By Sarah Pritchard, Deputy chief executive of the
Financial Conduct Authority
Reflections on my role as co-chair of the Financial
Stability Board's (FSB) working group on non-bank leverage, and
an outline of our implementation priorities for the UK.
Non-banks encompass a wide range of business models, including
pension funds, insurers, hedge funds, and many others. The
activities of these firms are vital for the financial health and
growth of the UK economy.
Therefore, making sure these firms are resilient and financially
stable ensures they provide consumers and businesses with the
services they need – in both good times and bad.
Non-banks use leverage (borrowing to invest) to increase
exposure, boost returns or hedge potential losses. This can be
achieved in various ways, ranging from taking out loans to using
complex derivatives. The use of leverage is an essential
component of the deep and efficient capital markets that we have
in the UK.
In good times, this leverage provides extra liquidity to the
system and helps maximise returns. But in periods of market
stress, leverage that is poorly managed, concentrated, or hard to
spot can raise instability. This is particularly true in markets
that are core to the functioning of the real economy. For
example, UK government debt markets, or when highly leveraged
non-banks risk transferring stress to institutions like banks,
which are central to the stability of the financial system.
As the regulator, our role is to ensure that markets work well.
Leverage is not inherently a cause for concern. But to ensure
that leverage can continue to play its part in supporting the UK
economy in good times and bad, we need to find ways to identify
and address systemic risks - without impeding market efficiency
or disproportionately burdening firms.
FSB recommendations
Two years ago, I took up a role as co-chair of the Financial Stability Board's
(FSB's)Link is external working group on non-bank
leverage. This group recently published policy recommendations (PDF)Link
is external seeking to identify and address financial
stability risks created by non-bank leverage.
Effective risk management depends on having the right information
at the right time. Without it, both market participants and
regulators are essentially flying blind. The report addresses
this fundamental challenge by recommending stronger risk
monitoring and greater market transparency.
The proposed measures put forward by the FSB focus on improving
how firms share critical information – both publicly and with
their trading partners. These measures should give firms better
insight into their own exposures and broader market conditions,
helping them manage investment risks more effectively. The
improvements should also provide authorities with a comprehensive
view of the entire system. Having this birds-eye view enables
authorities to spot risks that individual firms might not see –
such as dangerous concentrations of investments or overcrowded
market positions.
The FSB report also provides policy options for authorities to
consider once they address risks to financial stability. Given
the complex and diverse nature of the non-bank sector, there's no
one-size-fits-all approach – so the report sets out a number of
different alternatives that authorities may wish to consider.
This approach is a good one - what matters is that all
jurisdictions have sufficient measures to manage systemic risk,
even if different authorities choose a different set of policy
tools or measures to do so.
What's next for the UK?
We are already working to become a smarter regulator, and we're
focusing on how we collect and use data to spot risks early.
To do our job, which is to make sure that markets function well,
we know we need data that provides the practical insights we need
to make effective, proportionate decisions.
The FSB recommendations are well timed for us. We are already
taking steps to evaluate what data we need and switching off
regulatory reporting returns that are no longer relevant. There
is an ongoing programme of work looking at our data needs – and
we'll think carefully about which risk metrics are most useful
for us going forward, including how we can align with other
jurisdictions.
Working with our international partners
As much of the non-bank sector operates across borders, it's
crucial that we also collaborate with our international
counterparts to spot risks and potential spillovers effectively.
This means engaging bilaterally on issues like information
sharing and risk monitoring, while continuing to take an active
role in international standard-setting bodies. In this way, we
can strive for internationally consistent outcomes and be
confident that we're safeguarding the system, while still
ensuring that the UK remains competitive.
My time leading this FSB working group has highlighted that
non-bank leverage is a particularly tricky issue to tackle,
demanding in-depth knowledge, industry perspective, and extensive
international cooperation. The publication of the FSB's
recommendations is a major step forward in this space – and I'm
proud that the FCA has been able to play such a leading role in
advancing this work.
