Hedge funds are warning that proposed changes to Britain’s gilt repo market could unintentionally make the financial system less liquid during periods of stress.
The Alternative Investment Management Association, or AIMA, has raised concerns about reforms being considered by the Bank of England as regulators attempt to strengthen the resilience of the market used to finance large government-bond positions.
The proposals include greater use of central clearing and minimum haircuts on repo transactions that remain outside central clearing.
Repo transactions allow investors to borrow cash against securities, typically for short periods, and are a critical source of financing in sovereign-bond markets.
The Bank’s objective is to reduce vulnerabilities exposed during episodes including the March 2020 “dash for cash” and Britain’s 2022 liability-driven-investment crisis.
AIMA argues that mandatory minimum haircuts could have unintended consequences.
If longer-term repo financing becomes more expensive, market participants could shift toward shorter maturities instead. That could leave leveraged investors refinancing more frequently precisely when market conditions become unstable.
The scale of the market makes the debate important.
Net borrowing in Britain’s gilt repo market is approximately £200 billion, with hedge funds accounting for roughly £85 billion.
The regulatory discussion comes as sovereign-bond markets face increasing scrutiny globally.
Government borrowing requirements have grown, long-term yields have risen and hedge funds have become increasingly important participants in Treasury and gilt markets.
AIMA has urged British authorities to consider delaying some changes until regulators can assess the impact of related reforms underway in the U.S. Treasury market.
The Bank of England has not finalized the proposed framework.
For investors, the dispute highlights the trade-off regulators face: reducing leverage and counterparty vulnerabilities without damaging the liquidity that allows government-bond markets to function efficiently during periods of stress.
The eventual design of the rules will determine whether that balance can be achieved.
