Financial stability

This page should be read alongside our dedicated page on investment fund liquidity, which continues to be a central focus for the IA, as does the future regulation of money market funds, which also has a dedicated page.  However, the financial stability debate also encompasses a couple of specific areas of importance for the investment management industry, 

Proposed UK emergency lending facility

The gilt market crisis of Autumn 2022 was a further spur to the Bank’s increasing focus on the supposed financial stability risks posed by the Non-Bank Financial Institution (NBFI) sector, with liquidity mismatch in open-ended funds and the risk of market dislocation arising from poorly managed leverage cited as the biggest areas of concern.

While the Bank has historically relied on providing liquidity to the banking sector to restore overall financial stability, its view is that this channel had not functioned well in recent financial stability episodes. For example, during the March 2020 ‘dash for cash’ crisis the transmission mechanisms from the banking sector to the broader markets had broken, and therefore central banks had been forced to use asset purchase programs. In the LDI episode, lending facilities were not appropriate precisely because pension funds and LDI pooled funds were seeking to deleverage.

At the end of September 2023, the Bank therefore announced that it intends to develop a crisis toolkit for managing financial stability risks related to NBFIs, in two steps. Firstly, it is launching a collateralised lending facility aimed at the Insurance Sector and Pension Funds (including LDI pooled funds), areas it considers to be most resilient. The facility aims to make liquidity available through repurchase agreements involving “high quality collateral” – we understand initially this will apply to gilts, but the Bank may look to extend to other markets. A lending facility is considered preferable to the Bank, as it requires less balance sheet exposure and has a lower risk of moral hazard than asset purchases. The Bank has emphasised that the facility would only be available to firms that demonstrated sound risk management, and that the pricing offered would be on less attractive terms than prevailing market rates.

In a second phase of work the Bank will also look at developing a crisis toolkit for other parts of the NBFI sector, including open-ended funds. This element of the work will be informed by the findings of the ongoing System Wide Exploratory Scenario (SWES) exercise, which was launched last summer with the aim of enhancing the Bank’s understanding of the risks to and from NBFIs; the behaviour of NBFIs and banks in stress, including what drives those behaviours; and investigating how these behaviours and market dynamics can amplify shocks in markets and potentially pose risks to UK financial stability. The Bank is not expected to publish a report on the SWES until the end of 2024.

Last updated: 16 February 2024
Last reviewed: 16 February 2024

Contact: Peter Capper, Senior Adviser, International Funds Regulation

The IA continues to discuss with members how the industry can best input into the Bank's work in this area, particularly given the wider sensitivities around macro-prudential regulation in the context of the financial stability debate.  We will update members in due course on proposed actions for 2024.