Unlock Editor’s Digest Lock for Free
FT editor Roula Khalaf will select your favorite stories in this weekly newsletter.
EU regulators are planning their first stress tests to look for vulnerabilities in non-bank financial systems, reflecting fears about the rapid growth of unregulated groups such as hedge funds and private equity.
The plan by the European authorities follows a similar debut exercise by the Bank of England last year to investigate the impact of a potential market crisis on the broader financial system, including pension funds and insurance companies.
Officials from the EU’s major financial watchdog agency are still discussing details of system-wide stress testing for non-bank institutions, but two people involved in the discussions are optimistic that they can start next year.
The move could raise serious concerns among hedge funds, private credit agencies and money market funds that they could face greater scrutiny and restrictions by European regulators in the future.
Since the financial crisis of 2008, loan offerings have shifted from bank balance sheets to other companies that behave like traditional lenders but are lightly regulated.
According to the European Central Bank, it accounts for about a quarter of the total amount of loans in the eurozone at the end of 2023, saying “insurers and pension funds are offering more and more loans.”
Supervisors are increasingly concerned about the opacity and potential risks these companies can present, as well as the links back to the banking system. Loans to such non-banking companies by eurozone banks tripled since 1999, reaching six tons by the end of 2023.
Non-banking has been the center of several episodes of market turmoil in recent years, including dashcash in the bond market after the pandemic hit, the collapse of family office Archegos Capital Management three years ago, and liquidity crunching in energy traders after Russia’s invasion of Ukraine.
Claudia Buch, chair of the ECB’s Supervisory Committee, spoke to the European Parliament at a recent hearing.
“So it’s important that this is well understood and well regulated too,” Boeuf said. “So, not all NBFIs are at greater risk than banks and other financial institutions, but they need to address risks in a proper way, and regulations must cover those risks.”
EU regulators are also concerned that the region will be slow to close the rules for money market funds, a key source of bank funding, with a lower minimum liquidity requirement than the US and UK funding requirements.
Some European national authorities have already announced that they are planning to launch similar stress tests for so-called non-banking financial intermediaries (NBFIs), including those in France.
The EU exercises are built on specific sector-centric stress tests already regularly implemented for banks, insurance companies, money market funds and clearing houses in 27 country blocks.
The aim is to examine how a crisis spreads between different parts of the financial system and whether this can magnify the impact rather than absorbing it.
The discussion includes the European Banking Authority, the European Securities and Markets Authority, the European Insurance and Labor Pensions Authority, the ECB, the European Commission and the European Systemic Risk Committee. All regulators and committees declined to comment.
The committee said Friday that it would delay implementation of strict capital requirements for banks’ securities trading operations until early 2027. The delay will allow Brussels to clarify whether the US will proceed with rules agreed by the Basel Committee’s global regulator on banking supervision.
BOE engaged more than 50 city-city institutions in London institutions in a so-called system-wide exploratory scenario that includes theoretical defaults for hedge funds, and modeled how periods of stress ripple over non-banking companies.
City businesses were eased when BoE said two years ago that the responsible-driven investment fund in the pension scheme that had been causing a crisis in the gold leaf market was “relatively high.”
However, it warned that fire sales of assets by pension funds, hedge funds and other investors could escalate the market crisis, especially as they had “discontinuous expectations” about their ability to raise cash in meltdowns.
Additional Reports by Paola Tamma
