Leverage Risk: U.S. Government announces working group

Rick Steves

Today, the Financial Stability Oversight Council voted unanimously to release a public update on its review of potential risks to U.S. financial stability that may arise from asset management products and activities and next steps to respond to these potential risks, in the following areas: (1) liquidity and redemption; (2) leverage; (3) operational functions; (4) […]

Today, the Financial Stability Oversight Council voted unanimously to release a public update on its review of potential risks to U.S. financial stability that may arise from asset management products and activities and next steps to respond to these potential risks, in the following areas: (1) liquidity and redemption; (2) leverage; (3) operational functions; (4) securities lending; and (5) resolvability and transition planning.

Jacob J. Lew, US Treasury Secretary and Chairperson of the Council, said: “The Council was created to bring the financial regulatory community together to look across the entire system, ask tough questions, and address potential risks to financial stability before they materialize.  Our analysis of asset management products and activities is a crucial piece of that work”

“As financial markets evolve, the nature of potential risks shifts, and we need to be vigilant in monitoring and understanding these changes.  The analysis and views in this update harnessed the expertise of the Council members and their staffs, and we look forward to continued engagement with stakeholders as this work moves forward”, he concluded.

The statement goes on saying that Liquidity and Redemption Risk concerns the Council when it comes to pooled investment vehicles, particularly where investor redemption rights and underlying asset liquidity may not match. To address the issues, it is recommended the adoption of robust liquidity risk management practices, establishment of clear regulatory guidelines regarding the ability to hold assets with very limited liquidity, enhanced reporting and disclosures, tools to allocate redemption costs, and additional public disclosure.

Regarding Leverage Risk, and after analyzing data from the SEC’s Form PF, showing relatively small amounts of leverage in many hedge funds but concentrated in larger hedge funds, the Council acknowledges the high complexity of the relationship between a hedge fund’s level of leverage and risk, and whether that risk may have financial stability implications.

Reporting requirements increased transparency, but “does not provide complete information on the economics and corresponding risk exposures of hedge fund leverage or potential mitigants associated with reported leverage levels”, said the statement. “In addition, hedge funds’ major counterparties are regulated by various regulators with different jurisdictions.  Therefore, no single regulator currently has all the information necessary to evaluate the complete risk profiles of hedge funds. “

The Council sees the need for further analysis and will be creating an interagency working group for that purpose, to better understand hedge fund activities and further assess whether there are potential risks to financial stability.

“The working group will: 

  • Use regulatory and supervisory data to evaluate the use of leverage in combination with other factors – such as counterparty exposures, margining requirements, underlying assets, and trading strategies – for purposes of assessing potential risks to financial stability;
  • Assess the sufficiency and accuracy of existing data and information, including data reported on Form PF, for evaluating risks to financial stability, and consider how the existing data might be augmented to improve the ability to make such evaluation; and
  • Consider potential enhancements to and the establishment of standards governing the current measurements of leverage, including risk-based measures of synthetic leverage.

This group will seek to report its consolidated findings to the Council by the fourth quarter of 2016.”


The Council, headed by US Secretary Jacob J. Lew, will be engaging with industry participants and other stakeholders and will seek to develop a greater understanding of service providers, their operating infrastructure, and the measures used by asset managers and other financial institutions to mitigate potential risks from service providers.

CFTC Chairman Timothy Massad made a public statement in support to the Financial Stability Oversight Council’s publication, saying that while the CFTC do not regulate hedge funds, they together with the SEC, regulate the derivatives markets.

“The first challenge is the metrics we use to measure leverage. As the report notes, we do not yet have a good metric for leverage in this context. We have not yet “connected the dots” between the leverage metrics cited in the report and the amount of underlying risk that it represents. This is evident, for example, with respect to the use of “gross notional exposure.” This metric includes derivatives, but not in a manner that accurately measures risk. It measures notional amount, but does not take into account a variety of factors that affect risk, such as product type, offsetting positions, whether a transaction is cleared, or whether margin is collected. To analyze the implications of leverage, we need to take into consideration these and other critical market structure details”, said Massad.

Massad added that preliminary analysis of hedge funds with the largest derivatives exposures point to cleared derivatives, and extremely low levels of uncleared derivatives, with counterparties typically being large registered swap dealers. “That preliminary review illustrates why more work is needed to refine the data and conduct in-depth analysis”, he said, concluding that the regulatory reforms already taken regarding margin requirements for uncleared swaps and reporting, among others, “taken together with changes in the marketplace, may be contributing to increased derivative activity on the part of hedge funds and other asset management firms.”




Read this next

Retail FX

Weekly Roundup: eToro links up with Elon Musk, US crackdown on Russian FX

Let’s take a look back at top stories that dominated the financial markets in our Weekly Round coverage. This week’s digest takes a deep dive into the most recent events and trends within the Forex, Fintech, and cryptocurrency.


Must-Watch Top 5 Crypto Picks for Q2 2024 Featuring BlockDAG, Toncoin, Solana and More

Dive into BlockDAG’s meteoric rise and explore other promising altcoins like Pepe, Toncoin, Solana, and Render for superior returns.

Retail FX

Clone of Admiral Markets draws FCA attention

The United Kingdom’s financial markets watchdog today unmasked another fraudulent entity, this time bringing to light a clone firm that has been posing as FCA-‎authorised brand, Admiral Markets UK Ltd.

Digital Assets

Gemini Earn users to recover $2.18 billion in crypto payouts

Cryptocurrency exchange Gemini has agreed to pay $50 million worth of digital assets to investors in its Gemini Earn program as part of a settlement with the New York Attorney General (NYAG), announced on Friday.

Fundamental Analysis, Market News, Tech and Fundamental

Global FX Market Summary: British Pound (GBP) Weakness, US Inflation, Euro, USD June 14 ,2024

British Pound weakens due to lower inflation expectations, potential policy changes from Reform Party, and broader economic concerns.


Q2 2024’s Top 5 Cryptos to Buy: BlockDAG, Pepe, Toncoin, Solana and Render

Learn about 2024’s Q2 top 5 cryptos. Explore potential high-return and advancements of altcoins like BlockDAG, Pepe, Toncoin, Solana, and Render.

Fundamental Analysis, Tech and Fundamental, Technical Analysis

GBPCAD Technical Analysis Report 14 June, 2024

GBPCAD currency pair can be expected to fall further toward the next support level 1.7250, former strong resistance from last year.

Digital Assets

Binance acquitted of tax evasion in Nigeria, now faces AML charges

Nigeria has dropped tax evasion charges against two Binance executives, Tigran Gambaryan and Nadeem Anjarwalla, after the world’s largest cryptocurrency exchange appointed a local representative to handle court processes related to the allegations.

Digital Assets

Trezor launches new hardware wallet ‘Safe 5’ with fresh security features

Crypto hardware wallet manufacturer Trezor announced on Friday the launch of its latest flagship product, the Trezor Safe 5, featuring upgraded security to promote self-custody of digital assets.