FSOC supports interagency group to identify, monitor financial stability risks from hedge funds

Efforts to establish an interagency risk monitoring system to identify potential emerging financial stability risks from hedge funds is supported by federal financial regulators, the agencies said in a joint statement Friday.

The Financial Stability Oversight Council (FSOC) made the statement of support following its meeting Friday. The statement also noted that the council favors promoting “interagency collaboration” in understanding the risks posed by the funds.

The statement was one part of an overarching comment by the FSOC on nonbank financial institutions (NBFIs), particularly the effect the NBFIs had on the financial system in the spring of 2020 as the impact of the coronavirus crisis emerged. The council asserted that market dislocations of March 2020 demonstrated that “some NBFIs remain vulnerable to acute financial stresses and may amplify or transmit stress in the financial system.” The three types of NBFIs it is focusing on, the council said, are hedge funds, open-end funds, and money market funds (MMFs).

Regarding the hedge funds, which dominated the FSOC statement, the council noted that they were among the three largest sellers of Treasury securities by category in March 2020. The statement also asserted that the funds “materially contributed to the Treasury market disruption during this period,” although they were not the sole cause. The council said that, for example, the working group also found that the failure of Archegos Capital Management — a family office employing leveraged strategies also used by hedge funds — “transmitted material stress to large, interconnected financial institutions.”

In addition to establishing an interagency risk monitoring system to identify possible financial stability risks, and promoting interagency collaboration, the council also supports the working group’s efforts “to consider options to mitigate the risks it has identified.”

The statement also asserted that “gaps exist in the availability of data related to hedge funds” and that council members are taking steps to address these gaps (citing, for example, action by the Securities and Exchange Commission [SEC] and the Commodity Futures Trading Commission [CFTC]).

“In addition, the Council supports the Hedge Fund Working Group’s recommendation that the Office of Financial Research (OFR) consider ways to obtain better data on the uncleared bilateral repurchase agreement market, an important source of leverage for hedge funds,” the statement noted.

Regarding open-end funds and money-market funds, the statement noted:

  • The Council supports its Open-end Fund Working Group’s continued analysis of the potential risks to financial stability that may arise from liquidity transformation at open-end funds; and
  • The FSOC supports the SEC’s efforts to reform MMFs and strengthen short-term funding markets.

Financial Stability Oversight Council’s Statement on Nonbank Financial Intermediation