A simple model of the effects of entity and activity constraints on alternative investment funds

Leo Fernandes, Harkeerit Kalsi, Nicholas Vause, Matthew Downer, Sarah Ek and Sebastian Maxted

Hedge funds and other alternative investment funds (AIFs) often take positions in financial markets that significantly exceed their investors’ capital by using debt or derivatives. However, such ‘leverage’ can pose risks to financial stability. Regulators seeking to reduce these risks may consider applying constraints to the fund entities or the activities in which they engage. In this post, we use a simple portfolio choice model to examine the effects of the two approaches on fund investments. Under the entity-based approach, we find that fund managers substitute from lower-risk to higher-risk investments, whereas an activity-based approach can avoid this unintended reallocation by targeting specific investments.

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Leverage finds a way: a comparison of US Treasury basis trading and the LDI event

Adam Brinley Codd, Daniel Krause, Pierre Ortlieb and Alex Briers

We both drive cars, but the US drives on the right while the UK drives on the left. We both walk, but we do so on sidewalks in the US and pavements in the UK. We both have asset managers, who want to take leveraged positions in interest rates. US asset managers had around US$650 billion of long treasury futures in June 2023. UK asset managers, in Autumn 2022, held around £200 billion in leveraged repo. However, the ways in which the financial system found willing lenders for these borrowers, and intermediated the risk through the system of market-based finance, differ.

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What do we know about non-bank interconnectedness?

Zijun Liu and Jamie Coen.

Non-banks are clearly important in the financial system – according to the FSB, global non-bank financial intermediation grew to $75 trillion in 2013, roughly half of banking system assets. But how are they connected to banks, and what risks does this pose? Using a new granular dataset on the exposures of banks to non-banks, we gained some important insights into what these interconnections look like in the UK. Banks’ direct credit exposures to non-banks are currently small, but there is evidence that some non-bank financial institutions have entered the core of the repo network. We found little evidence in our dataset that hedge funds are conducting risky credit intermediation, but other non-bank financial institutions seem to be leveraging up via the repo market.

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