One of the unintended consequences of quantitative easing has been that it has encouraged corporates to approach capital markets to finance their investment (and shares buyback) needs. The tighter banking regulatory requirements have aided this trend.
A second order consequence of both QE and tighter regulations has been that banks have pulled back from playing the role of market makers in fixed income markets, thereby engendering a liquidity problem. Traditionally, banks used to hold a large inventory of bonds on their balance sheets, managed by their "proprietary trading" desks, which they would deploy to provide liquidity for market participants. Now, with tighter lending norms and risk regulation, banks have been reluctant to play this market-making role.
This has had the effect of transferring the liquidity provisioning risk has therefore now fallen on asset managers and investors. This, from an FT article quoting Jim Cielinski, global head of fixed income at Columbia Threadneedle, the fund house, is instructive,
“Liquidity risk is being transferred away from traditional holders and on to asset managers and end investors. There is only one conclusion: the risk is now our responsibility and must be managed.”
In stark contrast to this refreshing confession, Martin Gilbert, the CEO of Aberdeen Asset Management has gone to the extent of demanding that the central banks of the world consider extending emergency liquidity assistance to asset managers if the illiquid markets freeze up. This request for emergency funding assistance comes even as asset managers have stoutly defended attempts to designate them as systemically important institutions.
One way being suggested to mitigate the liquidity risk is to encourage fund managers to issue closed-end funds which need not be redeemed on demand. This would avoid the runs on assets, especially emerging market debt, which force their fire sales and unleash a spiral of decreasing prices.
In any case, I would say that the banks' retreat from asset management industry would have a beneficial effect on the fixed income markets in particular and financial markets in general. It would incentivize investors to be more vigilant with their investment decisions and fund managers to exercise greater due-diligence in building up their portfolios. It would also encourage the development of less liquid instruments by asset managers. This surely is a market disciplining trend that we should welcome wholeheartedly.
Interestingly, this trend comes at a time when asset management service of banks has been increasing in importance, threatening to eclipse the more glamorous investment banking business. This raises the possibility of banks being tempted to peddle in-house asset management products instead of external products so as to maximize their fees. Fund management industry, which has doubled over the past decade to $87 trillion, has become attractive for banks given that it generates a predictable fee stream and is capital-light, especially important when banks are buffeted by higher regulatory capital requirements.