February 28, 2025

Submitted via the FSB secure online form and email to: [email protected]

Re: Financial Stability Board Consultation Report, December 18, 2024 “Leverage in Non-bank Financial Intermediation”

The Asset Management Group of the Securities Industry and Financial Markets Association (“SIFMA AMG”)¹ appreciates the opportunity to respond to the questions raised in the Financial Stability Board’s Consultation Report on Leverage in Non-bank Financial Intermediation (the “Consultation Report”).² Our members are composed of market participants across the asset management industry, many of which fit within the Consultation Report’s broad category of non-bank financial intermediaries (“NBFIs”).

The diversity of unique business models and funding strategies across various sub-categories of NBFIs underscores the challenge in applying prescriptive, “one-size-fits-all” standards and highlights the need for a more targeted, data-driven approach to evaluating any financial stability risks that may be posed by NBFIs’ use of leverage. Within the asset management industry in particular, managed funds, hedge funds, private equity funds and other investment funds all differ in the amount of leverage they rely on, the means through which they source it, the purposes for which they deploy it and the risk management practices that accompany their use of leverage. Further, the implementation of regulatory reforms around the globe over the past decade and a half, particularly in the derivatives markets, has significantly mitigated risks with respect to so-called ‘synthetic’ leverage.

It also cannot be understated that the use of leverage is not unique to NBFIs, as leverage is heavily relied upon by both prudentially regulated entities such as banks and non-financial institutions, including corporates and sovereigns of all types. Broadly speaking, we urge the Financial Stability Board (“FSB”) to identify with more precision and supporting evidence the
potential financial stability concerns posed by the use of leverage by NBFIs and why such concerns are not sufficiently addressed by the current regulatory framework. In particular, we believe that any risks posed by the use of leverage within the asset management industry have largely been addressed through targeted regulatory reforms. For example, under the Securities and Exchange Commission’s (“SEC”) Rule 18f-4, certain mutual funds, exchange-traded funds, closed-end funds and business development companies are subject to limits on their derivatives transactions based on value-at-risk (“VaR”) limits, and managers are required to implement governance and board oversight over the use of such funds’ derivatives positions. In addition, the expansion of central clearing in the OTC derivatives market coupled with new margin frameworks for uncleared
OTC derivatives adopted over the past decade and a half has improved collateralization practices across the market and acts as an effective risk-based limit on leverage. Finally, as we describe further below, applying prudential and other regulatory requirements that have traditionally applied only to the banking industry to asset managers is not appropriate and may have the opposite intended effect on financial stability risks.

Overview

The Financial Stability Board’s report on the Financial Stability Implications of Leverage in Non-Bank Financial Intermediation (the “2023 Report”)³ finds that within the broader umbrella of NBFIs, insurance companies, pension funds and investment funds account for most of the assets held by NBFIs but comprise less than a tenth of total NBFI sector debt. Considering the breadth of NBFIs and the variance in their usage of leverage, imposing the same prescriptive measures on all NBFIs such as minimum haircuts, limits on leverage and stress testing requirements is not only impractical and unnecessary but will inevitably penalize certain market participants over others.

For example, within the NBFI sub-category of hedge funds, the 2023 Report cites hedge funds pursuing macro and relative value strategies as relying on high levels of synthetic leverage through derivative positions relative to hedge funds focusing on other strategies, such as credit or event-driven strategies.⁴ However, such measures provide a distorted and significantly overstated view of leverage by relying on a ‘gross notional exposure’ metric which does not represent underlying risk factors. Simply put, the actual risks associated with a given notional amount of a USD interest rate swap and an equivalent notional amount of a high yield credit default swap are vastly different. Further, hedge fund portfolios often include offsetting positions that reduce risk as opposed to amplifying it. Thus, high amounts of gross notional exposure can actually reflect low levels of actual net exposure. Additionally, hedge funds that use a long/short equity strategy will have vastly different levels of leverage than, for example, a relative value fixed income strategy. Finally, many simplistic measures of leverage do not take into account the degree to which portfolios are collateralized, subject to margin and netting arrangements and otherwise prudently risk managed.

The Bank of England’s recent System Wide Exploratory Scenario (“SWES”) exercise provides a model for a holistic, data-driven and collaborative effort between public and private participants to better understand (i) the different ways that various NBFI sectors react to market shocks, (ii) any financial stability risks that may be posed by banks and NBFIs in stressed market
conditions, and (iii) potential measures to address such risks.⁵) For example, the final report highlighted that “[r]epo market resilience is central to supporting core markets in stress,” and thus that “[f]urther policy work to increase repo market resilience, could, alongside central bank facilities, help support repo market resilience and the effective functioning of other markets during stress.”6 The SWES Report also helpfully noted the risk management practices employed by various NBFI segments. For example, the final report observed that participating hedge funds experienced only a modest loss in their net asset value (NAV) despite the severe shock, with a number of factors contributing to their resilience, including “high levels of unencumbered cash to meet potential IM/VM calls” and “less frequent redemption terms/conditions (e.g., quarterly).”7

The Consultation Report and 2023 Report also seem to disregard the many benefits of leverage. Derivatives and structured finance trades, for example, facilitate the efficient transfer of risk, promote price discovery, can stabilize markets, and provide financing to assets. Additionally, access to leverage can provide important countercyclical effects; for example, access to deep and
liquid markets can facilitate an NBFI’s overall liquidity preparedness in stress, which can reduce the likelihood of a sudden deleveraging cycle and destabilizing asset sales as well as the propagation of stress to other parties. Both the Consultation and 2023 Report appear to impugn the use of leverage without proper consideration of the important role it plays in the smooth and
efficient functioning of markets.

Both the 2023 Report and the Consultation Report also do not sufficiently account for the many market and regulatory reforms that have been implemented since the 2008 financial crisis, which not only provide greater transparency to regulators but also significantly mitigate any financial stability risks that may be posed by NBFI leverage. We urge the FSB to recognize that
NBFIs are already subject to comprehensive regulatory frameworks within their respective jurisdictions and generally transact in markets that are similarly highly regulated. The FSB should refrain from recommending incremental or overly prescriptive requirements without consideration of recent market-wide regulatory reforms.

Following the G20 reforms, for example, derivatives (i.e., swaps) are now subject to a robust regulatory framework that includes, among others, robust mandatory margin requirements and central clearing mandates for a wide variety of standardized rate and credit derivatives, which significantly reduce risks from the counterparty channel by diminishing the likelihood that any losses faced by an NBFI is propagated to its counterparties or providers of leverage. In a similar vein, as recently as December 2023, the U.S. Securities and Exchange Commission adopted a final rule to expand central clearing for both cash and repo transactions in the U.S. Treasury markets.

Additionally, the adoption of more robust risk-based capital charges for derivatives exposures of banks (otherwise known as SA-CCR) as well as the recommendations of the BCBS Guidelines for Counterparty Credit Risk Management 8 (the “BCBS Guidelines”) for sound counterparty credit risk management afford bank regulators and supervisors a more targeted
approach to reducing concentrations and countering the transmission risks posed by NBFI leverage.

The Consultation Report should also include more thoughtful consideration of the potential drawbacks and unintended consequences of deploying its very own recommendations. In addition to the burdensome costs of any additional reporting and disclosure requirements, we remain highly concerned that the introduction of any entity-based measures such as caps on leverage, minimum haircuts and increased margin requirements could have the net effect of reducing market liquidity and increasing the cost of hedging, among others.

1. SIFMA AMG brings the asset management community together to provide views on U.S. and global policy and to create industry best practices. SIFMA AMG’s members represent U.S. and global asset management firms whose combined assets under management exceed $45 trillion. The clients of SIFMA AMG member firms include, among others, tens of millions of individual investors, registered investment companies, endowments, public and private pension funds, UCITS and private funds such as hedge funds and private equity funds. [↩]
2. Financial Stability Board, Leverage in Non-bank Financial Intermediation (December 18, 2024), available at https://www.fsb.org/uploads/P181224.pdf. [↩]
3. Financial Stability Board, The Financial Stability Implications of Leverage in Non-Bank Financial Intermediation (September 6, 2023), available at https://www.fsb.org/uploads/P060923-2.pdf. [↩]
4. 2023 Report, at 20. [↩]
5. Bank of England, System-Wide Exploratory Scenario Exercise Final Report (November 29, 2024), available at https://www.bankofengland.co.uk/financial-stability/boe-system-wide-exploratory-scenario-exercise/boe-swes-exercise-final-report (the “SWES Report” [↩]