It can be seen in events in the gilt market I described earlier. The concentrated and correlated nature of pooled LDI funds’ exposures meant that their forced selling behaviour represented a sudden and profound shift in supply-demand dynamics. Indeed the self-reinforcing spiral it led to meant that around £ billion of pooled LDI funds[10] threatened the £ trillion traded gilt market, which itself acts as the foundation of the UK financial system, underlying around £ trillion of lending to the real economy through wider credit markets. [11] As such, it was a timely reminder that large concentrated exposures and correlated behaviours can strain market functioning so much that financial stability can be threatened. The counterparty channel  Now let’s turn to the counterparty channel ‒ where leverage increases the risk of an entity’s default and so brings losses for their counterparties, threatening the resilience of systemically important firms and so the real economy. Margins are at the core of bank and CCP toolkits for managing these counterparty risks. They are essential to stop cascading counterparty losses around the system broadly. But margins will only be adequate if counterparty credit risks can themselves be adequately assessed. And assessing the risk of a leveraged institution can be challenging ‒ perhaps because its exposures are in the form of synthetic or “hidden” leverage or because its exposures are more concentrated or correlated than the counterparty is able to understand.
That has included work on the specific issues of leverage and liquidity of LDI strategies, which was assessed with a stress simulation in 2018, and which led to further close work with the Pensions Regulator and the Financial Conduct Authority[14] to enhance understanding of financial stability risks, enhance monitoring and inform further work. The vulnerabilities in market-based finance that the FPC had articulated were exposed in dramatic fashion in the ‘dash for cash’ in the early stages of the Covid pandemic. [15] That gave additional momentum to this work. And there has been some progress in recent years, on the regulation and monitoring of the non-bank sector[16], particularly relating to liquidity mismatches in MMFs and OEFs. [17] The international community has made less progress in addressing the risks from non-bank leverage. The international nature of leveraged investors requires a firm response by the global regulatory community to assess those risks and develop policy solutions. And the UK’s recent experience is a timely reminder of the risks here. So in the final minutes I will zone in on the actions relevant to this issue. Let’s start with transparency, where it is vital that regulatory authorities have sight of leverage building up in the system, and what that means for resilience. That requires better regulatory disclosures for non-banks and investment in monitoring capabilities. The Bank has access to transaction-level data from regulatory datasets[18] which we use to monitor the build-up of systemic risks stemming from leverage in the non-bank system.