BOE unveils doomsday scenario for private markets stress test

[LONDON] The Bank of England will stress test private markets against a doomsday scenario featuring 7 per cent interest rates, a 35 per cent collapse in UK share prices, a 400 basis-point increase in leveraged loan spreads and a wide range of artificial intelligence disruptions, the central bank announced on Friday (Jun 19).

In the stress test, 46 firms have agreed to take part, including alternative asset managers Apollo Global Management, Ares Management, Blackstone, KKR & Co and Pemberton. Traditional asset managers also participating include BlackRock, Legal & General Investment Management and Fidelity International, institutional investors and banks that provide funding, according to the BOE.

The details were included in an update on the BOE’s so-called “System Wide Exploratory Scenario,” which policymakers are vying will give them greater understanding of hidden risks in the private markets. Such funders have become vital for UK businesses and are now deeply interlinked with traditional lenders.

Following the traditional model for stress testing banks, the BOE said it will analyse participant responses to a “severe, but plausible, global macro-economic recession over a five-year-period.” Unlike bank stress tests, the BOE will only share aggregate results, with the goal of getting an “advance understanding of private market developments globally.”

Private credit and private equity have been strong backers of AI and potential risks there feature strongly in the scenario. Those include risks that “AI-development is hit by higher energy prices and a shortage of key hardware components,” which “increases the costs for users of AI and slows the development of new models, meaning the near-term productivity gains from AI are limited,”

The first year of the scenario features inflation at 7 per cent, a sharp fall in asset costs and a volatility index at 40. Year two envisages a “deep global recession” where UK gross domestic product falls by 4 per cent, the FTSE all share index dips 35 per cent, interest rates rise to 7 per cent and a 400-basis-point increase in leveraged loan spreads.

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From years three to five, the BOE has pegged global recovery in the test as “slow,” with UK unemployment at 7.5 per cent and GDP growth coming in at 0.7 per cent. For the first round of the test, participants will be asked how they would respond to the stress, the BOE will then provide them with aggregated feedback on how the market as a whole responded, which firms will incorporate into their update submissions for the second and final round. 

The BOE said it would publish initial information from the exercise in July, followed by further reports later in the year and a final report in 2027. The exercise, a global first, stems from years long and growing concern from policymakers about the potential for private markets to deliver systemic shocks. BLOOMBERG