Designating Investment Funds as SIFIs: The Cost to Investors

May 20, 2014

Designating investment funds as "systemically important financial institutions," would have a significantly detrimental impact on investors, according to a new report from Douglas Holtz-Eakin and Satya Thallam of the American Action Forum.

In 2010, the Dodd-Frank reform bill established the Financial Stability Oversight Council, or FSOC. FSOC is a regulatory authority whose mission is to "identify risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large interconnected bank holding companies or nonbank financial companies."

Its power over "nonbank" financial companies gives it an extremely broad range of authority, including the power to designate companies as "systemically important financial institutions," or SIFIs.

  • The idea behind the SIFI designation is that a failure by that institution could lead to a financial crisis. Designating an institution as a SIFI would subject it to enhanced oversight and regulation.
  • Thus far, three companies have been designated as SIFIs: AIG, GE Capital, and Prudential Financial.

Lately, FSOC has been considering risks posed by the asset management industry, an industry that is very different from banking. Asset managers act on behalf of other investors and reduce individuals' risks by pooling together savings. And whereas commercial banks may be unable to fulfill creditor demands during times of distress, any investor in the asset management industry could ask for his assets back, and the money would be there.

Holtz-Eakin and Thallam attempted to measure the financial impact of designating asset management institutions as SIFIs. While the specific impact of the designation would depend upon details relating to the individual investor and the regulatory regime imposed, almost all funds with more than $100 billion in assets would be affected. In some cases, investors could see a 25 percent drop ($108,000) in their returns over the long term. Young investors, who have long investment time horizons, would be especially affected.

Source: Douglas Holtz-Eakin and Satya Thallam, "The Investor Cost of Designating Investment Funds as Systemically Important Financial Institutions," American Action Forum, May 15, 2014.

 

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