The European Central Bank published research in its Macroprudential Bulletin setting out a framework to assess financial stability risks from leveraged alternative investment funds (AIFs) and to evaluate potential policy responses. The approach links entity-level AIFMD reporting with transaction-level data on derivatives (European Market Infrastructure Regulation) and repurchase agreements (Securities Financing Transactions Regulation), and finds hedge funds and liability-driven investment (LDI) funds to be the most exposed to leverage-related vulnerabilities, with LDI funds particularly sensitive to interest rate shocks. Using end-of-2023 data and defining leveraged AIFs as those with a gross leverage ratio (assets under management/net asset value) above 3, the sample’s largest groups are LDI funds (aggregate NAV of EUR 85 billion) and hedge funds (EUR 13 billion). Relative value hedge funds show the highest leverage (gross leverage close to 30) and the most pronounced repo-related metrics, with gross repo borrowing about 20 times NAV and more than 37 times cash; LDI funds are mainly exposed to interest rate derivatives, while extensive repo borrowing is concentrated in GBP-denominated LDI funds and relative value hedge funds. In a stress test, a 300 basis point parallel upward shift in yields produces average investor losses of 31% for GBP LDI funds and 26% for EUR LDI funds, while hedge funds and other leveraged funds show negligible impacts in this scenario; a 100 basis point shock still generates liquidity pressures, with more than half of LDI funds’ cash insufficient to meet margin and collateral calls and an aggregate liquidity shortfall estimated at EUR 6.6 billion. The article presents initial findings from an ongoing European Systemic Risk Board analysis, with a broader project due to be published later in 2025, and positions the combined-data framework as a tool to run tailored risk scenarios and assess measures such as leverage limits, minimum haircuts, higher initial margins and minimum shock-absorption capacity requirements.
European Central Bank 2025-01-01
European Central Bank develops framework combining AIFMD, EMIR and SFTR data to assess leverage risks in EU alternative investment funds
The European Central Bank's Macroprudential Bulletin outlines a framework to assess financial stability risks from leveraged alternative investment funds (AIFs), highlighting hedge funds and liability-driven investment (LDI) funds as most vulnerable. Using AIFMD, EMIR, and SFTR data, it reveals LDI funds' sensitivity to interest rate shocks and significant leverage in relative value hedge funds. Stress tests indicate substantial potential losses for LDI funds under interest rate shifts, with a broader European Systemic Risk Board analysis forthcoming.