The European Systemic Risk Board published an occasional paper proposing a framework for monitoring financial stability risks from leverage in EU-domiciled alternative investment funds (AIFs) and assessing policy tools to contain those risks in line with Financial Stability Board recommendations. The analysis identifies hedge funds and liability-driven investment (LDI) funds as the most exposed to leverage-related vulnerabilities, with risk drivers differing by strategy and funding source. The paper builds a dataset that links fund-level Alternative Investment Fund Managers Directive (AIFMD) reporting with transaction-level derivatives and repo data under the European Market Infrastructure Regulation (EMIR) and the Securities Financing Transactions Regulation (SFTR). It focuses on 655 highly leveraged funds (gross leverage above three times net asset value), with total net asset value of EUR 170 billion and gross exposures exceeding EUR 1 trillion. Relative value hedge funds are shown to have the highest leverage and the greatest reliance on repo, while LDI funds are particularly exposed to interest rate shocks and related margin and collateral calls. In a 100 basis point parallel rate increase scenario, average estimated net asset value losses are 22% for GBP-denominated LDI funds and 13% for EUR-denominated LDI funds (versus 5% for hedge funds and 9% for other leveraged funds), with aggregate liquidity needs of EUR 8.7 billion and a cash-based shortfall of EUR 6.5 billion. In its policy simulations, a gross leverage limit of 10 times net asset value would affect 67% of hedge fund net asset value and reduce hedge fund gross exposures by about 50%, while having limited impact on LDI and other funds unless calibrated more tightly. Applying minimum repo haircut floors based on a simplified Eurosystem schedule would be expected to force relative value hedge funds to cut repo borrowing by around one-half, while GBP LDI funds would be largely unaffected due to sizeable unpledged bond buffers. The paper concludes that leverage containment tools can have sharply different effects across fund types and may interact with existing measures such as yield buffer requirements, pointing to the need for tailored policy design. It also highlights data limitations for some metrics (notably initial margin completeness in pre-Refit EMIR reporting) and flags further work on risk-sensitive leverage limits, margin-based approaches and broader shock analysis.
European Systemic Risk Board 2025-12-10
European Systemic Risk Board publishes analysis of leverage risks in EU alternative investment funds and tests leverage limits and repo haircut floors
The European Systemic Risk Board proposed a framework to monitor financial stability risks from leverage in EU-domiciled alternative investment funds, identifying hedge funds and liability-driven investment funds as most vulnerable. Using AIFMD, EMIR, and SFTR data, the analysis highlights significant leverage in 655 funds with gross exposures over EUR 1 trillion. Policy simulations suggest that leverage containment tools, such as gross leverage limits and repo haircut floors, could significantly impact hedge funds but have limited effects on LDI funds, underscoring the need for tailored policy design.