Top financial watchdog recommends limits on hedge fund leverage

Keep knowledgeable with free updatesSimply signal as much as the Monetary & markets regulation myFT Digest — delivered on to your inbox.Hedge funds and different non-bank teams may face limits on the quantity of leverage they’ll use and will have to offer extra disclosure to regulators about their borrowing, underneath plans put ahead by the world’s monetary stability watchdog.The Monetary Stability Board (FSB) stated on Wednesday that its really useful measures — which observe a session introduced late final yr — had been designed to sort out the build-up of leverage in non-banks, which “could be an essential amplifier of stress. If not correctly managed, it may well create dangers to monetary stability.” The plans spotlight the idea amongst central bankers and regulators that hedge funds and different non-bank actors akin to personal credit score funds, which regularly make heavy use of leverage however get pleasure from lighter regulation than banks, pose one of many greatest threats to the worldwide monetary system. Regulators have warned in regards to the so-called Treasury foundation commerce, a extremely leveraged wager wherein hedge funds brief US authorities bond futures whereas borrowing cash to take a money place, hoping the 2 costs will converge. The unwinding of this commerce was blamed for a pointy sell-off in bond markets in March 2020, whereas hedge funds had been additionally extensively seen as exacerbating Treasury market turbulence in April this yr.On Wednesday, the Financial institution of England stated it might seek the advice of on methods to deal with vulnerabilities in UK repo markets, with hedge fund borrowing reaching a file excessive of £77bn. A “small variety of hedge funds” accounted for 90 per cent of internet gilt borrowing, the BoE stated. The measures really useful by the FSB, which was arrange by the G20 group of nations after the 2008 disaster to co-ordinate international monetary regulation, embrace requiring non-banks to reveal extra information on leverage, making extra transactions centrally cleared, imposing more durable guidelines on borrowing by way of refinancing markets and even setting outright limits on leverage ranges for some funds.It offered a spread of choices for nationwide regulators to select from to “assist information authorities in deciding on, designing, and calibrating coverage measures”, it added.Hedge funds criticised components of the FSB’s proposals.“The report’s suggestions on blunt entity-level caps and minimal haircut necessities will not be acceptable instruments to cut back threat within the monetary system, and will have unintended, damaging penalties for financial progress and monetary stability,” stated Bryan Corbett, head of the Managed Fund Affiliation, which represents the largest hedge funds, together with Millennium Administration, Citadel and Apollo International Administration.Nonetheless, Corbett welcomed the FSB’s “concentrate on enhancing central clearing and counterparty threat administration as focused instruments to deal with dangerous types of leverage, and agree that present leverage measurement approaches are rigid and flawed”.The Various Funding Administration Affiliation, which represents a whole bunch of hedge funds, personal credit score funds and personal fairness teams, stated it supported the thought of “extra harmonised threat reporting to financing counterparties whereas preserving confidentiality”, which it stated would “cut back the necessity for blunt regulatory instruments”.The non-bank sector — which incorporates hedge funds, personal fairness, insurers and pension funds — has grown to virtually half of worldwide monetary belongings over the previous decade, with “enterprise fashions and methods repeatedly evolving and infrequently utilizing leverage”, the FSB stated. It stated the measures would enable nationwide authorities to “establish monetary stability dangers created by non-bank monetary intermediation leverage and have acceptable coverage measures in place to deal with the dangers that they establish”.The FSB additionally introduced the creation of a brand new job drive to establish and tackle areas the place it lacks ample information on the build-up of leverage outdoors of banks. The duty drive can be led by Andrew Bailey, who this month took on a three-year mandate as FSB chair alongside his function as Financial institution of England governor. It would begin by conducting a check case on “leveraged buying and selling methods in sovereign bond markets”. The FSB stated it had “recognized a number of information challenges which have hindered the efficient evaluation of non-bank sector vulnerabilities by authorities”. It plans to publish a report on sovereign bond leveraged buying and selling methods by the center of subsequent yr.In addition to bond market turmoil within the early phases of the coronavirus pandemic and earlier this yr, regulators’ issues intensified following the collapse of household workplace Archegos Capital Administration 4 years in the past, which left funding banks with $10bn of losses, and the UK gilt market disaster three years in the past, which was triggered by derivative-linked methods in pension funds.The FSB stated there was a constructive aspect to non-bank leverage, which “can improve effectivity and assist liquidity in monetary markets”.However it added: “That is solely possible when leveraged entities preserve ample headroom to extend threat and leverage, together with having ample liquidity.”