The Banque de France is concerned about the risk of contagion from non


– The British pension fund crisis at the end of September acted as a wake-up call for financial supervisory authorities. While banks and insurers are showing resilience in the adverse macroeconomic environment created by the war in Ukraine, it is the non-bank intermediaries (NBFIs) that pose the greatest risks to financial stability today. In terms of the vulnerabilities identified by the Banque de France in its half-yearly risk assessment: high volatility and liquidity tensions on the bond markets, the need for liquidity of non-bank players and the difficulties in dealing with margin calls for those which rely heavily on leverage. A cocktail that proved explosive across the Channel when Liz Truss’ budget announcements set the bond market on fire, forcing pension funds to urgently liquidate their positions.

The episode reminds us that the procyclical behavior of these highly leveraged players can amplify market movements in times of stress and thus lead to “disorderly adjustments”. A risk that the Banque de France now considers “very high” in its dashboard, even if it tends to stabilize in the short term.

However, the monetary authority wants to be reassuring: it has reviewed the leverage effect of non-banking players in France and this remains “generally under control”. “The British case study” should therefore not find a response in France, the only country in Europe not to have pension funds. Recourse to debt by French insurers is limited, their financial debt representing an average of 4.5% of the balance sheet. Given the highly liquid nature of life insurance funds, companies use derivatives to protect themselves against interest rate risk. They mainly use options, which are not subject to margin calls, rather than rate swaps.

The substantial leverage effect of certain funds

The leverage effect also remains “contained” in investment funds and below the European average, according to data collected by the Banque de France. On average, the value of the exposures of French funds (whether governed by the UCITS directive or the AIFMD directive on alternative funds) is between 110% (net positions) and 220% (gross positions) of the value net asset value at the end of 2021. The European regulation of December 19, 2012 defines “substantial” leverage as an exposure per commitment greater than three times the net asset value.

Some alternative funds, such as hedge funds or real estate, domiciled in France thus have leverage considered to be substantial. But these are essentially “closed funds” for which “the liquidity risk is greatly reduced”, specifies Emmanuelle Assouan, Deputy Director General of the Banque de France in charge of financial stability. The directive on alternative fund managers (AIFM) gives the possibility to the Autorité des marchés financiers, which supervises these funds, to impose limits on the leverage effect if necessary. What she has not done so far.

Increased exposure to non-bank players

Non-bank intermediaries (NBFIs) in France therefore generally have few vulnerabilities in the event of a liquidity shock. But the same cannot be said for non-resident players to which French banks are exposed as counterparties. Banks total €400 billion in exposure to European non-bank players, a low figure given their balance sheet, but which increased by 33% between January 2020 and September 2022. Almost half of this figure is repurchase agreements, therefore collateralised, as well as loans to these intermediaries. “The blind spot comes from unregulated players who are a challenge for banks and supervisors. Family offices like Archegos do not demonstrate transparency and may have counterparties in Europe and France,” recalls Emmanuelle Assouan.

The Banque de France therefore calls for a strengthening of international regulations. The single supervisory mechanism adopted in 2021 a program on the counterparty risk of NBFIs, exhaustive analysts are now required from European banks. Improving transparency is also at the heart of the concerns of the Financial Stability Board (FSB), which should regulate the use of leverage by these non-banking players, as it has done for the banks. The results of this work focused on hedge funds, family offices and prime brokers are expected in the first quarter of 2023.

The Banque de France is concerned about the risk of contagion from non-bank intermediaries