The European Securities and Markets Authority (ESMA) last week announced it was consulting on whether to introduce leverage limits for Alternative Investment Fund (AIF) managers, such as hedge funds and private equity, in a move that would harmonise the approach across the EU.
The consultation comes in response to the European Systematic Risk Board’s April 2018 recommendations to address liquidity and leverage, the regulator said. As it stands, AIFs can employ financial and derivatives leverage, but synthetic derivatives are not recorded on the balance sheet – making it difficult for regulators and national competent authorities (NCAs) to assess company and systematic risks.
‘Given the rapid expansion of the investment fund sector and the higher risk-taking, in a context of low interest rates, it is of utmost importance to implement a framework for NCAs to monitor the level of leverage and deleveraging process of highly leveraged alternative investment funds,’ ESMA said in the consultation paper.
Although AIFs are able to set leverage limits based on what they deem to be reasonable, regulators have thus far stopped short of imposing limits since AIFMD was introduced in 2014. That could be about to change, though, with the consultation suggesting regulators could impose leverage limits on funds or groups that pose a risk to financial stability.
Under the proposed guidelines, AIFs with over €500m regulatory AUM employing leverage of any kind will also be identified by NCAs, and could also find themselves facing tougher scrutiny or leverage limits.
‘In situations when financial markets are under severe stress, highly leveraged alternative investment funds can further amplify systemic risk,’ asid Steven Maijoor, ESMA’s chair. ‘Our proposed Guidelines address the assessment of leverage-related systemic risk and aim at ensuring that NCAs adopt a consistent approach when assessing whether the condition for imposing leverage-related measures are met.’
That consistent approach, meanwhile, will see ESMA target the use of consistent methodology to calculate leverage across member states, with NCAs asked to consider the leverage measures set out in the AIFMD framework.
ESMA is set to close feedback to its proposals on 1 September 2020.