Why BlackRock Is Better Off Without The ‘Systemically Important’ Tag

Earlier this month, the Federal Reserve released a report that highlighted the need to bring the country’s biggest money managers under stricter regulatory scrutiny by categorizing them as systemically important financial institutions (SIFIs). ^[1] While the debate about whether or not asset management firms should be designated as SIFIs is not a new one – with talks to this effect carried out three years ago – the possibility of the Fed going through with the labeling this time seems more likely, given its decision to name three non-banking financial giants as SIFIs earlier this year. ^[2]

Such a move would definitely impact BlackRock (NYSE:BLK), which is the undisputed leader in the global asset management industry with $4 trillion in assets under management. It could also make asset managers like Vanguard, Fidelity and PIMCO new additions to the list of SIFIs. If added to the list, the asset managers will be forced to meet more stringent capital requirement criteria and also keep more cash on hand – something that will hit their profitability. It should be noted that State Street (NYSE:STT), which ranks among the top-three asset managers around the globe in terms of assets, is already designated as a G-SIFI (global systemically important financial institution) due to its strong presence in the global custody banking space.

We maintain our $294 price estimate for BlackRock’s stock, though there could be a downside to this value in the event the company is named a SIFI.

See our full analysis for BlackRock

Since the economic downturn of 2008, regulators around the world have been busy trying to ensure two things: that the financial sector is healthy enough to minimize the chances of financial giants failing under adverse economic conditions; and secondly, that the impact on the economy at large if one of these firms does run into trouble would be contained. The concept of designating the biggest financial institutions as systemically important financial institutions (SIFIs) was one of the steps towards achieving the first objective.

The rationale behind doing so is simple – if a company is so big and inter-connected that the threat of its going bankrupt will have repercussions on the entire economy, then regulators want it to shore up its capital so it doesn’t run into trouble as easily if things change for the worse. These firms will also be watched more closely by these regulators to make sure they don’t take on too many undue risks. Clearly banks are not the only financial institutions that can be deemed SIFIs – with the Fed naming insurance giants AIG (NYSE:AIG) and Prudential (NYSE:PRU) as well as the financial arm of conglomerate GE (NYSE:GE), GE Capital, as SIFIs earlier this year. ^[3] Asset management firms are potential candidates thanks to the trillions in assets they manage – with a majority of this coming from institutional investors. To put things in perspective, about 70% of BlackRock’s $4 trillion in assets under management is from institutional investors – making it heavily inter-connected to a lot of other firms.

The downside of with being named a SIFI is that the higher capital requirements would mean more idle cash and a consequent reduction in revenues. Add to that more expenses from the heightened regulatory scrutiny. Operating margins are bound to decline as a result – a cause for concern if the firm’s value is very sensitive to margins, as in the case of BlackRock. You can see how drastically BlackRock’s share value reduces from a relatively small decrease in its margin figures by making changes to the chart below.

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1. U.S. Treasury Says Money Managers May Pose ‘Herding’ Threat, Bloomberg, Oct 1 2013 [↩]
2. BlackRock Lobbies Fed to Avoid Designation as Systemically Important Firm, Nov 17 2013 [↩]
3. AIG, Prudential Named Systemically Important by Panel, Bloomberg, Jun 3 2013 [↩]