Investment funds need bolstering to stop market turmoil repeat, says IMF

Fund regulation updates

Fundamental reforms are needed to bolster investment funds to prevent a repeat of the financial market turmoil triggered by the coronavirus pandemic, the IMF said on Friday.

Central banks were forced to intervene aggressively to restore order after sharp price falls across financial markets in the first quarter of 2020 were amplified by heavy selling by fund managers, who dumped stocks and bonds when their clients rushed for the exit.

“We need to boost the resilience of investment funds to safeguard financial stability and to better protect markets and economies from crippling capital outflows,” said Tobias Adrian, the IMF’s director of monetary and capital markets.

Along with proposals for an array of new liquidity management tools for asset managers, the IMF said policymakers should consider whether to change the current rules that permit investors to make daily withdrawals from nearly all types of mutual funds.

Investors could still pull their money with just one day’s notice from funds that invested in the most easily tradable assets, including sovereign bonds and large publicly listed companies. But so-called unqualified daily dealing would no longer apply to funds that invested in less-liquid assets classes, such as high yield corporate bonds, emerging market debt and real estate.

The IMF said that aligning the frequency of redemptions with the types of assets held could be “particularly helpful” in managing investors’ expectations about liquidity.

It also suggested that asset managers should make more use of “swing pricing”, when investors who want to redeem immediately from a fund in a period of market stress are hit with a reduction in the value of their holdings. Swing pricing can reduce the first-mover advantage that an investor gains if they sell out before other sellers drag prices down.

The Investment Company Institute, a global trade body for asset managers, said that it disagreed with the IMF’s conclusion that regulated funds had amplified market stresses in March 2020.

“We know of no compelling evidence of this. The March 2020 turmoil was driven by investors of all stripes — not just investors in regulated funds — seeking liquidity in the face of unprecedented uncertainty caused by the emerging global pandemic,” said the ICI.

Amin Rajan, chief executive of asset management consultancy Create Research, said regulators had been grappling with the issues of liquidity and daily dealing for mutual funds for at least two decades without success. These problems have been compounded by a reduction in investors’ time horizons, which has blurred the distinction between speculation and investment.

“More and more retail investors are participating in financial markets, but they are not pursuing long-term buy and hold strategies. They are speculators who run at the first sound of gunfire. It is very destabilising,” said Rajan.

Rule changes are the responsibility of national regulators but the IMF plays an important role in co-ordinating the policies of supervisory authorities globally. Its proposals for investment funds are supported by the International Organization of Securities Commissions, the global standards body for the world’s securities watchdogs, the European Securities and Markets Authority (Esma), a pan-European regulator, and the Bank of England.

Natasha Cazenave, executive director at Esma, said an internationally consistent approach to supervisory standards was required because of the “growing interconnectedness” between investment funds and the wider financial ecosystem, including emerging markets.

“Investment funds should act as shock absorbers and not shock spreaders. The investment fund sector has tripled in size over the past decade and it does present risks to global financial stability,” said Cazenave.

“Policymakers worked together to make banks safer following the global financial crisis over a decade ago. Now, we must do the same for investment funds,” said Kristalina Georgieva, managing director of the IMF.

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