Top financial regulator seeks global clampdown on hedge fund borrowing

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The world’s financial stability watchdog is launching a probe of the build-up of debt outside traditional banks, as it seeks to limit hedge funds’ borrowing and boost transparency.

Klaas Knot, chair of the Financial Stability Board, told the Financial Times the review was intended to address rising risks from so-called “non banks”, which include hedge funds and private capital.

“If we want to arrive at a world where these vulnerabilities are less, we have to tackle this issue,” he said, referring to the key role played by non-banks’ debt in stoking recent crises, such as the bond market meltdown at the start of the pandemic.

Knot said the review was a priority because non banks’ leverage “can potentially threaten financial stability”.

During the March 2020 “dash for cash”, highly leveraged hedge funds — which typically borrow from banks to increase the size of their positions — were widely blamed for helping to send global bond markets into freefall.

“In some areas we can mitigate the risk by having more transparency,” Knot said, in an allusion to making banks share information on lending to hedge funds and other institutions.

But he warned: “There may be other areas where we will actively have to contain the amount of leverage that is being taken on.”

The FSB, a grouping of central bankers, finance ministers and regulators, lacks legally binding powers, but can set the agenda through recommendations and the decisions of its individual members in their own jurisdictions.

The body hopes to announce recommendations on monitoring and limiting non bank leverage next year.

Knot, who is also governor of the Dutch central bank, said such steps could include pushing banks to demand more collateral from investment funds for borrowing against certain kinds of securities, which would ultimately restrict lending.

He said the collapse of Archegos Capital in 2021, which triggered a $4.7bn loss that contributed to the demise of Credit Suisse, also highlighted the risks of poor information about non-banks’ borrowing.

“The Archegos case brought to the surface that there was not a lot of transparency about banks’ exposure to the investment firm,” Knot said. He added that individual banks “didn’t know the exposures others had, so there was no consolidated oversight. That is clearly one thing that will be on the table”.

The review will be co-chaired by the UK Financial Conduct Authority’s markets head Sarah Pritchard and the European Central Bank’s financial stability head Cornelia Holthausen.

Verena Ross, head of Europe’s securities regulator Esma, told the FT she would welcome efforts by the FSB to improve transparency. She said it was “important” for banks to have good knowledge of who they lend to “to make sure that they actually understand where they are positioned”. 

Previous attempts to review the accumulation of debt outside the banking system include annual reporting by Iosco, the international grouping of securities regulators, on lending to investment funds, an initiative launched in 2019.