MNI POLICY: De Guindos "Seriously Concerned" By Fund Risks

By Luke Heighton

     FRANKFURT (MNI) - European Central Bank Vice President Luis de Guindos is

"seriously concerned" about the role investment funds might play in a future

bout of volatility as market liquidity declines, he said in a speech on Monday,

in which he called for tighter regulation of exchange-traded funds.

     There are "strong indications that liquidity risks are building up in the

fund sector", just as spillover and debt sustainability concerns in the public

and private sector are "re-emerging" across the continent, he said.

     Here are the key points from De Guindos' speech at the opening of the 21st

Euro Finance Week in Frankfurt:

     --De Guindos called for closer monitoring of investment funds' leveraging

ratios, and said close attention needs to be paid to the ETF market,

particularly the "small but rapidly-expanding bond ETF market." Further

regulatory action may include enhanced rules to limit counterparty risk exposure

of ETF investors, measures that provide more transparency around ETF liquidity

provision, and additional ex ante requirements such as minimum liquidity buffers

and redemption notice periods.

     --Tensions have grown in emerging market economies on the back of a

stronger U.S. dollar and increased trade frictions. These developments may

undermine global growth prospects and ultimately lead to abrupt increases in

risk premia. This could trigger a domino effect - leading to a sharp sell-off

and further price pressures in assets with stretched valuations - with the

potential to spill over to euro area financial markets.

     --The investment fund industry in the EU is highly concentrated in a few

jurisdictions, but - due to the diverse asset holdings and investor locations -

the impact of adverse developments in this sector could be felt across the bloc.

It is necessary to strengthen the European perspective in supervision of

investment funds while also ensuring a globally consistent approach to

monitoring.

     --Euro area investment funds have been taking on higher credit and duration

risk, and there are strong indications of liquidity risks. The share of

less-liquid assets in that sector has been growing constantly since the global

crisis, while liquidity and cash buffers have been declining.

     --Italy is only the most prominent example of a euro-area country where

debt sustainability concerns can be observed. Strong market reactions to recent

political events "have triggered renewed concerns about the sovereign-bank nexus

in parts of Europe. Although contagion has been limited so far, it remains a

possibility."

     --The current expansion of the U.S. is now significantly longer than

historical norms and the second longest in U.S. modern history. Looking ahead, a

down-turn in the U.S. macro-financial cycle could trigger a reassessment of

riskier asset classes.

--MNI Frankfurt Bureau; +49-69-720-146; email: luke.heighton@marketnews.com

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com