amplify risks? 

6. To what extent could the termination of securities borrowing transactions 

in stressed market conditions force securities lenders to unwind cash collateral 

reinvestment positions? To what extent are securities lenders exposed to significant 

risk of loss? 
17 

7. To the extent that any risks associated with leverage in investment 

vehicles present risks to U.S. financial stability, how could the risks to financial 

stability be mitigated? 

8. What are the best metrics for assessing the degree and risks of leverage in 

investment vehicles? What additional data or information would be useful to help 

regulators and market participants better monitor risks arising from the use of 

leverage by investment vehicles? 

III. Operational Risk

Operational risk refers to the risk arising from inadequate or failed processes or 

systems, human errors or misconduct, or adverse external events. Examples include 

business disruptions or failures in systems and processes, either within a firm or at

external service providers relied upon by a firm. Like other financial services firms, asset 

management firms rely significantly on both affiliated and unaffiliated providers of 

technology, data, and other operational services, and they are exposed to operational risk 

in many different forms. While the Council is interested in any areas of operational risk 

within the asset management industry that could present risks to U.S. financial stability, 

the Council is particularly interested in two areas: (1) risks that may be associated with 

the transfer of significant levels of client accounts or assets from one asset manager to 

another; and (2) risks that may arise when multiple asset managers rely on one or a 

limited number of third parties to provide important services, including, for example,

asset pricing and valuation or portfolio risk management.18 

 

18 While Section IV focuses on the financial implications of the failure or closure of an entity in the asset 

management industry, the Council is also interested in any unique operational risks that may arise if an 

asset manager, its affiliates, or investment vehicles were to fail or be liquidated. 
18 

The Council is interested in exploring any potential risks associated with the 

transfer of a significant level of client accounts or assets from an asset manager and 

whether there could be obstacles to this process, particularly during a period of financial 

market stress, that could pose risks to U.S. financial stability.19 Such transfers could 

occur on a large scale for various reasons, including damage to a manager’s reputation 

that leads clients to select other managers or a manager’s voluntary or involuntary exit 

from the business. Although clients have routinely replaced asset managers without 

significant impact in non-stressed situations, there could be delays or other obstacles 

associated with transferring client accounts to other managers or transitioning client 

assets to another custodian, particularly in a stressed scenario. 

The Council seeks information on market practices, processes, and systems

employed by asset managers and other market participants (e.g., custodians and transfer 

agents); these entities’ operational capabilities to transition client accounts and assets

between managers; and the effectiveness of such market practices, processes, and 

systems in times of idiosyncratic or market stress. 

The Council is also interested in exploring risks associated with reliance on 

service providers—either affiliated entities or independent third-party providers—for 

important components of the asset management business. Asset managers may use 

service providers for key functions or may be providers of such services to other asset 

managers or financial institutions. For example, asset managers often use affiliated 

entities or third parties to provide custody, brokerage, asset pricing and valuation, 

 

19 The transfer of client accounts or assets refers to the transfer of SMAs. Outflows of assets from a 

manager in the form of redemptions from pooled investment vehicles are discussed in Section I.
19 

portfolio risk management, and administrative services (e.g., recordkeeping, accounting, 

and transfer agency services). 

The Council seeks to understand the potential risk across the asset management 

industry if multiple asset managers rely exclusively on one or a small number of 

providers for certain services and the resulting risk if one of these providers either ceases 

operations or renders the services in a flawed manner (e.g., providing asset pricing and 

valuation or portfolio risk models that contain errors in methodology). Careful 

consideration of how asset managers use service providers, particularly the degree of 

reliance by multiple asset managers on a concentrated number of service providers, is 

important in understanding whether there may be risks to certain markets or asset classes 

if asset managers were to suffer a disruption in service. 

More generally, strong operational controls and risk management are important 

within the asset management industry in areas such as accounting and recordkeeping, 

trading operations (including algorithmic trading), data security, custody, and pricing and 

valuation. Asset management firms, like other financial services firms, rely significantly 

on technological systems, including processing, recordkeeping, and communications 

systems, which are vulnerable to a number of operational risks ranging from normal 

system disruptions to targeted cyber-attacks. Asset managers that operate globally may 

be confronted with additional operational risks. The Council is interested in 

understanding whether any operational risks to asset managers could have broader 

implications for U.S. financial stability. 
20 

 Questions for public comment 

The Council requests comment on the questions below. The Council also 

welcomes input on other areas relating to operational risks in the asset management 

industry that could potentially present financial stability concerns. 

1. What are the most significant operational risks associated with the asset 

management industry and how might they pose risks to U.S. financial stability? What 

practices do asset managers employ to manage operational risks (e.g., due diligence, 

contingency planning)? 

2. What are the risks associated with transferring client accounts or assets 

from one manager to another and how do these risks vary depending on the nature of 

the client, the asset types owned by the client (e.g., derivatives), or how the asset type 

is traded or cleared? For certain asset classes or strategies, are the number of asset 

managers offering a comparable strategy so concentrated that finding a substitute 

would present challenges? How rapidly could investment management accounts be 

transferred, including during a time of financial market stress? 

3. What market practices, processes, and systems need to be in place to 

smoothly effect transfers of client accounts or assets by asset managers and/or 

custodians? What differences exist in information technology systems, processes, or 

data formats that could pose operational risk, particularly when markets are stressed? 

Are there specific risks related to foreign clients, foreign custodians, foreign assets, or 

the use of offshore back-office operations? 

4. While asset liquidation is not required for, and is not typically associated 

with, the transfer of client accounts, are there any significant risks of asset 
21 

liquidations in the event of a large-scale transfer of accounts or assets from an asset 

manager? 

5. To what extent do asset managers rely on affiliated or unaffiliated service 

providers in a concentrated or exclusive manner for any key functions (e.g., asset 

pricing and valuation, portfolio risk modeling platforms, order management and trade 

processing, trading, securities lending agent services, and custodial services)? What 

would be the impact if one or more service providers ceased provision of the service, 

whether due to financial or operational reasons, or provide the service in a seriously 

flawed manner? To what extent do potential risks depend upon the type of service 

provided, whether the provider is affiliated with the asset manager, or whether the 

service provider is non-U.S. based? What due diligence do firms perform on systems 

used for asset pricing and valuation and portfolio risk management? 

6. What operational interconnections exist between the asset manager and 

the investment vehicles it manages, among investment vehicles managed by the same 

asset manager or affiliated managers, or between the asset manager and its affiliates? 

For example, to what extent do asset management firms rely on shared personnel, 

technology, or services among affiliates? Could any of those interconnections result 

in operational risk transmission among affiliated investment vehicles or asset 

managers in the event of a failure and resolution of an affiliate? Do market practices 

ensure that operational interconnections are sufficiently documented to allow for an 

orderly continuation of an investment vehicle’s operations if the asset manager or 

affiliated or independent third-party service providers were to declare bankruptcy? 
22 

7. What are best practices employed by asset managers to assess and mitigate 

the operational risks associated with asset management activities performed by 

service providers, whether affiliated with the asset manager or not, and how common 

are these practices across the industry? What agreements or other legal assurances 

are in place to ensure the continued provision of services? What are asset managers’ 

contingency plans to deal with potential failures of service providers, and how might 

these plans be impacted by market stress? 

8. To the extent that any operational risks in the asset management industry 

present risks to U.S. financial stability, how could these risks to financial stability 

be mitigated? 

IV. Resolution

The Council is interested in the extent to which the failure or closure of an entity 

could have an adverse impact on financial markets or the economy.20 While previous 

sections of this Notice explore aspects of potential risk that could be associated with 

material stress at an asset manager or investment vehicle, this section explores whether 

there are specific financial interconnections that could present risks if an asset manager, 

investment vehicle, or affiliate were to become insolvent, declare bankruptcy, or 

announce an intent to close and liquidate.21 The Council seeks information on whether 

there are any financial interconnections, such as transactions, investments, or loans across 

affiliated investment vehicles, between investment vehicles and an asset manager, or with 

 

20 For the purposes of this Notice, resolution refers to the commencement of proceedings in bankruptcy or, 

if bankruptcy is not appropriate, other proceedings or processes for the resolution, reorganization or 

liquidation of a legal entity. 21 A pooled investment vehicle is owned by its investors, who are entitled to distribution of the vehicle’s 

net assets if the vehicle were to be closed and liquidated. 
23 

third parties, that could complicate resolution in the asset management industry, 

particularly during a period of financial market stress. The Council also is interested in 

understanding the potential implications of the failure or liquidation of a private fund for 

financial stability.

22 The Council also seeks information on whether there are any actions 

that market participants or counterparties to contracts could take that would adversely 

affect a resolution or give rise to liquidity concerns. The Council would like to explore 

whether there are issues that could make the resolution or liquidation of an asset manager 

or an investment vehicle with international operations more complex. For example, the 

Council seeks input on the extent to which access to assets in foreign jurisdictions or 

shared services located abroad may be impaired, or proceedings may be subject to 

multiple jurisdictions with potentially conflicting resolution regimes. In addition, the 

Council seeks information on practices or planning undertaken by asset managers to help 

mitigate the potential for disruption to clients or markets more generally in the event of a 

failure of a firm or liquidation of an investment vehicle. 

The Council recognizes that asset management firms and investment vehicles 

have closed without presenting a threat to financial stability. The Council notes that an 

investment vehicle has a separate legal structure from the asset manager, any parent 

company, or any affiliated investment vehicles under the same manager. In addition, the 

assets of the investment vehicle are not legally available to the asset manager, its parent 

company, or affiliates for the purpose of satisfying their financial obligations or those of 

 

22 As discussed in Section II, leverage can present risks to investment vehicles, and the use of leverage by 

some private funds has raised concerns in the past. For example, margin calls and liquidity constraints 

were a prominent reason for the near-failure of Long-Term Capital Portfolio LP and the other funds 

managed by Long-Term Capital Management in 1998, which led a consortium of commercial financial 

institutions to recapitalize these funds to avoid potential financial instability. See “Hedge Funds, Leverage, 

and the Lessons of Long-Term Capital Management,” Report of the President’s Working Group on 

Financial Markets (April 1999). 
24 

affiliated investment vehicles. Nonetheless, the Council would like to explore any 

potential issues that may arise in a resolution or liquidation of an entity in the asset 

management industry, particularly in circumstances of financial market stress, and if an 

entity were to have a high degree of complexity and multi-jurisdictional operations. 

 Questions for public comment 

The Council requests comment on the questions below. The Council also 

welcomes input on other areas relating to resolution and liquidation in the asset 

management industry that could potentially present financial stability concerns.

1. What financial interconnections exist between an asset manager and the 

investment vehicles it manages, between an asset manager and its affiliates, or among 

investment vehicles managed by the same or affiliated asset managers that could pose 

obstacles to an orderly resolution? To what extent could such interconnections result 

in the transmission of risk among asset managers and affiliated investment vehicles? 

Do market practices ensure that any financial interconnections are sufficiently 

documented to allow for an orderly continuation of operations if an asset manager, 

investment vehicle (e.g., private fund), or affiliate were to become insolvent, declare 

bankruptcy, or announce an intent to close? 

2. Could the failure of an asset manager or an affiliate provide counterparties 

with the option to accelerate, terminate, or net derivative or other types of contracts of 

affiliates or investment vehicles that have not entered insolvency? 

3. In what ways, if any, could the potential risks associated with liquidity and

redemption or leverage discussed in Sections I and II, respectively, impact the 

resolution of an asset manager or investment vehicle in times of financial stress? 
25 

4. Are there interconnections that exist between asset managers and other 

financial market participants that in times of financial stress could transmit risks? For 

example, are there risks that securities lenders indemnified against borrower default 

by an asset manager lending agent may terminate their loans if the asset manager 

were to fail?23 If so, could those terminations have disruptive consequences if 

counterparties face an unexpected requirement to return borrowed securities upon 

early loan terminations?

5. For asset managers, investment vehicles, or affiliates that operate 

internationally, in what ways could cross-border resolution complicate an orderly 

insolvency or resolution in one or more jurisdictions? Do contracts with service 

providers, such as custodians or prime brokers, allow for assets to be custodied, or 

subcustodied, at offshore entities, and what are the implications for resolution? 

6. What contingency planning do asset managers undertake to help mitigate 

risks to clients associated with firm-specific or market-wide stress?

7. To the extent that resolution and liquidation in the asset management 

industry present risks to U.S. financial stability, how could the risks to financial 

stability be mitigated? 

8. What data currently are available or should be collected to monitor 

activities that may affect a resolution? 

V. Conclusion 

 

23 Securities lending agents often indemnify lenders against borrower default, and under indemnification 

agreements must cover the shortfall between the value of the securities on loan and the value of the 

collateral pledged by the borrower (but typically not losses resulting from cash collateral reinvestment). 
26 

The Council invites comment on all of the questions set forth in this Notice and 

welcomes input on other issues that commenters believe are relevant to the Council’s 

understanding of risks to U.S. financial stability, if any, posed by asset management 

products and activities. The Council recognizes the areas of risk highlighted in this 

Notice may be interrelated and welcomes views on whether the interrelation of any of the 

risks described above or any other risks might present financial stability concerns. The 

Council will consider all comments as part of its evaluation of potential risks to U.S. 

financial stability. 

Dated: ________________________ 

_____________________________ 

David Clunie 

Executive Secretary

Department of the Treasury