FSB Sounds Alarm Over $2.2tn Hedge Fund Bet on Sovereign Debt, Warns of Systemic Meltdown Risk
The world's bond markets are sitting on a potential powder keg, according to a stark warning from the Financial Stability Board (FSB). The watchdog cautions that hedge funds have amassed a staggering $2.2tn (£1.7tn) in leveraged bets on government debt, creating a systemic weak spot that could rupture under economic pressure.
Led by Bank of England Governor Andrew Bailey, the FSB's latest report highlights how the surge in non-bank activity has left countries dangerously exposed to the threat of destabilising fire sales. A sudden loss of confidence in a government's creditworthiness, or a sharp spike in market volatility, could force these highly leveraged funds into a rapid liquidation of assets. This, in turn, could send global borrowing costs soaring and potentially spark a fresh financial crisis.
The mechanism at the heart of the concern is the global repurchase agreement (repo) market, valued at around $16tn. In this market, institutions like hedge funds borrow cash by using government bonds as collateral. Data reveals hedge fund cash borrowing in repos has ballooned to $3tn, representing a quarter of their total assets—a clear indicator of extreme leverage. The UK alone accounts for 15% of this vast market.
"Demand and supply imbalances in repo markets can arise quickly in stress periods," the FSB stated. "Cash lenders may retreat precisely when borrowers need liquidity most, leading to a vicious cycle of forced selling."
Governor Bailey, who has long flagged the risks posed by hedge funds in gilt markets, told lawmakers last month that while these players help governments issue debt, they also create channels for instability to spread. His deputy, Sir Dave Ramsden, pointed to the 2022 UK pension fund crisis—triggered by the "mini-Budget"—as a real-world example of how stress in one corner of the gilt market can rapidly infect the broader system.
Regulators are now finalising measures to curb the risk, including pushing more trades through central clearinghouses and imposing larger "haircuts" (collateral discounts) to dampen excessive leverage.
Reaction & Analysis:
"This isn't a hypothetical risk; it's a ticking time bomb," says Marcus Thorne, a veteran fixed-income strategist at Veritas Capital. "The sheer scale of leverage, especially in the UK repo market, means a minor shock could have catastrophic, domino-effect consequences. The Truss episode was a warning shot we seem intent on ignoring."
Eleanor Vance, Chief Economist at the Albion Policy Institute, offers a more measured view: "The FSB is right to highlight this vulnerability, but we must balance financial resilience with market function. Hedge funds provide essential liquidity. The goal of regulation should be to make the system more robust, not to drive activity into the shadows."
Meanwhile, David Chen, a portfolio manager at a major pension fund, expressed sharp frustration: "It's infuriating. We're told to de-risk and hold 'safe' government bonds, yet the bedrock of that safety is being hollowed out by speculative leverage. The regulators have been asleep at the wheel while hedge funds turned sovereign debt into a casino. When this blows up, Main Street will pay the bill—again."