BIS Alerts on Hedge Fund Leverage Risks in Government Bond Markets
The new head of the Bank for International Settlements (BIS) emphasizes the importance of regulating hedge fund leverage in government bond markets. With public debt continuing to rise, this issue has become increasingly pressing. Pablo Hernández de Cos, who assumed his role in July, highlighted the financial stability risks posed by non-bank financial institutions (NBFIs), particularly hedge funds.
BIS Focus on Hedge Fund Leverage Risks in Government Bond Markets
During a recent speech at the London School of Economics, de Cos discussed the dangers associated with the growing influence of hedge funds in bond markets. These entities have utilized leveraged “relative value” trading strategies, exploiting small price differences between bonds and their futures. The surge in these trading practices follows a significant disruption in 2021, when margin calls on U.S. Treasury future trades triggered volatility within the market.
Key Statistics on Hedge Fund Repos
- 70% of U.S. dollar bilateral repos from hedge funds are issued at zero haircut.
- 50% of euro bilateral repos also lack haircut constraints.
These figures indicate a concerning trend, where creditors are not imposing limits on the leverage utilized by hedge funds in government bonds. De Cos stated that the combination of high public debt and the expanding role of NBFIs requires immediate action from policymakers.
The Need for Policy Changes
De Cos advocates for a careful selection of tools to manage NBFI leverage effectively. He identified two critical measures for consideration:
- Implementation of greater central clearing to ensure equal treatment among participants in the government bond market.
- Introduction of minimum haircuts on bonds used as collateral by hedge funds to curtail excessive leverage.
He underscored that these measures must be targeted, as the growing burden of public debt introduces new financial stability challenges. The BIS head also pointed out that central bank swap lines are essential for maintaining global financial stability during periods of stress.
Monetary Policy and Debt Sustainability
Monitoring inflation is vital to support debt sustainability and minimize risk premiums. Additionally, de Cos stressed that the need for credible monetary policy and central bank independence has intensified, particularly amid deteriorating sovereign credit ratings.
As policymakers engage with these issues, the focus on hedge fund leverage in government bond markets remains critical. It highlights the broader implications of rising public debt and the role of non-bank entities in financial stability.
