Amundi sounds the alarm on hidden leverage
Could ‘something break’ in 2023?
Things fall apart; the centre cannot hold; Mere anarchy is loosed upon the world. — WB Yeats, 1919 (and fund managers, 2022)
As the dust has settled on the wild gyrations in the gilts markets, investors are starting to think about what else can go wrong.
Vincent Mortier, chief investment officer at Amundi, Europe’s largest asset manager has warned that the tremors in the UK pensions market should be a “wake-up call” to investors and regulators about the dangers of hidden leverage in the financial system.
He reckons that the recent turmoil unleashed by the UK government’s “mini” Budget was “a reminder that shadow banking is a reality. I don’t believe that anyone before the crisis had any idea of the magnitude of this shadow banking in the pension fund industry.”
Leverage in the overall financial system, says Mortier, “is in multiple places that are difficult to track”.
Increased capital requirements imposed on banks to make them safer following the financial crisis. That made sense. The problem is, a lot of risk appears to have shifted to less regulated parts of the financial system, namely asset managers, insurance companies and pension funds.
Investors have fuelled the shift by pouring money into alternative strategies such as private credit as they searched for yield in a low interest rate environment. In 2000, non-banks held $51tn of financial assets, compared with banks’ $58tn, according to the Financial Stability Board. Its latest data showed non-banks hold $227tn in financial assets at the end of 2020, outstripping banks at $180tn.
Mortier said that the shift in leverage from banks to non-banks has made it very difficult for regulators to get a true picture of the risks. “It’s much more difficult than in 2007, when leverage was predominantly in the banks,” he said. “The issue is that we don’t know exactly where it is. When you can’t measure something it’s difficult to act upon it.”
Meanwhile across the Atlantic, some nasty currents are swirling in the $23.5tn world of American government bonds, writes my colleague Gillian Tett in New York.
A JPMorgan index of Treasury market liquidity has deteriorated to the lows seen in March 2020. A separate Bloomberg index suggests the situation could be even worse. Meanwhile the Ice-BofA Move index of implied Treasury market volatility is also hovering near March 2020 levels, while buyer demand at auctions is weakening. More striking still, these trends recently prompted Janet Yellen, US Treasury secretary, to take the rare step of admitting in public that she is “worried about a loss of adequate liquidity in the market”.
These strains are not new. But now that interest rates are rising fast in response to sky-high inflation, investors fret that big moves in bonds could set off more landmines, writes markets editor Katie Martin.
Max Kettner, chief multi-asset strategist at HSBC, sums up why it is a mounting concern that “something breaks” in 2023:
“Given the record amount of tightening of financial conditions, the risk of an accident in financial markets has greatly increased. Whether it’s the recent turmoil in the UK, the relentless weakening of the yen, deteriorating liquidity on credit and even rates markets, defaults in emerging markets, or indeed something we’re completely missing — the list has become longer in recent months.”