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Vanguard has increased the amount of money it can borrow from banks to more than $3bn in order to meet emergency redemption requests, as pressure mounts on the world’s largest asset managers to prove they can meet fund withdrawals in times of stress.
The world’s second-largest fund company, which oversees $3tn of assets, has raised the size of its credit line by $200m since last summer in response to “market forces”, according to a spokesperson for Vanguard.
The Pennsylvania-based company said in its US filings that “borrowings [from the credit line] may be utilised for temporary and emergency purposes”.
Franklin Templeton, the US-listed fund house, has similarly disclosed that it has set up a $2bn credit line “for temporary and emergency purposes . . . to meet unanticipated or unusually large redemption requests by shareholders”.
The fund company’s credit line was $1bn when it was established in 2009.
Most asset management companies say these credit lines are a sensible tool to ensure investors can pull their money in times of market stress, but regulators around the world are increasingly concerned about the use of these facilities and their potential to exacerbate systemic risks.
A senior regulatory official told the FT in March: “Credit lines are a sensible way to deal with short-term idiosyncratic shocks. But there comes a point in the broader market when credit lines may become negative.
“The message we have put out to fund managers is that it’s great they have explained their credit lines but if investors all move in the same way at the same time, you have a problem. If feedback loops get going, it will be dangerous.”
The fear is that in a stressed-market scenario, investors might have an even stronger incentive to try and pull their money out of a fund first in the belief that the credit line will provide a buffer against big falls in the underlying value of a fund’s holdings.
Vincent Mortier, deputy chief investment officer at Amundi, Europe’s largest listed fund house, which oversees €1tn of assets, agreed credit facilities can be “dangerous” for investors and said this is why his company does not use them for fund redemptions.
He said: “We do not have any credit lines. This is a choice we have made. It is not something we would enter into. It puts additional leverage and risk into a fund. For people who remain in the fund, [their investment] will have a different risk profile. That is unfair and even dangerous.”
The Securities and Exchange Commission last year highlighted several problems posed by the existence of credit facilities as part of a series of proposals put forward by the US regulator to improve liquidity risks within mutual funds.
The proposals, which are still being finalised by the SEC, indicated these facilities could unfairly advantage investors who pull their money from a fund first, forcing the remaining investors to “bear the costs of borrowing”.
The Financial Stability Board, the Basel-based international body that monitors the global financial system, said in its June report on structural vulnerabilities in asset management that credit lines “may address financial stability risks in situations of general market stress”.
But the FSB added: “The use of credit facilities to meet redemptions introduces leverage to a fund that is already under stress and may exacerbate strains if redemptions do not abate.”
Vanguard typically meets redemption requests by selling holdings in liquid government securities or highly liquid bonds that readily convert to cash, according to the spokesperson for the company. He added that Vanguard has never tapped into a line of credit, but having such a facility, in addition to liquid holdings, is “best practice”.
A former senior regulatory official, speaking on condition of anonymity, said the SEC’s proposals were “a hot topic” among asset managers in the US. The US regulator has received more than 70 responses from the industry to the proposals.
He added that asset management companies were taking out new credit lines or extending existing facilities in an attempt to prove to the regulator that they can cope with high levels of outflows in times of market stress.
“These funds are taking it into their own hands to prevent a problem if there are a load of redemptions. They don’t have to have [the credit lines], but they like to have them,” he said.
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