The Bank of Canada’s Financial Stability Report noted an increase in asset managers’ leverage over the past 12 months, led by an increase in hedge fund repo borrowing, according to a summary from the Investment Industry Association of Canada (IIAC).
The data show:
- Leverage obtained by asset managers through borrowing in the repo market increased by roughly 30% in the past 12 months. Hedge funds and pension funds increased their repo leverage by 75% and 14%, respectively. Estimates are based on transaction data reported to the Canadian Investment Regulatory Organization (CIRO) through the Market Trade Reporting System 2.0.
- Pension funds are the largest non-bank participants in Canadian repo markets, with over $90 billion in total borrowing outstanding. They tend to face relatively less refinancing risk than hedge funds. About half of pension fund repo leverage has a maturity greater than one month, while about 70% of hedge fund repo exposure has maturity of less than one week as hedge funds tend to rely more on overnight and short-term repos. Some individual repo positions held by hedge funds are also very large and highly concentrated, for example, in a single Government of Canada bond. The concern is high repo leverage, especially when it is obtained through overnight or short-term repo maturities, can amplify sudden price movements in the underlying bond market.
“The large degree of leverage employed can leave hedge funds vulnerable to changes in the price difference between the underlying securities as well as to sudden changes in the availability and cost of repo financing”, the report said.