On 25 February 2025, Sarah Pritchard, executive director of consumers, competition, and international at the UK Financial Conduct Authority (FCA), delivered a speech at the Investment Association Roundtable where she outlined the FCA’s approach to managing systemic risk associated with non-bank financial intermediation (NBFI) leverage. Here we set out a summary of the key points from the speech and highlight the implications for market participants.
This speech is part of an on-going focus we have seen from regulators on understanding both the use and quantum of leverage in the UK, including the Prudential Regulatory Authority’s thematic review of PE financing activity in 2024.
Overview of Sector and Recent Market Volatility
Recognising the growing role of hedge funds, private equity and other NBFI entities in global markets, the FCA is concerned about the potential for excessive leverage to amplify market stress. In particular, Pritchard highlighted several recent episodes of market volatility where NBFI leverage contributed to market disruption:
- The “dash for cash” in March 2020, where hedge funds unwound highly leveraged positions in U.S. Treasury markets.
- The autumn 2022 surge in long-dated yields, leading to large margin calls on UK pension funds’ investments in liability-driven investment (LDI) strategies.
- The collapse of Archegos Capital Management in March 2021, which led to significant losses for its bank counterparties.
These events underscored the need for effective risk management and transparency in the use of leverage.
Lines of Defence
The FCA sees three lines of defence against excessive leverage on the part of NBFI entities:
- The first line of defence against systemic risk is the NBFI entities themselves, which must manage their investment risks effectively. This requires access to adequate data and information about market conditions and risks.
- The second line of defence is counterparty credit risk management by leverage providers, who need sufficient understanding of the risks they face. To this end, the FCA supports regulatory initiatives to enhance the availability of information that can help NBFI entities manage their risks. This includes public disclosure of anonymous, aggregated information on concentrated positioning and liquidity conditions. Additionally, private disclosure between counterparties can improve leverage providers’ ability to manage counterparty risk.
- Regulators are the third line of defence, requiring the necessary data, systems and tools to monitor NBFI leverage use from a systemic perspective. The FCA is focused on developing a range of metrics to assess leverage-related risks and considering measures to address and mitigate these risks.
Implications for Market Participants
Clients should take note of the FCA’s evolving regulatory approach and consider the following actions:
- Increased disclosure requirements. The FCA is prioritising improved data collection and transparency to assess risks associated with NBFI entities. The FCA is likely to enhance both public and private disclosure to improve transparency and risk management. This may include anonymous, aggregated information on market positioning and liquidity conditions, as well as enhanced private disclosure between counterparties. Clients can expect more stringent disclosure and reporting requirements concerning leverage, and more data requests, as the FCA refines its oversight framework.
- Market resilience measures. The FCA is evaluating potential policy interventions to strengthen market resilience. This includes consideration of stress testing methodologies, margining practices and liquidity risk management to mitigate systemic spillovers.
- Focus on risk management. NBFI entities must prioritise effective risk management practices to mitigate systemic risk. This includes having access to adequate data and information about market conditions and risks. Leverage providers should also enhance their counterparty credit risk management practices. Clients with exposures to leveraged counterparties should reassess their risk frameworks, ensuring they can withstand potential market disruption.
- Regulatory oversight. The FCA will continue to play a critical role in monitoring and addressing systemic risk from NBFI leverage. Clients should be prepared for potential regulatory measures that may constrain leverage use, either indirectly through increased costs or directly through limits on leverage. Clients operating in highly leveraged sectors should also prepare for more proactive supervisory dialogues. In addition, we can expect regulators to continue to question the use and sustainability of leverage when assessing deals in the regulated sector.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.