In a Consultation Report, IOSCO proposed a framework to evaluate leverage used by investment funds.
The proposed framework includes a two-step process intended to achieve a "meaningful" and "consistent" analysis of global leverage. In the first step, regulators would perform an analysis of metrics which may exclude from consideration funds unlikely to create "stability risks." In the second step, regulators would perform a risk-based analysis of funds found to create stability risks.
The consultation paper responds to a request from the FSB in its 2017 report, "Policy Recommendations to Address Structural Vulnerabilities from Asset Management." Comments on the proposed framework must be submitted before February 1, 2019.
Commentary / Nihal Patel
A wise man once said, "In order to manage risk we must first understand risk. How do you spot risk? How do you avoid risk and what makes it so risky?"
The consultation paper takes that sage Costanza guidance to heart. It is short on conclusions and primarily an analysis of the efficacy of various types of risk metrics. In particular, the report considers: (i) gross notional exposure, without adjustment, (ii) adjusted gross notional exposure, and (iii) net notional exposure. The report also considers how these measurements might differ across asset classes.
These issues may sound dull, but they are good questions for a regulator to consider before implementing regulations. As the debate relating to the CFTC de minimis threshold has shown, the metric chosen by the government can have a significant impact on whether a participant is subject to further regulation. Asset managers who could be asked to provide this information to a regulator in the not-so-far-away future should consider responding to the consultation paper.
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