The Bank of England (BoE) is continuing with measures aimed at limiting the amount of borrowing hedge funds can use in trades involving UK government bonds, reported the Financial Times.
The critics argued that the move could increase borrowing expenses and weaken trading conditions in the gilt market, the report noted.
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The central bank’s objective is to strengthen the gilt market against future periods of stress by curbing the volume of short-term funding that hedge funds can obtain when gilts are posted as collateral.
Its approach centres on setting a minimum “haircut” in the gilt repo market, creating a bigger cushion against swings in prices.
These haircuts, or discounts applied to collateral used for borrowing, offer lenders protection on the downside, while also making funding more expensive for investors.
Sarah Breeden, the BoE’s deputy governor for financial stability, is due to set out further details in a blog later this month, according to sources.
She is expected to contend that fears over higher overall funding costs for hedge funds and other investors are overstated.
At a gathering of market participants last month, Breeden sought to calm those concerns, saying: “Any design of potential minimum haircuts will take account of portfolio-level approaches. A well-calibrated approach need not increase overall margin costs.”
At the same time, the BoE holds the view that intense rivalry among banks seeking business from large hedge funds is leading them to provide overly generous leverage, added the report.
“To be clear, I agree that well risk-managed portfolio margining can be a good thing,” Breeden said last month. “However, zero haircuts may also reflect competitive pressures from powerful clients,” she added.
“Even if portfolios are cross-margined, it’s not obvious to me that within that gilt repo haircuts — given the systemic importance of this market — should be at zero,” she said.
The proposal for minimum haircuts in gilt repo transactions first appeared in a BoE discussion paper last year.
