Hedge funds and commodities traders urged to hold more liquid assets

Financial regulators are calling on hedge funds, pension investors, and commodities traders to bolster their liquidity reserves and implement stress tests to withstand sudden market shocks reports The Financial Times. The Financial Stability Board, comprised of top finance officials and regulators worldwide, issued this directive following evaluations of recent market disruptions, highlighting inadequate preparation among many market players. The scrutiny extends to non-bank financial institutions, which have gained prominence since the 2008 financial crisis. Instances such as the 2020 bond market turmoil at the pandemic's onset and the 2022 UK pension fund crisis underscore the vulnerabilities of these entities. Additionally, incidents like the 2021 Archegos hedge fund collapse due to margin calls and the 2022 commodities market upheaval emphasize the need for better risk management.

The FSB identified deficiencies in liquidity risk management and governance as key factors hindering effective responses to margin and collateral calls. Leveraged hedge funds and large commodity traders, subject to less stringent regulations than banks, are particularly under scrutiny. To address these concerns, the FSB issued eight recommendations, including stress testing for margin call exposures and ensuring executive oversight of risk management.

Companies are urged to maintain adequate liquid assets to meet margin calls promptly and automate collateral management processes to mitigate operational risks. Global regulators are increasingly focusing on shadow banking risks, including pension funds and insurance firms, to prevent contagion within the wider financial system.