BlackRock: Regulators Misunderstand Securities Lending Risks

May 14 2015 | 9:44am ET

By Sarah Lynch (Reuters) - BlackRock on Wednesday pushed back against arguments by the New York Federal Reserve and other regulators that asset managers' securities lending operations may pose major risks to the market and may need greater oversight.

In a seven-page white paper seen by Reuters, the world's largest money manager says financial regulators misunderstand securities lending and are overstating its risks with regard to the industry as a whole, and BlackRock in particular.

The defense comes as regulators, including the Federal Reserve, raise concerns about potential dangers lurking in the asset management industry, citing its rapid growth, massive scale, and liquidity risks in the event of a financial panic.

The Financial Stability Oversight Council (FSOC), a body of U.S. regulators chaired by Treasury Secretary Jack Lew, has been particularly focused on how the sector operates.

It has the power to label large non-banks as "systemic" - a designation that compels greater oversight which has already been extended to insurers like AIG and Metlife.

The asset management industry worries it could be next in line and has lobbied fiercely against the so-called Systemically Important Financial Institution (SIFI) designation.

Regulators including the FSOC, the Federal Reserve and others have all raised concerns about the practice in which pensions, mutual funds and other institutional investors lend out their securities to banks and hedge funds in exchange for collateral. Asset managers like BlackRock typically act as the lending agent on their clients' behalf.

In a confidential presentation seen by Reuters, New York Federal Reserve Assistant Vice President Nicola Cetorelli told a group of international regulators in April 2014 that asset managers involved in securities lending behave like banks in many ways.

"If it looks like a bank, (it) quacks like a bank," he wrote in one slide.


He added that certain practices by asset managers, such as how they may reinvest cash collateral, is "banking in its most basic form (but no equity, no bank regulation, and no backstops!)."

Cetorelli has since gone on to publish an academic paper in December 2014 which contains many of the same perspectives.

In its white paper, BlackRock cited Cetorelli's December 2014 paper as one example where regulators may not fully understand how securities lending works.

"Unfortunately, these concerns have formed the foundation of recent policy discussions," BlackRock wrote in the paper. "We believe it is imperative for policy makers to have all the facts."

A New York Federal Reserve spokeswoman declined to comment.

In both the confidential power point and in his public December 2014 paper, Cetorelli explicitly referred to BlackRock's securities lending practices as an example of how asset managers may behave like banks such as JP Morgan Chase and Citigroup.

Asset managers staunchly oppose such comparisons because of their different business models. Unlike banks, they act as agents managing other peoples' money.

BlackRock and other asset managers like Fidelity and Vanguard have come under the regulatory microscope in the years since the 2007-2009 financial crisis, as regulators have grappled with ways to prevent future meltdowns.


The industry has also faced pressure from the Financial Stability Board (FSB), the Group of 20 economies' regulatory task force, which is drawing up a list of large funds that it believes should come under stricter supervision.

BlackRock's white paper due to be released on Wednesday, the latest in a series of efforts to weigh in on regulatory issues, lays out responses to concerns raised about such arcane topics as cash collateral and indemnification.

Rules implemented in 2010, for instance, BlackRock says, deal with any risks involving how cash collateral is reinvested by imposing shorter maturities and high credit quality requirements.

"Cash collateral is conservatively invested in funds with guidelines" that are consistent with these rules, BlackRock wrote.

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