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Financial regulatory body advocates for caps on borrowing levels among hedge funds

Financial intelligence agency FSB suggests improved transparency in lending practices among non-bank institutions, as growing unease mounts over potential risks leading to a financial catastrophe.

Financial oversight authority suggests imposing restrictions on the amount of borrowing by hedge...
Financial oversight authority suggests imposing restrictions on the amount of borrowing by hedge funds.

Financial regulatory body advocates for caps on borrowing levels among hedge funds

In a bid to enhance financial stability and mitigate risks to the global financial system, the Financial Stability Board (FSB) has proposed a series of measures to regulate leverage and increase disclosure for hedge funds and other non-bank financial institutions.

## Proposed Measures

The FSB's proposals aim to address the build-up of leverage in non-banks, which can amplify stress and pose risks to financial stability. The measures include:

1. **Direct Leverage Limits**: The FSB suggests imposing direct limits on the leverage of non-bank financial institutions, specifically capping gross asset-to-net asset ratios.

2. **Margin Requirements**: Strengthening collateral rules in derivatives markets is proposed to curb over-leveraged trades.

3. **Position Reporting**: Mandating disclosure of large exposures is suggested to monitor concentration risks, such as crowded trades in government bonds.

4. **Central Clearing**: The FSB recommends mandating central clearing for more transactions, which can reduce counterparty risk.

5. **Disclosure Requirements**: Increased disclosure regarding leverage is proposed to provide regulators and investors with a clearer picture of the risks associated with hedge funds and other non-bank entities.

## Addressing Potential Risks

These measures aim to address several risks: excessive leverage, lack of transparency, and market instability. By limiting leverage, enhancing transparency, and reducing the use of excessive leverage in strategies like Treasury basis trades, the FSB seeks to prevent the amplification of stress during economic turbulence, improve visibility into the operations of non-bank financial institutions, and mitigate the impact of sudden market movements.

The Bank of England, led by Andrew Bailey who is both the FSB chair and the Bank of England governor, has announced it will consult on ways to address vulnerabilities in UK repo markets, with hedge fund borrowing reaching a record high of £77bn. The FSB's recommendations include enhancing central clearing and counterparty risk management as targeted tools to address risky forms of leverage.

The FSB acknowledges that non-bank leverage can enhance efficiency and support liquidity in financial markets, but only when leveraged entities maintain sufficient headroom to increase risk and leverage, including having sufficient liquidity. Regulators' concerns about non-bank leverage have been heightened by events such as the collapse of Archegos Capital Management and the UK gilt market crisis.

The FSB has identified several data challenges that have hindered the effective assessment of non-bank sector vulnerabilities by authorities. To address this, the FSB has announced the creation of a new task force to identify and address areas where it lacks sufficient data on the build-up of leverage outside of banks. The FSB plans to publish a report on sovereign bond leveraged trading strategies by the middle of next year.

The Alternative Investment Management Association supported the idea of more harmonized risk reporting to financing counterparties while preserving confidentiality. The FSB's proposed measures aim to allow national authorities to identify financial stability risks created by non-bank financial intermediation leverage and have appropriate policy measures in place to address these risks.

  1. The Financial Stability Board (FSB) proposes increasing disclosure for wealth-management firms and personal-finance advisors, as it believes this will provide investors with a clearer understanding of the risks associated with their investments.
  2. In the context of business and finance, the FSB's measures aim to address risks such as excessive leverage, lack of transparency, and market instability, which can hamper a company's overall financial health.
  3. To further safeguard the global financial system, the FSB recommends that investments in financial markets should be made wisely through careful consideration of the proposed leverage limits and various disclosure requirements.
  4. The FSB emphasizes the importance of proper business strategies involving smart investment decisions in managing wealth, as they can help minimize risks and maintain financial stability, even during economic turbulence.

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