IOSCO published a report outlining recommendations with respect to a framework for monitoring leverage in investment funds that may pose financial stability risks. The report presents a two-step framework: Step 1 indicates how regulators could exclude from consideration funds that are unlikely to produce financial stability risks while identifying a subset of funds for further analysis that may pose such risks; Step 2 entails a risk-based analysis of the subset of funds identified in Step 1. IOSCO shall, based on the data available to it, publish an annual report reflecting leverage trends in the global asset management industry. The first report is scheduled to be published in 2021, though IOSCO intends to gradually expand subsequent reports to include more jurisdictions.
For the first step, IOSCO recommends that regulators use Gross Notional Exposure or adjusted Gross Notional Exposure as baseline analytical tools. By collecting information on long and short exposures, on an asset class basis, the regulatory community will gain greater insight on the direction of leverage. For the second step, IOSCO recommends that each regulator determine its approach to define appropriate risk-based measures for analyzing funds identified under the first step that may potentially pose significant leverage related risks to the financial system. The recommendations aim to achieve a balance between precise leverage measures and simple, robust metrics that regulators can apply consistently to the wide range of funds offered in different jurisdictions.
The two-step leverage framework provides a holistic approach to capture significant leverage-related risks of a fund (or group of funds) to give regulators the tools to assess these risks for financial stability purposes. The framework embeds proportionality, by acknowledging that not all funds need to be captured for financial stability monitoring purposes, given the immense diversity in funds’ structures, types, and strategies as well as domestic legal and regulatory frameworks governing these investment vehicles. Some funds, for example, are prohibited from using leverage. More generally, under this leverage framework, funds that do not pose systemic risks due to their leverage would be excluded, such as funds capped in terms of leverage and/or limited in size.
Keywords: International, Banking, Securities, Leveraged Lending, Financial Stability, Investment Funds, IOSCO
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