U.S. regulators concerned about leverage in large hedge funds

WASHINGTON/BOSTON (Reuters) - The heads of the major U.S. financial regulatory agencies on Monday raised concerns about a concentration of leverage in large hedge funds and called for a working group to collect and analyze data on the privately held firms in a report on asset management.

But the Financial Stability Oversight Council, tasked with finding and reducing systemic risk, did not designate any asset managers as "systemically important" - a move that could ease concerns that have gripped the fund industry for years.

In a public meeting late on Monday, the regulatory group, including the U.S. Treasury secretary and chair of the Securities and Exchange Commission, updated its two-year-old review of risks to the U.S. financial system posed by hedge, mutual and other funds' liquidity, leverage and redemptions.

In the update, it set the stage for an analysis of hedge fund risk, noting the council was "constrained by limitations in the available data."

The working group, largely made up of staffers of member agencies, will report by year-end on items including counterparty exposures, margin investing, trading strategies and possible standards for measuring leverage.

The Managed Funds Association, the hedge-fund industry's trade group, said it hopes "to have a constructive dialogue with this newly formed group."

It added its industry is smaller than many other parts of the market, and hedge funds' leverage is, on average, lower than that of banks.

The council also took a light stance on addressing liquidity and redemption risks, saying it would wait to see how the SEC implements funds rules proposed nearly a year ago.

    The council will "review and consider whether risks to financial stability remain," it said, adding it "will take into account how the industry may evolve in light of any regulatory changes." It also suggested certain steps that "should be considered" in how funds handle illiquid assets, redemption costs, and financing.

The SEC proposed requiring mutual funds and exchange-traded funds to set up programs for managing liquidity risks and broaden disclosures about their liquidity and redemption practices. Regulators and investors have been concerned that a market sell-off could result in a situation where some funds and ETFs could not sell assets quickly enough - and at sufficiently high prices - to pay all investors seeking to redeem shares.

At Monday's meeting, SEC Chair Mary Jo White said that "although there is overlap," FSOC's update "should not be read as an indication of the direction that the SEC’s final asset management rules may take."

The council's mission dates to the Dodd-Frank financial reform law of 2010, which designated some large banks as "systemically important," a regulatory label indicating they are "too big to fail." That designation can trigger capital requirements and other regulatory oversight.

So far regulators have faced difficulty in designating nonbank firms as one of the Systemically Important Financial Institutions, or SIFIs, which is also allowed under Dodd-Frank.

On March 30 a U.S. district judge rescinded the designation for major insurer MetLife Inc, which had argued that the FSOC used a secretive and flawed process in determining it could harm the whole system if it went into distress. The U.S. government has appealed that decision.

U.S. asset managers including BlackRock Inc and Vanguard Group, which collectively have about $18 trillion, have fought for years to avoid being designated as SIFIs. Industry representatives have argued their products invest directly and do not use the type of leverage that caused problems during the financial crisis. It is also unclear what type of government involvement a designation would invite.

Vanguard, BlackRock and Fidelity declined comment on the FSOC's report.

(Editing by Sandra Maler, Matthew Lewis and Leslie Adler)