Bank of England to Apply Stress Tests to Pension Funds, Hedge Funds, Asset Managers

The Bank of England has launched an exploratory scenario exercise intended to improve understanding of the behaviors of banks and other financial institutions during times of stressed financial market conditions.

The exercise will explore how the behaviors of banks and non-bank financial institutions might interact to amplify shocks in the U.K. financial markets that are central to U.K. financial stability. The main goal is to improve the Bank of England’s and participating firms’ understanding of how markets operate under stress, support efforts to address vulnerabilities in the domestic market-based finance system and contribute to ongoing international policy work.

The exercise seeks to enhance understanding of the risks to and from non-bank financial institutions and the behavior of NBFIs and banks during stressed market conditions, including understanding what drives that behavior. For example, if a common response to a stress scenario is for participants to sell the same asset, then fire sale-type dynamics may occur, which, according to the Bank of England, can only be understood with a system-wide perspective.

Participating firms will include large banks, insurers, pension funds, hedge funds and funds managed by asset managers.

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The bank, along with the U.K.’s Prudential Regulation Authority, already conducts a variety of stress tests of the major U.K. banks, central counterparties and insurers. However, the new exercise will seek to broaden that understanding to include NBFIs in stressed financial market conditions.

According to the bank, participants in the exercise will be actively engaged in its design and execution.

The bank said that events in recent years, such as the March 2020 “dash for cash” and September 2022’s gilt market meltdown that required its intervention, show that market-based finance has been increasingly prone to sudden liquidity stresses during periods of market volatility.

“We regularly run scenario exercises with a variety of firms which support our efforts to protect and enhance the stability of the U.K. financial system,” Jon Cunliffe, the Bank of England’s deputy governor for financial stability, said in a release. “The launch of this exercise will provide valuable insight into the system-wide dynamics for banks and non-banks following a severe but plausible stress to financial markets.”

The bank also announced it will work closely with the Financial Conduct Authority and The Pensions Regulator to combine data and information from various parts of the financial system to develop insights, with the aim of accounting for amplification effects within the financial system.

The exercise is not a test of the resilience of the individual firms participating, the bank noted, adding that published materials will not provide information on any individual firms. The markets of focus include the gilt market, gilt repo market, sterling corporate bond market and associated derivative markets.

The bank will publish the list of participants and details of the stress scenario later in the year, and a final report will be published in 2024, to include system-wide findings, implications for the exercises’ markets of focus and any conclusions for its assessment of risks to the U.K. financial system.