(Bloomberg) --
Tighter global regulation may be needed to prevent dangerous levels of debt building up after the turmoil in the UK pensions industry wreaked havoc across financial markets, a senior Bank of England official said.
Sarah Breeden, executive director for financial stability strategy and risk, said in a speech on Monday that the international community has made limited progress in addressing risks from leverage outside regulated banks. Regulators must have sight of leverage building up in the whole financial system, she added.
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“Beyond improving transparency, regulators will need to consider how best to ensure leverage is well managed,” Breeden said. Measures could include “market regulations to ensure excessive leverage is better controlled by market pricing and margins.”
Her comments mark one of the first indications of a regulatory rethink after the UK government's mini-budget on Sept. 23 roiled financial markets. Pension funds with leverage driven investment strategies were caught on the hop by rapidly falling gilt prices forcing them into a wave of asset sales.
The dramatic price drop could have damaged the whole economy, Breeden said. “Around £200 billion ($229 billion) of pooled LDI funds threatened the £1.4 trillion traded gilt market, which itself acts as the foundation of the UK financial system, underlying around £2 trillion of lending to the real economy through wider credit markets.”
Banks should improve their stress testing and require counterparties to show greater transparency around hidden leverage Breeden said. They need to have a “a laser like focus on wrong-way risk, where the value of collateral held as security falls in the very situation where the counterparty defaults,” Breeden said.
Prime brokers should have access to data on a fund's overall leverage, not just the portion to which they have contributed, she added. “Given the global nature of non-bank business models, it is essential that transparency and data availability are enhanced through international efforts.”
Breeden said that intelligence suggests that LDI funds raised over £40 billion in funds and made over £30 billion of gilt sales during the BOE's operations, significantly lowering leverage.
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