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Global financial regulators are preparing a clampdown on so-called shadow banking as they confront the unintended consequences of previous waves reform that pushed risks into hidden corners of the financial system. The European Systemic Risk Board, the Bank for International Settlements and global securities regulator Iosco have all called out mounting risks.

Before then, the conversation had focused on whether to designate individual non bank institutions — such as major asset managers — as “too big to fail” as global regulators do with systemically important banks. Now policymakers had shifted to identifying risks across the shadow banking sector as a whole, Alder said. Another senior bond trader active with big investment houses and hedge funds said transparency was only one part of the problem. The other was size. “The dealer community is constrained on its balance sheets, and at the same time . . . our clients now are just so much bigger than us. That shows up in moments of stress like after SVB failed. Liquidity is systematically compromised.”

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An overly heavy hand could end up creating yet more uncomfortable and unintended consequences, said a former financial stability policymaker who declined to be identified. “What is the answer?” he said. “Obviously no one wants no market volatility — that’s a bit weird. Also you don’t want the absence of leverage because we wanted that margining for good reason. But what is a blow-up? How much volatility is too much?” There have been good reports from the FSB on money market funds for example,” says one financial stability expert who is active in the international debate. “You wonder ‘is anybody paying any attention?’ I don’t know how much of the inaction is due to lobbying, political questions, preoccupation with other issues and so forth. What is clear is that not much is being done.” We ask that question all the time. I’m relying on clients to tell me the truth,” says a senior banker at one prime broker. The FSB is looking at ways for banks to share information, but market sources say that would be a long and complicated effort. In that speech, he noted that policymakers needed to get the balance right between allowing investors to take their own risks, and global stability.

Together, the non-banks on regulators’ radar — which include hedge funds, pensions and insurers — account for 50 per cent of global financial services assets.

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Ashley Alder, a veteran international markets regulator who now chairs the FCA, said the “turning point” in regulators’ thinking around non-bank financial risks was the March 2020 “dash for cash”, when bond markets went into freefall in the early pandemic, forcing central banks to intervene. Clearly there is work we still need to do,” Klaas Knot, chair of the FSB, told the Financial Times. “We are moving from policy development to policy implementation,” he said. A short-term fix being looked at by regulators is compelling banks to be more careful about their lending to hedge funds. “We need to increasingly rely on banks’ role as the watchtowers of the sector,” said the ECB’s top banking supervisor Andrea Enria in a recent speech. In recent weeks, the UK’s top financial regulator has drawn up plans for a probe into private capital valuations, while the Bank of England has declared such “non-banks” to be so important that policymakers should create a new facility to lend directly to them in times of crises. Even prime brokers — the investment banks that lend to hedge funds — have limited visibility on the funds’ overall borrowings, a blind spot that was illustrated by the collapse of Archegos when the true scale of its borrowings from multiple brokers emerged only on its deathbed.