Global Watchdog Flags $3 Trillion Bond Bets Risk

The Financial Stability Board (FSB), a leading global financial watchdog, is calling for enhanced scrutiny of substantial leveraged positions in government bonds. These positions, heavily utilized by hedge funds and other investors, currently amount to approximately $3 trillion. The FSB's report, published recently, highlights concerns regarding the increasing leverage within repurchase agreement (repo) markets.

The watchdog has outlined several "vulnerability metrics" intended to bolster regulatory surveillance capabilities. These metrics are designed to monitor risks associated with strategies like the cash-futures basis trade, where hedge funds exploit minor price discrepancies. The FSB emphasizes the critical need to preserve the functionality of repo markets, particularly during periods of financial stress, and views the build-up of leverage as a persistent concern.

Regulators are concerned that highly leveraged investors might be compelled to liquidate assets during market downturns to meet liquidity demands. Such sales could exacerbate market volatility, creating adverse feedback loops. While the FSB and the Bank of England have previously suggested measures like minimum haircuts on collateral, the finance industry opposes these, arguing they would impede market liquidity. The FSB also recommended reviewing disclosure practices between leveraged non-banks and their providers, suggesting public-private partnerships to develop industry standards.