FCA: Better data on leverage needed to prevent next crisis
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The Financial Conduct Authority says “targeted improvements” to public and private disclosures about leverage by non-bank financial institutions – such as liability-driven investment or hedge funds – could reduce systemic risks arising from the use of derivatives and repos.
Systemic risks can arise from the use of leverage, Sarah Pritchard, the FCA’s executive director of consumers, competition and international, has said speaking at an Investment Association Roundtable on Tuesday.
Pritchard called for better data exchange to tackle this, as she reminded her audience of recent near misses like the 2020 ‘dash for cash’ affecting hedge funds, the fallout for banks from the collapse of family office Archegos, and the LDI crisis of 2022 that required Bank of England intervention.
"We believe that targeted improvements to public and private disclosure could go a long way in mitigating the build-up of systemic risk from [non-bank financial intermediation] leverage,” she said.
“The good news is we already have a large portion of the data necessary to identify risks from funds’ leverage use, so we do not need to start from scratch. That said, there may be some targeted changes we could make to our data collection to ensure we are able to assess leverage use in a comprehensive and risk-sensitive manner,” she said, adding that the FCA will consider this as part of its upcoming review of the EU’s Alternative Investment Fund Managers Directive.
“We are conscious that any change in reporting will come at a cost, and so any proposals will be proportionate and subject to a full consultation and cost benefit analysis. We will also engage closely with industry on this when the time comes,” she added.
Her remarks were made shortly before the Financial Stability Board’s consultation on non-bank leverage closes on Friday.
Systemic risks can arise from the use of leverage, Sarah Pritchard, the FCA’s executive director of consumers, competition and international, has said speaking at an Investment Association Roundtable on Tuesday.
Pritchard called for better data exchange to tackle this, as she reminded her audience of recent near misses like the 2020 ‘dash for cash’ affecting hedge funds, the fallout for banks from the collapse of family office Archegos, and the LDI crisis of 2022 that required Bank of England intervention.
"We believe that targeted improvements to public and private disclosure could go a long way in mitigating the build-up of systemic risk from [non-bank financial intermediation] leverage,” she said.
“The good news is we already have a large portion of the data necessary to identify risks from funds’ leverage use, so we do not need to start from scratch. That said, there may be some targeted changes we could make to our data collection to ensure we are able to assess leverage use in a comprehensive and risk-sensitive manner,” she said, adding that the FCA will consider this as part of its upcoming review of the EU’s Alternative Investment Fund Managers Directive.
“We are conscious that any change in reporting will come at a cost, and so any proposals will be proportionate and subject to a full consultation and cost benefit analysis. We will also engage closely with industry on this when the time comes,” she added.
Her remarks were made shortly before the Financial Stability Board’s consultation on non-bank leverage closes on Friday.
Funds are responsible for managing their own risk
Pritchard said the “first line of defence” against systemic risks being created through leverage is risk management by non-banks themselves, followed by counterparty credit risk management, based on information exchange.
Better data should include publicly available data in the form of anonymous, aggregated information on concentrated positioning and liquidity conditions, and private information on counterparties, though she admitted there was a fine line to tread to avoid breaching confidentiality.
Where firms fail to prevent the build-up of market risks, the regulator comes in, she said, arguing that the FCA requires a diverse set of metrics to regulate this area effectively, including those that capture default and liquidity risks, sensitivity to market risk, and concentration risk.
“Using a suite of diverse metrics will allow us to develop a better sense of the risks related to leverage use in individual NBFIs, but also to understand whether risk is building in specific segments of the markets,” she said.
Where the FCA thinks too much risk is building up, it can constrain leverage use. It can do so either directly by imposing a limit on the use of leverage or setting a resilience standard – as has been done for LDI funds – or indirectly by making leverage more expensive.
Better data should include publicly available data in the form of anonymous, aggregated information on concentrated positioning and liquidity conditions, and private information on counterparties, though she admitted there was a fine line to tread to avoid breaching confidentiality.
Where firms fail to prevent the build-up of market risks, the regulator comes in, she said, arguing that the FCA requires a diverse set of metrics to regulate this area effectively, including those that capture default and liquidity risks, sensitivity to market risk, and concentration risk.
“Using a suite of diverse metrics will allow us to develop a better sense of the risks related to leverage use in individual NBFIs, but also to understand whether risk is building in specific segments of the markets,” she said.
Where the FCA thinks too much risk is building up, it can constrain leverage use. It can do so either directly by imposing a limit on the use of leverage or setting a resilience standard – as has been done for LDI funds – or indirectly by making leverage more expensive.
Do you expect leverage to cause problems again in the near future?
