U.S. panel highlights ETFs, bond funds as potential risks

[May 20, 2015]  By Sarah N. Lynch

WASHINGTON (Reuters) - Exchange-traded funds and fixed income mutual funds could potentially pose risks to the marketplace during times of stress, according to a report released by a panel of U.S. regulators on Tuesday.

The Financial Stability Oversight Council highlighted those two products in a list that also included volatility derivatives, captive reinsurance, clearinghouses and non-bank mortgage servicers as examples of products or activities that could threaten or weaken the U.S. financial system.

The FSOC is a panel of regulators created by the 2010 Dodd-Frank Wall Street reform law to help detect potential new systemic risks. It has the power to dub large non-bank financial firms as systemically important - a tag that carries greater oversight.

Chaired by Treasury Secretary Jack Lew, its membership is comprised of the top U.S. regulators including Federal Reserve Chair Janet Yellen and Securities and Exchange Commission Chair Mary Jo White.

One of the panel's tasks is to publish an annual report that lays out risks that may continue to exist or new risks that emerge.

In this year's report, the FSOC cited ETFs and bond mutual funds as areas of possible concern.
 

"The council is exploring how these funds... may raise distinct liquidity and redemption risks, particularly during periods of market stress," the report said, noting that the panel is also looking into how "incentives to redeem funds may increase the risk of fire sales."

The FSOC's report comes just one day before the SEC is slated to propose rules that would require mutual funds and other asset managers to report more details about their holdings.

The SEC's plan is one of three previewed in a speech by White last year, in an effort to improve the data that the agency collects from the industry and also to help reduce possible systemic risks.

The SEC's proposal will call for mutual funds to disclose more detailed and timely data about their holdings, according to people familiar with the matter.

A second part the rules the securities watchdog is set to propose on Wednesday will require investment advisers to provide additional disclosures on the registration forms they file with the SEC.

Some of the disclosures will involve information about their management of so-called "separate accounts," or accounts that companies manage for individual clients, as opposed to pooled investment vehicles, these people said.

The FSOC's comments in its annual report about ETFS and bond funds may stir more debate about the asset management industry, an area the FSOC has been exploring for the past several years.

The FSOC last year sought public comment for a review it is undertaking on whether certain products or activities may pose systemic risks. The industry has been lobbying fiercely amid concerns the panel could deem certain funds or large industry members to be systemic.

Lew said Tuesday the preliminary results of the review would be announced in the coming months.

Many observers see the SEC's proposed reforms as a way to address many of the systemic risks outlined by the FSOC.

For instance, Tuesday's annual report raises concerns about the lack of data and visibility into how separate accounts are managed.

The SEC is also planning to eventually propose rules requiring mutual funds and exchange-traded funds to beef up internal risk controls and rules that will require asset managers to draw up plans in the event they must unwind and transfer their clients' assets.

Separately, the SEC's economists are also working on a white paper to study ETFs and whether they may exacerbate volatility.

(Reporting by Sarah N. Lynch; Editing by Andrew Hay and Christian Plumb)

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