By Sarah N. Lynch
WASHINGTON (Reuters) - Some activities of asset managers could pose risks to the broader marketplace, according to a study released by the Treasury Department on Monday that boosted the likelihood the largest such firms would face tougher federal scrutiny.
The report does not draw any conclusions about particular asset managers or whether any firms should be designated as potentially risky to the broader market.
While it does not call for new designations, the report does lay out potential factors that could be used to determine if an asset manager is risky. Those factors include the use of leverage aimed at boosting returns, such as through the use of derivatives, or a reliance on borrowing.
The report also discusses how "herding," or the tendency of managers to crowd into similar or the same assets at the same time, can also pose risks if the investments are illiquid.
"A certain combination of fund and firm level activities within a large, complex firm or engagement by a significant number of asset managers in riskier activities could pose, amplify or transmit a threat to the financial system," according to the report by the Office of Financial Research, the Treasury's financial research arm.
"These threats may be particularly acute when a small number of firms dominate a particular activity or fund offering."
The findings make it appear more likely that tougher scrutiny is on the horizon for large firms such BlackRock, Vanguard Group Inc. and Fidelity Investments.
That is because the Financial Stability Oversight Council (FSOC), which called for the study, has been contemplating whether or not certain large, complex asset management firms should be designated as "systemically important financial institutions."
Any firm given this tag will face new capital requirements and oversight by the Federal Reserve, in addition to any current regulations.
BlackRock has staunchly opposed the idea of being designated, saying its activities do not pose a risk to the financial system.
The FSOC is a council of regulators chaired by Treasury Secretary Jack Lew and comprised of the country's top financial regulators, including the heads of the Securities and Exchange Commission and Commodity Futures Trading Commission, which both regulate asset managers.
The Office of Financial Research helps conduct financial research for the council, and its head is a non-voting member of the FSOC.
The FSOC has already designated other kinds of financial institutions, including banks, clearing agencies and insurance firms like American International Group and Prudential Financial, the second-largest U.S. life insurer.
In a statement, a spokesman for the Investment Company Institute, a funds trade association, said the group was glad the report recognizes key differences between asset management companies and banks.
But the ICI reiterated that investment companies registered with the SEC are already highly regulated and should not be designated by FSOC.
"We continue to believe that designation as systemically important financial institutions or 'SIFIs' is not an appropriate regulatory tool for addressing risks, if any, that registered funds or their advisers might raise regarding financial stability," said ICI spokesman Mike McNamee.
The OFR report did not focus on risks posed specifically by money market funds, which have already been studied by the council.
The SEC is currently weighing new rules designed to reduce potential risks posed by money funds, including a switch from a stable $1 per share net asset value to a floating net asset value.
The report also did not consider risks posed by certain private funds, such as hedge funds or private equity funds.
(Additional reporting by Emily Stephenson; Editing by Dan Grebler)