ESMA assesses the risks posed by the use of leverage in the fund sector

The European Securities and Markets Authority (ESMA), the EU’s financial markets regulator and supervisor, today publishes its annual risk assessment of leveraged alternative investment funds (AIFs) and its first analysis on risks in UCITS using the absolute Value-at-Risk (Va R) approach. Both articles represent ESMA’s work to identify highly leveraged funds in the EU investment sector and assess their potential systemic relevance. While most EU investment funds make limited use of leverage, a subset of AIFs are substantially leveraged, and a group UCITS using the absolute Va R approach has very high levels of gross leverage. Risk assessment of leveraged AIFs shows that hedge funds display the highest levels of leverage, even though they represent a small part of the EU fund industry. The real estate (RE) funds are under pressure in some jurisdictions due to the combination of declining real estate prices and outflows from some funds, but in general the RE fund sector has been resilient at EU level. The assessment of GBP Liability-Driven Investment (LDI) funds, which gain leveraged exposures to the UK government bond market, shows that imposing limits to the interest rate risk they can take successfully increased the resilience of the sector, and even resulted in a decline of leverage for some funds. In a new analysis, ESMA reports that UCITS using the absolute Va R approach to manage their risk profile account for around 8% of the UCITS universe. These funds follow a...