Private markets remain “untested” in a higher interest rate and weaker growth environment, while widespread use of leverage makes it “particularly exposed” to macroeconomic uncertainty, the Bank of England (BoE) has warned.
In its latest Financial Stability Report, the BoE’s Financial Policy Committee (FPC) acknowledged that the growth in private markets over the past 15 years to approximately $16tn (£11.8tn) in assets under management, including in the UK, has the “potential” to support long-term growth in the UK economy.
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“However, the widespread use of leverage across the private finance ecosystem of funds, their portfolio companies, and interactions with banks makes it particularly exposed to macroeconomic uncertainty and tighter financing conditions,” the FPC stated in its report.
“And the private market ecosystem remains largely untested in an environment of sustained higher interest rates and weaker growth.”
The FPC has previously established that the main vulnerabilities associated with private markets arise from “high leverage, opacity and potential conflicts of interest around valuations, and strong interconnections with riskier credit markets such as leveraged loans, all of which could amplify economic and financial shocks”.
The report cited the current risk environment as increasing the risk that those vulnerabilities could crystalise.
“The private finance sector has been resilient so far,” stated the FPC in its report.
“But having grown rapidly in a low interest rate environment, it is now facing challenges from higher interest rates and a weaker and more uncertain growth outlook, in part related [to] global fragmentation around trade. These challenges have the potential to interact with existing private market vulnerabilities from high leverage, opacity around valuations, and interconnectedness.”
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The Bank plans to engage with private market participants and key providers of capital to the sector as part of its work to understand how private markets would operate following a financial shock, as well as the implications for financial stability and real economy financing.
The FPC also pointed to the increasing interconnectedness between private market firms and the global insurance sector.
It stated that “differences in insurance regimes between jurisdictions have encouraged the growth in funded reinsurance arrangements between insurers and reinsurers”, adding that these arrangements are “often complex, opaque, and increase interconnections in the financial system which has the potential to pose systemic risk if unaddressed”.
Elsewhere in the Financial Stability Report, the FPC observed that while corporate credit conditions are broadly unchanged, there has been a slight weakening in corporate demand for credit.
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