Watchdogs should pay more attention to the “who” when regulating the grey corners of finance
As a market that could be over $225 trillion in size, the non-bank financial industry is regulators’ new target. They are hawkish over hidden risks here, especially after British pension funds narrowly dodged catastrophe in 2022.
The Bank of England had to launch a 65-billion-pound scheme in September to stabilise the bond market.
Glits prices were strongly hit by the government’s unbacked mini-budget, while UK pension funds were caught short by the fall.
The funds would have had to liquidate investments to meet margin calls on their loans, if the BoE didn’t step in.
Panicked sales of bonds could have pushed borrowing costs up in the mortgage market, rippling through the wider economy, as Reuters notes.
So it’s no wonder that even the G20’s financial stability task force, as regulators everywhere, is looking for hidden leverage.
Markets like Indonesia, Brazil and Mexico carry riskier assets, but these outlets are of great interest when rates are low.
Emerging market funds could be the first place for the regulators to start the search, since these are the places where investors are dumping assets when political crises arise, for example.
Another should be the leveraged loans, where the so-called open-ended funds make up 4% of this market.
These instruments allow investors to demand their money back, even though the fund’s assets are hard to sell.
In the market suctions of March 2020, open-ended funds sold $14 billion of leveraged loans, contributing to a 19% drop in prices.
That’s because those funds accounted for 11% of the transactions in the secondary market.
But there are pension funds where losses would be more simply provoked, so they shouldn’t deserve heavy-handed regulation.
The collapse of cryptocurrency exchange FTX in November is one example, since it left banks unscathered.
And that’s because most regulated institutions have given crypto a wide berth.
So maybe when stress-testing the system, it would make most sense to be clear about who has the potential to cause systemic risk, not just what.