Offshore hedge funds drive rising non-bank default risk in UK
A Bank of England note maps and quantifies non-bank default risk in key UK financial markets. It documents rising default risk in NBFIs, with a notable concentration in offshore entities and a large tail of risk linked to hedge funds.
Mapping the shadow banking geography
The analysis links Legal Entity Identifier codes with NBFI classifications and country-of-risk information, drawing on Bank of England and Financial Conduct Authority databases from 2016-2025.
This covers derivatives, cash, securities financing, and repo markets, mapping over 70 percent of non-banks active in UK markets, including asset managers, hedge funds, insurers, and pension funds.
While most NBFIs show an EU footprint, hedge funds exhibit a different pattern with significant US and offshore shares.
Offshore NBFIs, though a small proportion overall (around 4 percent), are highly concentrated, with Cayman Islands-based entities accounting for over 60 percent.
Notably, approximately 75 percent of offshore hedge funds are registered in the Cayman Islands, consistent with international evidence.
This cross-border dispersion complicates risk monitoring but provides a foundation for identifying vulnerabilities.
Quantifying the offshore vulnerability
Default risk is measured using one-year-ahead probability of default (PD) indicators, derived from anonymised bank-level counterparty assessments.
These forward-looking measures capture shifts in perceived creditworthiness, complementing balance-sheet indicators.
Monitoring PDs is crucial for assessing credit risk in collateralised markets like derivatives and repo, where NBFIs play an increasing role.
Elevated PDs for NBFIs based in certain offshore jurisdictions, particularly the Cayman Islands, suggest higher default risk, potentially reflecting greater leverage or less stringent oversight.
The average PDs for offshore NBFIs have consistently been the highest, widening after periods of market stress.
In 2025, the upper tail of offshore PDs reached around 500 basis points, significantly exceeding other regions and past stress episodes.
This widening gap highlights vulnerabilities for UK markets.
A systemic blind spot
The study effectively highlights a critical blind spot in financial stability: the concentrated and rising default risk within offshore hedge funds.
While the Bank of England's enhanced surveillance is a vital step, the fragmented regulatory landscape for these cross-border entities remains a significant vulnerability.
Urgent international cooperation is thus essential to prevent future market disruptions from opaque, highly leveraged non-bank channels.