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 The review marks another area of scrutiny for the Financial
Stability Oversight Council, a group of regulators that has already
imposed tougher rules for companies including insurers, banks and
market utilities such as derivatives clearinghouses. The council is
also generally responsible for identifying emerging risks to the
larger financial system.
In a closed-door meeting on March 25, FSOC staffers delivered a
presentation about a niche group of third-party firms that sell
asset valuation, investment advice and risk measurements to pension
funds, asset managers, insurance agencies and banks, according to
the documents.
The documents lay out the government's concern that financial firms
may rely too heavily on the same outside risk models and valuations,
and that any flaws in these services could result in a wide
misunderstanding of the true risk of firms' investments and other
assets.
A Treasury spokeswoman told Reuters that the proposed scorecard
approach is consistent with the council's mandate to look at issues
across the financial system. She added that no decisions have been
made on the approach, that it is not designed for any particular
company or industry, and should not be read into.
Among the service providers mentioned were BlackRock Solutions, a
unit of giant fund manager BlackRock, Bloomberg LP's Bloomberg Asset
and Investment Manager (AIM), MSCI's RiskMetrics and BarraOne,
Citigroup's Yield Book, Barclays' POINT, BNY Mellon's HedgeMark,
FactSet, IBM's Algorithmics and Charles River's Charles River
Investment Management Solution.
Though the documents viewed by Reuters list 10 examples of
third-party service providers that help institutional investors
evaluate risk, the presentation highlights one company - BlackRock
Solutions. The documents say that BlackRock offers what are known as
"end-to-end" services, meaning it helps clients throughout the
entire investment process.
They also contain a "draft scorecard" for BlackRock Solutions,
focusing on risk factors such as user reliance on its investment
decision and valuation services, and the amount of assets and
liabilities.
The document did not describe why staffers chose to highlight
BlackRock Solutions, a unit that provides investment management
technology systems, risk management services and advisory services
for a fee.
The FSOC has already been exploring whether parent company BlackRock,
with $4.3 trillion in assets under management, should be designated
as a "systemically important financial institution." The group can
dub large financial firms as "systemic" - a tag that imposes
additional oversight by the Fed.
BlackRock and its competitors have resisted the designation, saying
asset managers are already highly regulated by the Securities and
Exchange Commission and pose no systemic risks.
The documents from FSOC highlight several products offered by
BlackRock, including Aladdin - a proprietary system that provides
data to help clients manage their portfolio. As of December 2013,
the platform processed $13.7 trillion in assets, according to the
FSOC documents. The unit's revenue rose 11 percent to a record $577
million, according to BlackRock's 2013 annual report.
"BlackRock Solutions configures a unique instance of Aladdin for
each client," said Tara McDonnell, a BlackRock spokeswoman. "The
system is highly flexible and aggregates third-party data from a
variety of sources, as determined by the client, and clients can use
Aladdin or other models to conduct analysis in support of their
objectives. Aladdin does not make investment decisions or replace a
company's risk management function. It simply aids a company's risk
managers, portfolio managers, traders and operations professionals
in managing their workflows."
Spokesmen for Citigroup, Barclays, FactSet and BNY Mellon declined
to comment. Spokespeople for MSCI, Bloomberg and IBM had no
immediate comment. A spokesperson for Charles River could not be
immediately reached.
MONDAY MEETING
Concern surrounding the sharing of pricing, custodial and analytical
services by asset managers is expected to be discussed on Monday
when the FSOC hosts a conference on the asset management industry,
according to a person familiar with the council's thinking.
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At the heart of the council's discussions is whether asset managers,
pension funds and insurers may be relying too heavily on such
third-party service providers to value their assets, manage their
risks and make investment decisions.
For instance, some consulting firms help other asset managers price
less liquid bonds and determine how much margin should be required
to manage the risks of trading them.
If too many money managers all rely on the same models, it could
reduce the amount of independent analysis and "expose the financial
system to significant risk that may result from asset mispricing,
faulty risk reporting or related outputs from such products or
services," according to the documents, which are not public.
Flawed risk models played a major role in the 2007-2009 financial
crisis. Financial firms' internal modeling and assessments from
credit rating agencies did not anticipate the systemic effect that a
significant drop in housing prices could have on global markets.
The issue grabbed the spotlight again in 2012 when JPMorgan Chase &
Co's risk models failed to capture the dangers of its "London Whale"
trades that led to a $6.2 billion loss.
Firms that provide risk-modeling services are not strictly
regulated. The FSOC's staff review of these services is at an early
stage, and any eventual policy response is unclear.
ADDITIONAL OVERSIGHT
The FSOC is a council of regulators created by the 2010 Dodd-Frank
Wall Street reform law to help monitor the market for emerging
risks. It is chaired by the Treasury Secretary and comprised of the
leaders of every major U.S. financial regulator, including the
Federal Reserve and the Securities and Exchange Commission.
The in-house group focused on model risk from third-party service
providers is called the Systemic Risk Committee. That committee is
tasked with scouring the marketplace for emerging risks, and it is
not involved in the designation process.
According to the documents, the committee started holding
preliminary discussions about the consulting services on January 28
and has also held several conference calls with companies in the
sector.
At the late March meeting, a group of staffers presented a draft
"scorecard" that it said could be used as a tool to quantify the
potential risks of each service provider. The documents propose
completing the score card and distributing it to the various FSOC
member regulators.
"Although imperfect, a survey may be the best approach to narrow
down the field of providers that may require additional
review/analysis," the documents say.
It was unclear what kind of regulatory action the committee may
consider, or whether the findings could affect the FSOC's decision
to designate some firms as systemic.
Last year, the FSOC's research arm issued a report which found that
certain activities by large fund managers could pose broader
systemic risks.
One such concern cited was "herding" behavior, in which funds all
crowd into the same assets at once.
In the documents from the March meeting, the council's Systemic Risk
Committee suggests that reducing reliance on third-party service
providers could help reduce herding risks in the market.
(Reporting by Sarah N. Lynch, with additional reporting by Emily
Stephenson; Editing by Karey Van Hall and John Pickering)
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