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Financial policymakers have urged hedge funds, pension investors and commodities traders to keep more liquid assets on hand and develop stress tests to better withstand shocks from extreme market moves.
The Financial Stability Board, which includes the world’s leading finance ministers, central bankers and regulators, said on Wednesday that after assessing a series of recent market panics, many funds and traders had made “inadequate” preparation for sudden price moves.
Its call increases the scrutiny of so-called non-bank financial institutions, which have become a larger part of trading in financial markets since the 2008 financial crisis.
Many have come under deep strain from unexpected moves in market prices, from the March bond market meltdown at the onset of the coronavirus pandemic in 2020, to the UK’s pension fund crisis in 2022, when a wave of selling by some pension fund strategies forced a Bank of England intervention.
Alongside those shocks, the FSB assessed the implosion of hedge fund Archegos in 2021 after it failed to meet margin calls, and the commodities market turmoil of 2022, when nickel rose on the London Metal Exchange and European gas prices soared in the summer.
The FSB pinpointed “weaknesses in liquidity risk management and governance” as a reason so many struggled to respond to outsized margin and collateral calls, because they did not have easy access to emergency funds or were unprepared if their trading counterparty got into financial difficulties.
The Basel-based supervisor particularly pointed to leveraged hedge funds, which have “minimal directly applicable” risk rules, and large commodity traders and utilities, which typically enjoy less restrictive regulations than banks.
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The board made eight recommendations to companies to manage future cash crises, including running stress tests on their exposures to sudden rises in margin and collateral calls.
These should “identify the sources of liquidity strains” and “cover a range of extreme but plausible scenarios, including both backward-looking and hypothetical”, the FSB added.
It also said companies should allocate clear executive responsibilities for looking at the risks from margin calls, “to ensure effective and timely decision making by senior management and boards”.
The FSB recommended that companies hold sufficient cash and other liquid assets readily available to meet margin calls. It also suggested companies automate their collateral management to reduce the possibility of operational delays or failures.
Global financial supervisors are increasingly focusing on the risks arising from the shadow banking sector, which includes pension funds, family offices, trading houses and insurance firms.
Regulators such as the European Banking Authority are looking at the sector’s links with banks to monitor the potential for contagion from stresses in the wider financial system.