The Prudential Regulation Authority (PRA) plans to follow a US model and demand that hedge funds disclose gross leverage exposures to their prime brokers.
Securities lending is booming along with surging equity markets, prompting concern at the Bank of England about bank exposure to leveraged counterparties. While current Basel rules enshrine netting at the heart of securities financing disclosures, the PRA is looking toward the US, where Securities & Exchange Commission Form PF requires hedge funds to provide a gross leverage exposure measure to lenders and regulators.
Rebecca Jackson, executive director of the Prudential Regulation Authority (PRA) discussed the rapid expansion of prime brokerage services in a speech on 28 January 2025, “As prime brokerage continues to grow, alongside hedge funds, we need to understand what has driven this growth and its implications.”
According to a study from the Bank for International Settlements (BIS), the largest prime brokers (Goldman Sachs, Morgan Stanley, and JP Morgan) now serve over 1,000 funds each, compared to just over five hundred for their nearest competitor. According to FSB research, the hedge fund industry itself has also expanded significantly, with assets reaching US$8.5 trillion by the end of 2023—a 21.9% increase year-on-year, marking the fastest growth rate since 2012.
This growth is further demonstrated by data from the Bank for International Settlements (BIS), which reported that as of the end of 2022, US-registered hedge funds held over US$4.5 trillion in gross assets. These funds primarily rely on a few prime brokers who mostly are global systemically important banks, with the largest serving more than 1,000 funds each.
Jackson noted that this expansion has been driven by rising equity prices, the proliferation of sophisticated quantitative trading strategies, and a broader shift in capital allocation toward alternative investments. “One major factor is the continued appreciation in equities, especially in US markets,” she said. “As equity prices increase, the loans required to finance their purchase naturally become larger, as does the gross value of synthetic transactions.”
The FCA’s review found that many prime brokers are extending credit to counterparties without a clear understanding of their risk profiles. “Firms have been all too ready to do business with clients whose risk profiles they do not properly understand and cannot adequately monitor,” Jackson warned.
A key concern is the reliance on net exposure metrics, which can obscure the true scale of risk. “By virtue of netting, these metrics tend to obscure the scale and potential impact of growth trends. They do not provide a meaningful constraint on business growth, allowing firms to ‘reduce’ risk in ways that may not hold up in times of stress.”
Jackson warned banks that the PRA will start requiring SEC-style gross exposure metrics. “We expect to see all prime brokers start using measures of gross exposure and absolute leverage to understand and control this business better”, she said.
The collapse of Archegos Capital Management in 2021 is a reminder of the dangers. The failure of the private office managed by Bill Hwang resulted in billions of dollars in losses for major banks, highlighting the perils of inadequate due diligence and counterparty risk management. “The issue is that new entrants may not have the necessary infrastructure and risk management capabilities to operate effectively in this space,” Jackson cautioned. “Financial history is littered with examples of firms entering new markets without adequate controls, only to suffer catastrophic losses.”
In addition to gross exposure metrics, the FCA is now demanding that should set minimum standards for disclosure frequency, ensure that risk appetite decisions are directly influenced by counterparty transparency, and establish clear governance around exceptions. “We think it is your job to make judgments about your clients based on what they do or do not tell you,” Jackson emphasised. “It is not enough to simply include a disclosure score as one of many marginal factors affecting a client’s credit rating.”
To ensure robust oversight, the FCA expects prime brokers to integrate automated systems capable of monitoring client disclosures on an ongoing basis. These systems should flag missing or outdated data, detect concerning trends, and cross-reference disclosures with internal and external sources. “Good practice relies on automated solutions that can meaningfully analyse data and promptly escalate potential risk changes to senior management.”
Looking ahead, the FCA plans to continue its thematic work on prime brokerage, aligning its expectations with the recently updated Basel guidelines on counterparty credit risk. “The issues I have raised here—entry to new business lines, operational resilience, and decision-making based on adequate information—apply beyond just this sector. Firms must find the time to join the dots across their businesses.”
“We recognise that implementing these frameworks comes at a cost,” Jackson concluded. “But the costs of sub-standard disclosures could be much, much higher.”
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