By Promit Mukherjee and David Ljunggren
OTTAWA, March 4 (Reuters) – The risks posed to debt markets by hedge funds and private credit might be growing faster than the ability of monitoring agencies to understand and mitigate them, Bank of Canada Governor Tiff Macklem said on Wednesday.
“Economic uncertainty is already high — we cannot afford to add financial instability to the mix,” he said.
Macklem said risks to growth were greater than normal and tilted to the downside.
The U.S. and Israeli strikes on Iran have increased volatility in energy and financial markets and there is considerable uncertainty about the duration and fallout of this conflict, Macklem said.
While non-bank actors are part of a healthy financial system and not a problem to be solved, they are also more prone to financial stress, he said.
“These new and rapidly growing players do bring vulnerabilities that need more attention. Risks may be growing faster than our ability to understand and mitigate them,” he told the Global Risk Institute in Toronto.
Macklem said fiscal flexibility was limited and valuations were stretched in equity and credit markets.
“These risks could also interact with vulnerabilities in the financial system … and our global surveillance and regulatory frameworks haven’t kept pace with the change,” he said.
Hedge funds, which buy almost half of Canadian government bonds, have become central to how sovereign debt markets function. But they tend to have high leverage and are more sensitive to disruption.
“One scenario we worry about is a shock to markets that leads to a spike in interest rate volatility,” said Macklem.
“If leveraged investors are forced to reduce their positions, they may need to sell sovereign bonds into already stressed markets … the scale of these trades and speed at which they can unwind pose a systemic risk.”
Another potential factor is the role of private credit, which Macklem said was filling gaps in the system.
“The issue is not private credit itself. It’s how private credit will behave under stress … the opacity of private credit means investors may not have enough information about the quality of loans held in their funds,” he said.
“A spike in defaults could prompt them to try to exit their positions quickly. This could cause severe strains, including spillovers to public credit markets.”
((Reuters Ottawa bureau))
Keywords: CANADA CENBANK/
