“Right now we just don’t have enough data to measure key risks in private NBFI markets,” FCA chair Ashley Alder told the MFA Global Summit in Paris this week.

His speech on the challenges facing regulators in the area of Non-Bank Financial Intermediation (NBFI) – which represents about 50% of global financial assets – pushed the message that: “The priority for NBFI regulation should be a global effort to improve the data needed to enable regulators to spot risks in private markets and supervise them credibly.”

Alder said the FCA was working with the Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO) to “land on a set of concrete policy outcomes for NBFI that could also have implications for hedge funds, alternatives, and private markets in general”.

Vast range covered

He spent some time underlining the economic significance of NBFI, describing it as “shorthand for much of the diverse and often complex investment and funding markets which aren’t covered by the prudential regulatory frameworks applicable to banks” but also pointing out that it covers “covers a vast range of other businesses and activities operating in what might loosely be called market – based finance. This extends to OEFs, MMFs, hedge funds, private equity, pension funds, and even insurers and commodity firms”.

Concern that risks around financial stability had migrated from better-regulated banks to NBFI after the 2008 crisis was what had prompted the current policy program, Alder explained. But, he said: “it is essential that policy makers recognise that investment funds and other NBFI entities are structurally very different to banks, and carry out very different economic functions”.

“The key point is that opaque private markets exhibit vulnerabilities which make it hard to spot and contain problems, including those that may give rise to broader financial crises.”

Ashley Alder, Chair, FCA

He referenced Archegos and the LDI crisis as examples of problems that had arisen in non-bank markets, saying that: “The key point is that opaque private markets exhibit vulnerabilities which make it hard to spot and contain problems, including those that may give rise to broader financial crises.”

In Alder’s view, the assessment of NBFI risks in private markets should be based on three main elements:

• “a good understanding of hidden on or off – balance sheet leverage;
• a better assessment of liquidity risks;
• far better information on exposures between private markets and traditional banks.”

But the lack of data necessary to measure key risks in private NBFI markets was a challenge –its “patchy” availability in the cases of Archegos and LDI being cases in point.

Alder said: “We need to enhance reporting from NBFIs, while being conscious of the burden on firms and confidentiality issues for public reporting, and we need better frameworks to assess leverage, both hidden and synthetic.” And he outlined current efforts, including:

• an FSB deep dive on NBFI leverage;
• an IOSCO survey of fund leverage;
• a joint FSB/IOSCO project analyzing data on equity swaps;
• an SEC decision to adopt amendments to form private funds.

Alder also wants to see enhanced reporting from NBFIs, which also recognises regulatory burden and the balance between confidentiality and public reporting; and fuller disclosure of relevant exposures. “All these data requirements are a prerequisite to enable credible stress testing and other risk management disciplines to operate properly across private non-bank activities,” he said.

Concluding, he emphasised the need for international regulatory cooperation, saying “we can only manage risks in NBFI and other global markets through close cooperation and data sharing among regulators, international standard setting bodies and wider market participants”.

Rob Mason, Director of Regulatory Intelligence at our parent company Global Relay, said: “NBFIs create a number of challenges from a regulatory perspective as they include a number of disparate firm types. These can be large institutions like insurance brokers, smaller ones like hedge funds and a variety of more retail focused firms providing ‘high-street’ type financial services. Applying risk assessment and reporting requirements which fit, and are relevant to all, is therefore challenging.”

“The speech outlines some current efforts but there is clearly an appetite from the FCA to engage and supervise more thoroughly in this area which means that they are aware of some potential risks.”

The full text of the speech can be found on the FCA website.