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FSOC Report Pinpoints Critical Risks

Last week the Financial Stability Oversight Council published its fourth annual report in which it discussed significant risks, regulatory developments and its recommendations related to the the stability of US financial markets. While the sweeping report is quite extensive, investors and managers can view this as a roadmap to upcoming issues that will impact the asset management industry.

As we predicted, managed accounts are being targeted for data collection. Referencing the Office of Financial Research’s asset management report from last year, the FSOC recommends that regulators and the OFR “discuss additional sources of data for that industry, particularly with respect to the management of separate accounts.” With respect to the asset management industry generally, the report says the Council is “considering potential next steps.”

In addition, money market fund reform continues to be a topic of interest and the FSOC seems to be (im)patiently waiting on the SEC to finalize its rules designed to prevent runs in the event of a liquidity or credit shock. Notably, FSOC stated that the SEC is “best positioned” to implement the reforms—and that it does not plan to step in if the SEC proceeds in a timely manner.

Cybersecurity was also addressed in the report which notes, “the vulnerability posed by cross-sector dependencies and interconnected systems across firms, markets and service providers can lead to significant cybersecurity risks.” FSOC urges a government-wide effort to mitigate these risks, and recommends that regulators assess the extent to which regulated entities are following regulatory requirements as well as non-regulatory principles such as the NIST framework released in February. This framework is quickly becoming an important benchmark to for cybersecurity risk management practices—we recommend organizations strive to meet the “Adaptive Tier.”

The report also touched on non-deliberate cyber issues, specifically technology malfunctions at exchanges that resulted in a suspension of trading or in the erroneous placement of orders. It points out that the vulnerabilities may be heightened as a result of high-frequency trading. Without providing a specific recommendation, the FSOC instructed regulations to consider these issues not only at venues both also with respect to market participants.

In a discussion of risks posed by benchmark manipulation, the report raised recent inquiries into possible FX manipulation. Although the FSOC did not specify any plans to intervene (it believes a collaborative effort amongst global regulators is needed—most likely stemming from the Financial Stability Board), the FSOC could take a leading role if there isn’t any forward progress on a worldwide basis in the coming months.

Other notable risks mentioned in the FSOC include the impact of rising interest rates and volatility in emerging markets.

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