BofE launches stress testing ‘exercise’ for major banks and buy-side to prevent future bonds collapses

Exercise will shed more light on the behaviours of major institutions in stressed financial market conditions with a focus on the fixed income and derivatives markets; follows the UK’s gilts crisis in September.

The Bank of England (BofE) has today launched a new stress testing “exercise” to improve the understanding of how major banks and buy-side behave in stressed market conditions, including how these behaviours might interact to “amplify shocks”.

The launch follows the UK gilt crisis in September last year where in less than three days, 30-year UK gilt yields spiked following the announcement of the mini-budget by the former Chancellor of the Exchequer, Kwasi Kwarteng, ultimately forcing the Bank of England to step in and buy gilts to stabilise the price.

Today’s launch is intended to understand institutional behaviours in periods of stress to learn lessons for the future. As part of the new system-wide exploratory scenario (SWES) exercise, participants including major banks, hedge funds, asset managers and pension funds will be asked to evaluate the impact of “severe but plausible” stress including what actions they might individually take in that scenario, with a focus on the UK markets.

“Large institutional investment managers hold huge systemic importance to the global economic system, with some of the world’s biggest asset managers falling very much into the ‘too big to fail’ category,” Joseph Cordahi, product strategy director at NeoXam, told The TRADE.

“Hedge fund and pension fund managers should not wait for central banks to come knocking at their doors, they need to act now and begin voluntary stress testing measures. This will not only equip them for regulation down the line but will give them a competitive edge, which given the current climate, is crucial. To accurately stress test, asset managers need to have an accurate and timely view of portfolio transactions, trading positions, corporate actions, as well as pricing to support investment.”

The markets included in the exercise include gilt market, gilt repo market, sterling corporate bond market and associated derivative markets. The exercise is not designed to test the resilience of firms but rather to understand collective actions and responses from firms and how these could then also have an amplifying effect on the initial stress.

BofE, the UK’s Financial Conduct Authority (FCA) and the Pensions Regulator will work together to collate data from all corners of the market.

A final report will be published in 2024, BofE said, including any findings and assessments of risks of UK markets’ stability.