The Bank of England is moving to cap how much leverage hedge funds can deploy when trading UK government bonds, targeting a corner of the financial system where a handful of players have built positions so large they could destabilize the broader market if things go sideways.
Net gilt repo borrowing by hedge funds has swelled to nearly £100 billion, up from £77 billion earlier in the year.
A market dominated by a handful of players
Five hedge funds reportedly account for 90% of gilt repo market activity. Some positions are leveraged as high as 50x, meaning a fund is controlling £50 worth of gilts for every £1 of its own capital. In some cases, these trades are being executed with zero haircuts, meaning the counterparties extending the credit aren’t requiring any collateral cushion at all.
The maturities on these repo agreements also tend to be short, which creates rollover risk. If market conditions deteriorate and counterparties refuse to renew the lending, funds could be forced into rapid deleveraging. Anyone who remembers the UK gilt crisis of late 2022, when liability-driven investment funds triggered a doom loop that forced BoE intervention, can see why regulators are nervous.
