The European Central Bank published research in its Macroprudential Bulletin analysing how euro area investment funds build financial leverage through repurchase agreements and margin lending, and what this implies for financial stability. The analysis finds that investment funds’ borrowing has increased over the past two years and is largely sourced from non-euro area banks in foreign currencies, creating a potential channel for the transmission and amplification of external shocks. Repo borrowing is reported to be slightly more than 53% denominated in pounds sterling, about 32% in euro and 14% in US dollars, while margin lending cash borrowing is predominantly in US dollars (78%). For repo transactions, the currency of borrowed funds closely matches the currency of collateral assets (correlation of about 0.98), partially offsetting exchange rate risk. Although leverage is low on average, pockets of high leverage are identified in some segments, particularly hedge funds; leveraged repo borrowing funds tend to have smaller net asset values, while margin lending funds show the opposite relationship but at low leverage levels. Network analysis indicates that lender networks expand with borrowing volumes and that no fund appears central to the borrowing-lending network, which may limit knock-on effects from excess leverage. The box also notes that investment funds are increasingly lending to euro area banks and that a stress-driven deleveraging by funds could reduce repo funding available to banks in the very short term. It concludes that pockets of high leverage in non-bank financial intermediation warrant close monitoring and further policy work, pointing to ongoing efforts at the Financial Stability Board to contain risks from NBFI leverage.
European Central Bank 2025-01-15
European Central Bank research highlights rising repo and margin borrowing by euro area investment funds and pockets of high leverage in hedge funds
The European Central Bank's Macroprudential Bulletin highlights euro area investment funds' use of repurchase agreements and margin lending to build leverage, posing financial stability risks. The research notes increased borrowing from non-euro area banks in foreign currencies, with significant repo borrowing in pounds sterling and margin lending in US dollars. Despite low average leverage, high leverage pockets, particularly in hedge funds, and potential stress-driven deleveraging impacting euro area banks, warrant close monitoring and further policy work.