One of the more disquieting parts of covering banking regulation is how often, in an interview, either a regulator or a banker will say something like this: Regulators have to treat banks with some respect. If they clamp down too hard, the money will go somewhere else, to a place we only dimly understand. Beyond the banks, the logic goes, there be monsters.
In a speech last week to a group of asset managers in London, Andrew Haldane, in charge of financial stability for the Bank of England, began to map out the land of the monsters. The number of people saving money in the world has grown larger, older, and richer, he said. Life expectancy is rising—as is population and per-capita GDP. And all these rich old people need to put their savings somewhere. It is not going into savings accounts but instead into a category known as assets under management, or AUM: pension funds, exchange-traded funds, hedge funds, private equity.
AUM in the U.S. was about half of GDP in the 1940s; it has now grown to almost two and a half times GDP. Global AUM will top $100 trillion in 2020, according to PricewaterhouseCoopers. The world has entered what Haldane terms the Age of Asset Management. The world’s biggest asset manager, BlackRock (BLK), is much larger than the world’s biggest bank, China’s ICBC (1398:HK). We are beyond the banks. There be monsters.
This is not to say that a nonbank is necessarily vicious and dragon-y. BlackRock, in particular, showed during the financial crisis that it actually understood, at a ZIP-code level, the risks behind mortgage-backed securities.
But as assets move beyond banks into different classes of investment vehicles, it becomes more difficult for regulators to understand whether and how all this AUM is at risk. For example, the Financial Stability Board, an arm of the Bank for International Settlements, an international regulatory body, is now only in the process of attempting to define what a nonbank, noninsurer, systemically important institution is. It’s a fun document and includes such footnotes as “characteristics that in combination may indicate the presence of a hedge fund.” As a journalist, you can usually tell that you’re in the presence of a hedge fund because everyone has great teeth and no one is talking to you.
Haldane’s speech, rich with detail and references to current research, is worth reading in its entirety. While pointing out that regulation of systemically important asset managers is still in its infancy, he offers a couple of broad points. First, pension funds and insurance funds tend to operate procyclically; that is, they make market peaks higher and troughs lower. Worse, deliberate choices on regulations and accounting standards have discouraged these funds from holding on to equities when the market dips—we may be making it harder for institutional investors to buy low.
And approaches designed to keep banks safer may not work for asset managers. Globally, regulators are beginning to agree that banks should finance themselves with more equity and less debt. Asset managers, since they’re handling other peoples’ money, don’t leverage themselves up with debt the same way banks have. But hedge funds and private equity (and, increasingly, even pension funds) may deal with less-liquid assets, as when they buy an entire company. A requirement to keep a certain minimum of liquid assets, says Haldane, may be a more appropriate regulation.
But mostly, he says, this is all very, very new. The world just spent five years trying to figure out how to keep its banks from all failing together again, a process that Haldane calls “house-training the beast.” Because of that, he says, all the existing tools for regulation focus on bank capital and bank balance-sheet ratios. For regulating the systemic risks in the here-be-monsters area of asset managers, however, Haldane has only a single scary word: greenfields. As in nothing yet really in place.