Central clearing can cut dealer gilt repo exposures by 60 percent
Bank of England Executive Director Nathanaël Benjamin outlined risks from non-bank leverage and pledged policy proposals for gilt repo resilience in early 2027. Speaking at the ISDA Forum, he warned that competitive pressure leads dealers to offer unjustified near-zero haircuts.
Where leverage hides in gilt markets
Hedge funds have shifted over the past four years from net cash lenders to net cash borrowers in repo markets, relying heavily on dealer banks for leverage.
Bank of England data shows this borrowing expansion coincided with rising futures open interest, tracking the growth of the UK cash-futures basis trade over the last 18 months.
Analysis indicates that expanding central clearing could have reduced gilt repo exposures on bank balance sheets by 40 percent to 60 percent during the 2020 market turmoil.
Furthermore, supervisory reviews revealed that dealers frequently set near-zero or negative haircuts not based on risk offsets, but to prevent clients from moving to competitors.
The illusion of available liquidity
System-wide stress simulations revealed a dangerous mismatch in market expectations: hedge funds assumed repo liquidity would remain available during stress, while dealer banks confirmed they would withdraw capacity.
This dynamic forces leveraged funds into disorderly unwinds.
“Doing nothing is not an option,” Benjamin said, confirming that the central bank will publish comprehensive policy proposals on gilt repo market resilience in early 2027 alongside international partners at the Financial Stability Board.
Transparency alone will not stop a run
Sharing surveillance data is a sensible diagnostic step, but relying on market self-discipline remains naive.
As long as dealer banks slash haircuts to win hedge fund business, systemic leverage will accumulate.
True market resilience requires binding clearing mandates rather than voluntary transparency.