Hedge funds and other parts of the shadow banking system should face greater scrutiny after last month’s upheaval in US government bonds, the country’s top markets regulator has said, reflecting concerns that speculative investors pose a risk to financial stability.
Gary Gensler, chair of the Securities and Exchange Commission, told the Financial Times that taming risks from speculative funds and other so-called non-bank financial institutions was now “more important than ever”.
He added he wanted a better understanding of how bets by such asset managers — often highly leveraged — can spill out across asset classes and into the real economy.
Gensler’s comments signal regulators’ determination to tackle risks outside the banking sector following a UK government bond crisis that contributed to the ejection of Liz Truss’s government last year, and what the SEC chair termed as March’s “once-in-a-generation” rally in Treasuries.
“We just had Treasury yields move more significantly than they had in 35 years in three days in mid-March,” he said, referring to the rally sparked by the failure of Silicon Valley Bank. “When you have that, it’s appropriate as a capital markets regulator to talk to folks and see whether that risk . . . propagates out.”
As well as initiating such contacts, the SEC can also propose forcing market participants to increase disclosure of their activities.
But regulators have concentrated over the past decade on the banks that helped spark the 2008 financial crisis, largely leaving hedge funds alone — even after the 2021 collapse of Archegos, the hedge fund-style family office.
In the meantime, assets managed by hedge funds globally have more than quadrupled to $4.8tn since 2009, according to data provider BarclayHedge.
However, several heavy-hitting macro hedge funds suffered billions of dollars of paper losses when investors moved in to bonds after SVB failed.
A pick-up in bond prices quickly turned into the biggest rally since 1987 as hedge funds rushed to close out bets against Treasuries that had brought them handsome rewards last year.
“A little bit of news got vastly amplified” by the “speculative community”, Sushil Wadhwani, a former central banker and chief investment officer at PGIM Wadhwani, an asset manager, said at an event this week.
A hedge fund manager told the FT he and several peers had now received inquiries from regulators seeking information on their institutions’ positions in Treasuries — a crucial market that determines prices across global asset prices. Gensler declined to comment on any specific requests to firms.
Another hedge fund manager said that leverage built up by shadow banks had been the focus of recent conversations. They said the regulator was “gathering market intelligence” on this rather than expressing specific concerns.
Gensler added that authorities should not be distracted from the risks posed by non-banks by the failures of lenders such as SVB and Credit Suisse — a message echoed by other global regulators at the IMF spring meetings in Washington.
He said he had previously identified hedge funds as a risk to financial stability, adding that the SEC’s oversight, along with other regulators of bank lending to hedge funds, was “a really important focus of not just ours but of others overseeing [the banking sector]”.
The SEC was in direct contact with market participants and received quarterly reports from hedge funds as well as information from banks, Gensler said.
The US regulator has put forward proposals to give it access to more real-time data in times of market stress. Last year it also proposed guidance that would require hedge funds to inform it immediately when they have large investor withdrawals or big losses.
Klaas Knot, chair of the Financial Stability Board, an international alliance of regulators, last week also emphasised the focus on shadow banking.
The drive extends beyond hedge funds, since other non-bank institutions can exacerbate market volatility. Last year’s crisis in UK government bonds was sparked off by specialist investors serving pension funds.
Gensler said recent inflows also strengthened the arguments for tighter regulation of money market funds, which investors have piled in to for shelter from chaos in the banking sector.
Additional reporting by Harriet Agnew