Bank of England raises concerns as hedge fund positions in gilts reach £100 billion

Hedge Funds’ Massive Gilt Bets Raise Alarm at Bank of England

According to recent figures, hedge funds had borrowed nearly £100 billion from banks by the end of November, using these funds to reinvest in UK government bonds, also known as gilts.

This significant exposure has prompted the Bank of England to warn that the UK could be at risk of a severe disruption in the bond market. Governor Andrew Bailey is expected to address concerns from Members of Parliament this week, following the Bank’s warnings about hedge funds borrowing large sums against gilts as collateral.

Bailey has cautioned that fluctuations in the bond market are inevitable, and officials are increasingly worried that hedge fund activity could threaten the stability of the financial system. Unlike banks, hedge funds face lighter regulatory oversight, yet they manage an expanding share of global assets.

Regulators have proposed new measures to limit risk-taking in the gilt market, but hedge funds have pushed back, arguing that tighter rules could discourage investment in UK debt and potentially increase government borrowing costs.

This week, Bailey will appear before the Treasury select committee to discuss these threats to the UK’s financial system.

Growing Influence of Hedge Funds in Gilt Trading

Hedge funds now account for about one-third of all gilt transactions, a sharp rise from just 15% a few years ago. While borrowing against government bonds is a long-standing practice, hedge funds are leveraging gilts to amplify their bets—sometimes by as much as 100 times—profiting from small price differences between current and future bond values.

Bank of England data reveals that hedge fund borrowing for gilt trades has soared tenfold in just over a year, reaching £99.9 billion by November, compared to less than £10 billion previously.

Chris Coghlan, a Liberal Democrat MP on the select committee, highlighted that a small group of mainly US-based hedge funds now account for 90% of all net borrowing in this market.

Officials have warned that a sudden shock to the economy or financial system could trigger rapid “fire sales” of gilts, potentially destabilizing financial markets.

Coghlan commented, “The Bank of England is right to scrutinize the small number of hedge funds taking on significant leverage and accumulating large amounts of UK government debt, as this could intensify the effects of a market shock.”

International Comparisons and Regulatory Responses

Economists have drawn parallels between the UK and the US, where hedge funds’ exposure to US Treasuries surged by nearly $1 trillion between 2017 and 2019.

During the onset of the pandemic in March 2020, the rapid unwinding of these leveraged positions was blamed for extreme volatility in what is typically the world’s most liquid market. Hedge funds sold over $200 billion in Treasuries within days, reducing their total exposure by $430 billion.

This wave of selling caused bond yields to spike even as stock markets crashed, forcing the US Federal Reserve to intervene by purchasing $1 trillion in government debt to restore stability.

Calls for Reform and Industry Pushback

Bailey has noted that the structure of bond trading has undergone significant changes in recent years, contributing to increased market volatility.

Regulators are finalizing new rules aimed at curbing excessive risk-taking by hedge funds. These proposals include directing more trades through central clearing houses, which require margin payments that could reduce hedge fund profits. The US has already adopted similar measures, set to take effect in 2027.

Authorities are also considering whether to impose a “haircut”—a valuation below market price—on assets used as collateral in repo transactions, which would make such borrowing less attractive.

However, industry groups such as the Alternative Investment Management Association and the Managed Funds Association have criticized these plans in their responses to a Bank of England discussion paper.

Sir Dave Ramsden, the Bank’s deputy governor, recently emphasized that change is inevitable, stating, “We don’t think the status quo here is an option. Something needs to be done.”