Bank of England puts ‘threat to stability’ by hedge funds under microscope

The Bank of England’s risk-watchers put hedgies in the spotlight today as potentially vulnerable to rising market interest rates.

The Financial Policy Committee, chaired by Governor Mark Carney, is to carry out more research with the Financial Conduct Authority into hedge funds to assess more fully whether they pose a threat to financial stability.

A statement following its latest meeting said: “The levels of leverage within, and therefore the vulnerability of, hedge funds needed to be looked at more closely.”

An industry source said the regulator’s twice-yearly survey of London’s 50 biggest hedge funds had not flagged up potential risks from leverage. “Leverage among hedge funds is generally lower than banks,” he said.

The FPC, which made no further recommendations this month, said the “moderate” rise in long-term interest rates seen in recent months as the US Federal Reserve readies itself to slow stimulus and the economy gradually recovers “did not pose immediate threats to banks or insurers”.

It said rising interest rates “had not led to dislocations in market functioning or significant impact on financial institutions” but added that banks had failed to take full account of potential “amplification channels”, where individual institutions tightening rates or selling assets in response to a specific shock could cause knock-on effects on other banks.

The committee also played down fears over a housing bubble with market activity and loan to value ratios on mortgage loans below their long term average despite a recovery which “appeared to have gained momentum and be broadening”.

The FPC remains “vigilant to potential emerging vulnerabilities” and remains ready to employ tools including supervisory guidance on underwriting standards, sectoral capital requirements and recommendations to the regulators on tightening of affordability tests.

The Bank’s monetary policy committee can cancel its new forward guidance policy if it believes there is a threat to financial stability. But Chris Williamson, chief economist at financial data provider Markit, said: “The statement points to few worries about financial stability in the UK.  While there are some amber warning lights showing, the FPC made no policy recommendations. As such, there is little likelihood of the financial stability ‘knockout’ clause being invoked any time soon.”