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The threat to financial markets from leveraged trades has not abated in the last year, despite regulators’ efforts to rein them in, the head of Europe’s securities regulator has warned.
“My view is that leverage and liquidity risks in funds remain as high as they were [in the past year],” Verena Ross, chair of the European Securities and Markets Authority (Esma), told the FT, of her outlook for 2024. “This continues to be an area where we need to monitor very closely and react where we see risks.”
Deals that use borrowed money to boost investors’ returns have drawn growing scrutiny from global regulators over the past few years, after the early pandemic “dash for cash” exposed the potential for shocks in areas of finance subject to less stringent supervision than traditional banks.
Since then there have been a series of other shocks, including last year’s wild swings in the nickel price on the London Metal Exchange and the UK gilt market crisis, when a wave of selling by obscure pension fund strategies forced a Bank of England intervention.
Authorities have focused on bets that use derivatives such as futures and swaps to magnify their returns, as well as liquidity mismatches that could lead to fire sales and US hedge funds’ enormous bets in government bond markets.
Ross said that Esma, which supervises and regulates Europe’s financial markets, was preparing to publish a first-of-its kind report on leverage so that outsiders could see data on the level of borrowing by different types of investment funds, including an in-depth analysis of real estate funds in the largest EU jurisdictions.
While the data will be from the end of 2022, Ross said Esma was also carrying out “ongoing monitoring” with national authorities on leverage in their markets.
“With improved data and an improved ability to analyse what the funds actually look like . . . we can also have a better picture of what the risks are and then make sure the right tools are in place to deal with that, if the market moves in a particular direction,” Ross said.
“Leverage is not the only risk that we will actually be monitoring,” she added. “We’re also looking at liquidity mismatches, at valuations . . . And so in these other areas, you will also see action being taken.”
Her comments echo the recent concerns of other regulators over funds that hold hard-to-sell assets like property but allow investors instant access to their cash.
“Funds that allow for daily redemption when they have very illiquid assets are a problem,” said Ross.
