G20 watchdog in step-by-step approach to funds sector 'vulnerabilities'

By Huw Jones

LONDON (Reuters) - Systemic vulnerabilities in investment funds and other "non-banks" that make up almost half the world's financial system will be addressed by tweaking existing rules before assessing whether more radical action was needed, a G20 watchdog said on Thursday.

Central banks had to inject liquidity when money market funds ran into difficulties as economies went into lockdown in March 2020.

There was also central bank intervention in Britain in September when liability-driven investment funds struggled to meet collateral calls, prompting the Bank of England to consider unilateral action in non-banks until global efforts catch up.

The collapse of investment house Archegos also drew attention to "hidden leverage" in the vast non-bank financial intermediation (NBFI) sector, according to a report and policy proposals from the G20's Financial Stability Board on Thursday.

"The policy proposals involve largely repurposing existing policy tools rather than creating new ones," the FSB report, sent to G20 leaders ahead of their meeting next week, said.

"The FSB will assess in due course whether repurposing such tools is sufficient to address systemic risk in NBFI, including the need to develop additional tools for use by authorities."

Graphic: FSB non-banks graphic November 2022 - https://fingfx.thomsonreuters.com/gfx/mkt/xmpjkgmzbvr/FSB%20non-banks%20graphic%20November%202022.PNG

Sharply rising interest rates and looming recession underscore the need to scrutinise non-banks, which include hedge funds, pension funds and insurers.

The FSB set out proposed stocktakes of existing rules and regulatory guidance in the non-bank sector through 2023 and beyond to make the sector better prepared to cope with a surge in the demand for liquidity so that central bank intervention is a "backstop" and not a "frontstop".

It has no power to impose rules but its members - regulators, central banks and treasury officials from G20 economies - commit to implementing finalised policies.

The caution reflects a need to see if FSB recommendations made a year ago on money market funds make a difference, and the complexities of regulating a sector that has many links to banks, clearing houses and markets - and regulatory debate over how far to go.

The FSB said there was a need to ensure non-banks have enough liquidity to meet big margin calls in times of crisis by ironing out 'mismatches' between redemption periods and type of assets being held in the fund, along with making better use of data on the sector.

"The main focus on the proposals is to reduce liquidity demand spikes, enhance the resilience of liquidity supply in stress, and enhance risk monitoring and the preparedness of authorities and market participants," the FSB said.

"Finally, the FSB will consider further promoting the use of fund- and system-level stress testing."

(Reporting by Huw Jones; Editing by Alex Richardson)