Remarks by Martin Moloney, Deputy Secretary General of the Financial Stability Board, delivered at the 39th ISDA Annual General Meeting, Amsterdam, 14 May 2025.
The views expressed in these remarks are those of the speaker in his role as FSB Deputy Secretary General and do not necessarily reflect those of the FSB or its members.
The Moment
A few years ago, when I was in a different role, I spoke to ISDA about crypto and the need to bring it in from the cold, to mold appropriate regulation. I was hoping to focus attention at that ISDA AGM on a key choice I thought we were facing about crypto and to draw attention to the obligation on us global standard setters to be pathfinders for the way forward.
I think events continue to suggest that that was indeed a key moment and the history of crypto will now take a route into a more regulated space – arguably a more sustainable space for crypto and a safer space from a financial stability perspective. This is because the FSB and IOSCO both recognized back then that it was time to provide guidance at a global level on what good regulation of crypto should look like.
As jurisdictions around the world now develop more mature regulatory frameworks for crypto, I think we correctly marked the moment at that ISDA AGM.
Today I wanted to speak about leverage, because I think our recent leverage consultation also constitutes a similar key moment. Perhaps it is not quite as full of growth potential as discussions of crypto, but perhaps it is even more important for keeping our financial system stable.
What we have said at the FSB is that now is the time to start putting guardrails around leveraged trading. As our financial markets continue to get bigger relative to the size of the real economy and more complex, they become relentlessly less stable and there comes a point where we need to all recognize that there is a need for proportionate containment.
The FSB’s Initiative
So, what have we done? Over the year end, we conducted a consultation on very new proposals for managing the risk to financial stability from leveraged position taking in financial markets. We are now working through the 36 responses we received, many of them substantial.
You would expect no less in relation such a new initiative regarding something which is now at the heart of how financial markets work and particularly how risk management works. Leverage is widely used both to control risk and to intensify it.
I can’t tell you the outcome of our further reflections on leverage because we still have a couple of months of work to do before reaching our final recommendations. But I can give you some personal reflections on the very interesting points we received.
The nub of the problem is very simple and has been well recognized for hundreds of years: when leverage is used to construct market positions, the forced unwinding of those leveraged positions can significantly amplify the harm financial markets in free fall can do to the real economy. Over the last thirty years, as financial markets have grown in size relative to the size of the real economy, that threat looms larger and larger. What are we to do?
Consultation Reponses
i) Trade-Offs
One key point made very forcefully to us in our consultation process was a plea to recognize the tradeoffs here! Leverage is very widely used for risk management and for arbitraging away the differences between markets in a way that contributes to the very constitution of the global financial system.
It’s a point well made. This is not a costless area for policy makers to get into. For every benefit we might use policy to construct, there is also a cost.
ii) Clarify the Goal
A follow-up to that point was to say to us: define your target more clearly. We had already spoken about the need to focus on core markets, but the point made to us was that our consultation did not give clarity as to what were and what were not core markets. Nor had we excluded the option of policy initiatives with a broader application.
Notwithstanding what we had said about core markets, there was an obvious fear behind many of these comments that we would start from an approach of trying to get leverage down across markets.
I don’t know if any of you ever heard the story – which I have only read once and I’m not even sure if its true – that when the film the Wolf of Wall Street was being developed they consulted people in the financial sector and one savvy investor suggested the line for inclusion in the script: ‘Leverage is the root of all evil’.
It is true that most incidents of market stress involve deleveraging but that doesn’t mean that all leverage is bad. We never thought we were starting from that perspective, but the response we got has focused on how we get across more clearly what our starting point was.
By the way, I believe the sentence didn’t make it into the final version of the film. You certainly won’t find that kind of sentiment in our finalized views. I expect we will have something more to say on this in our final response, but it is also important, as a next step, to allow jurisdictions to reflect on what are their core markets.
I anticipate that debate will develop and we will progressively get greater clarity on what it means to aim for proportionate, targeted and jurisdictionally tailored approaches focused on core markets.
iii) How to Measure Leverage
A particularly pointed response we got was to question the use of the gross notional leverage measure, because it doesn’t differentiate between hedging and leveraged directional positions.
When I read that I had a strong sense of déjà vu. Some years ago, IOSCO – responding to an FSB recommendation – wanted to develop a way to look for build-ups of leverage. I was involved and we had lengthy discussions on what gross notional data was good for and what it was not good for. Our conclusion rested on a key observation: a hedge only works as long as it works, by which I mean as long as there is the liquidity to finance it.
Remember our focus is not on leverage, but on deleveraging. And a hedge can unwind under stressed market conditions just like a leveraged directional position. We need to know what is the total amount of leverage in a market to know how much can go wrong.
My memory is that IOSCO at that time concluded that it needed a two-stage process, stage one: find out what is the total leverage, stage two: understand where the leveraged risk sits. Gross notional was deemed good for the first, but not so useful for the second.
It seems very likely to me that the FSB will come to a similar conclusion for its purposes as IOSCO came to at that time for statistical purposes. And its easy to illustrate that: ISDA’s own Interest Rate Derivatives Trading Activity report will tell you a total number, lets say, the increase in IRD notional.1 That doesn’t explain to you what is happening in the market, but it allows you to pose an informed and pointed question for further analysis. I expect the Gross Notional measure of leverage will have a similar role in our work on leverage.
There is an assumption sometimes that if we collect a data point that that is what we will try to limit. That is not so. We recognise that the data has to be analysed to understand what is going on.
iv) Big Hedge Funds
Another argument we have been presented with is the argument that we should focus only on the large highly leveraged funds.
This argument also reminded me of an argument ESMA heard some years ago when it consulted on using its AIFMD leverage powers. Its response, if I recall correctly, was ‘no’, a build-up of leverage by a large number of small entities is also potentially threatening to financial stability. We can’t just ignore it as we would if we focused only on the large players. I hope you can see the sense of that.
In any event, our focus is not on hedge funds, its on a particular kind of trading irrespective of who does it. Many hedge funds do lots of other trading using different trading strategies and, no matter how big they are, those other trading strategies – and the hedge funds that do them – are not our concern.
v) Information
But what both these discussion points highlight is that there should be no rush to simplistic conclusions when it comes to leverage risk, there should be analysis on a market-by-market basis.
In this regard, there were three points which came up again and again in the responses we received that I think were very important and suggest ways forward:
Firstly on data: how can we focus in on what is really risky and leave the rest of the market to get on with it, unless the relevant authorities can see clearly what is happening in markets?
Secondly on public disclosure: we know that many of those engaged in leveraged relative value trades are often highly professional firms with well-developed risk management systems running both historical and hypothetical stress tests on a huge scale. They don’t want their positions to unwind, but their risk management can only be as good as the information that is publicly available to them.
Thirdly on bilateral disclosure: The Basel Committee has recently issued very comprehensive Guidelines for Counterparty Credit Risk management. It correctly emphasizes the need for lenders to assess the riskiness of the deal, riskiness of the counterparty overall and of instrument or market. This is demanding for lenders. I suspect the most pointed challenge this excellent guidance leaves prime brokers with is how to manage against horizontal hoarding without an appropriate degree of disclosure from borrowers? But how do we reconcile that with the commercial confidentiality concerns that a number of our consultation responders referred to? There has to be a way.
vi) Margins/Haircuts
What is outstanding is the issue of non-cleared margining and collateral haircuts. What should we recommend?
That is a matter for on-going consideration by our members. I am not going to pre-empt them.
What I can observe is that there is an obvious relationship between how well other measures work and the strength of the case for rules or good practices on margin and haircuts. If we had no other cards in our hand, this is where we would have to focus. In particular, I think it depends on how much we can achieve through better data and information both for authorities and market participants. The less well markets are being actively supervised or influenced by parties well aligned with delimiting the financial stability risk of leverage, the stronger the case for margin and haircut rules. That depends on data, it depends on public disclosure and bilateral disclosure.
vii) Timing
There was one last argument that we heard that has some merit which was: ‘wait for the numerous initiatives already underway to have their full effect before taking more action’. Here respondents were referring mainly to US treasury market clearing and the Basel guidance. This is an important point and it seems to me to have some force. But I would point out that even when these recommendations are agreed there is a next phase in the process whereby jurisdictions need to work out what is right for them. That will necessarily take time. I think that means that the timing issue will work out OK.
Conclusion
For me, the leverage issue is a critical one. If we can get to the point of allowing leverage to provide its benefits to markets within guardrails that mean the financial system remains safe enough, even as it continues to grow in size, we will have done financial markets a great service. We will have done more that respond to the Great Financial Crisis, although we certainly have done that. We will have done more than learn the lessons of the March-April 2020 events in markets, although we have certainly also done that. We will have taken a huge step forward in empowering markets to finance public policy and private entrepreneurship resiliently for the period ahead. I have some confidence that ISDA will play its part in that, because ISDA always has.