ESMA Warns Over Hedge Funds With 2,000% Leverage Risking Market Stability

A group of hedge funds heavily involved in mortgage bonds, with an average gross leverage exceeding 2,000%, has raised concerns with the European Securities and Markets Authority (ESMA) due to the potential risks they pose to market stability, according to a report from Bloomberg.

The ESMA report highlights the dangers associated with leveraged alternative investment funds, noting that this particular group of hedge funds is responsible for up to 15% of trading activity in the local mortgage-backed securities market. While their market share has remained stable even during periods of financial stress, such as the COVID-19 pandemic and the conflict in Ukraine, these funds typically buy in rising markets and sell during downturns. ESMA believes this strategy could exacerbate market movements, contributing to increased volatility and further market instability.

Out of the 130 hedge funds included in ESMA's analysis, approximately 10% report leverage ratios exceeding 2,048%, with the median leverage standing at more than 500%. This places them among the most highly leveraged funds in the alternative investment sector. The ESMA's concerns are focused on the fact that such high levels of leverage could magnify risks, especially in times of economic downturns, leading to significant market disruptions.