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In a recent speech, Bank of England (BoE) Governor Andrew Bailey said the Banking system is no longer the sole conduit of financial activity. With nearly 50% of global Financial Assets now held by the Non-Bank sector, the vulnerabilities associated with Hedge Funds, Private Credit and Algo Trading Firms, have grown exponentially.
He outlined several Risks, including the rise of multi-manager Hedge Funds, that could lead to amplified financial shocks. These large, highly sophisticated Funds operate with independent Trading teams under one umbrella, managing Risk centrally. However, their ability to leverage capital from prime brokers at high levels means that any rapid unwinding of positions could send shockwaves through markets.
Algo Trading, once primarily confined to Equities and currencies, is also now influencing Debt markets. These rapid-response strategies can exacerbate volatility by triggering automatic deleveraging in response to price shifts. Algo Trading firms, once focused on intra-day activity, are now holding Risk for longer periods. While they have improved Market Liquidity in normal conditions, their behavior in times of stress “remains uncertain, potentially drying up Liquidity at critical moments” Bailey said in the speech.
He emphasized the importance of new approaches to financial stability oversight. For example, a new stress testing framework, the System-Wide Exploratory Scenario (SWES), aims to assess how market shocks flow through the financial system. Unlike traditional Bank stress tests, this exercise evaluates the interplay between Banks and Non-Banks, revealing potential systemic Risks. Initial findings from SWES have already shown that mismatches in expectations about counterparties’ actions under stress could exacerbate financial instability.
Cédric Cajet, Product Director at NeoXam, said in emailed commentary: “This is a welcome measure by the Bank of England that recognizes the difficulty of fully assessing the vulnerabilities associated with Non-Bank leverage. When it comes to Liquidity Risk, these institutions have never been held to the same standards as the Banks, in spite of their increasingly integral role in the effective functioning of global markets. Pension Funds, Asset Managers, Hedge Funds, Insurers, and other Non-Banking Financial Institutions need to ensure they capture positions, valuations, and exposures based upon all of their Investment information.”
