Containing risks posed by leverage in alternative investment funds

Antoine Bouveret, Pierre-Emmanuel Darpeix, Massimo Ferrari, Michael Grill, Luis Molestina Vivar, Daniel Jonas Schmidt, Christian Weistroffer, Dorota Okseniuk, Franck Raillon and Annegret Schäfer

No 28, ESRB Occasional Paper Series from European Systemic Risk Board

Abstract: This paper proposes a framework for monitoring risks arising from the build-up of leverage in EU-domiciled alternative investment funds (AIFs) and examines policy tools that could be effective in mitigating these risks in line with international recommendations. We develop a novel framework that combines confidential fund-level and transaction-level data on derivatives and repurchase agreements to present a comprehensive overview of the sources of leverage in highly leveraged AIFs. Using a range of risk metrics, our analysis identifies hedge funds and funds pursuing liability-driven investment (LDI) strategies as the most vulnerable to leverage-related risks. If interest rates rise, LDI funds may face significant mark-to-market losses and liquidity needs due to margin and collateral calls. Hedge funds appear to be more resilient against this type of shock but are sensitive to credit risk, especially hedge funds with relative value strategies. To mitigate these risks, we evaluate the impact of a range of policy tools such as leverage limits and minimum haircuts on collateral used for repo. Our analysis shows that the impact of the tools depends on the types of funds considered. Imposing a direct limit on net leverage of ten times the net asset value would lead to a sizeable reduction in the net exposures of hedge funds, but would barely affect other leveraged AIFs. Minimum haircuts on collateral would most likely affect only hedge funds with relative value strategies, as LDI funds, which already operate under a leverage limit, appear to have enough unencumbered assets to meet any additional collateral requirements. Overall, our findings suggest a need for tailored policy designs and highlight the complex interplay between different regulatory measures. JEL Classification: G15, G23, G28

Keywords: AIFMD; alternative investment funds; derivatives; EMIR; haircut; initial margin; leverage; leverage limit; repo; SFTR; synthetic; yield buffer (search for similar items in EconPapers)
Date: 2025-12
New Economics Papers: this item is included in nep-ifn
Note: 1280809
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Persistent link: https://EconPapers.repec.org/RePEc:srk:srkops:202528

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