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A sharp rise in global interest rates is likely to lead to lower valuations of private assets, the UK’s top financial regulator warned on Wednesday, as it confirmed it was looking into the build-up of risks in sectors such as real estate.
Nikhil Rathi, chief executive of the Financial Conduct Authority, confirmed a Financial Times report last week that his agency was planning a sweeping review of valuations used across private markets, amid growing fears over the impact of higher rates on the sector.
“The macro economy has moved from a period of low interest rates for a very lengthy period of time, and markets are now expecting . . . higher interest rates for longer,” Rathi said. “At some point, you might expect that risk will crystallise in valuations of assets.”
Rathi cited commercial real estate as one area of potential difficulty, pointing to “what’s happening in China”, where developers are struggling under mounting liabilities, with property companies’ share prices being hard hit.
“We’ve also seen over a number of years the growth of private markets, the growth of private equity and the use of leverage in those markets,” Rathi added.
“We’re looking at it from a risk management perspective to understand where that build-up of risk might have taken place, how the valuations are governed and how that might feed back into other parts of the financial system be that banking, insurance or elsewhere.”
Rathi said that work by international regulators on leverage outside the traditional banking sector was also key to better understanding the market. “Private markets in particular are challenging because different jurisdictions have different powers of information collection around those markets,” he said. “Some can reach into them, others can’t.”
The Financial Stability Board, a global body of policymakers and regulators, has convened a new working group to probe leverage among non bank financial institutions, a broad group spanning hedge funds, private equity, insurance and other firms.
Rathi said the working group, which will be co-chaired by the FCA’s markets head Sarah Pritchard, would “identify those areas where there are data gaps and which the international community needs to address”.
Klaas Knot, the FSB chair, last week told the FT that the work could ultimately limit the amount that hedge funds can borrow, as well as boosting transparency around how much they owe to banks.
The FCA boss was speaking after the regulator’s annual public meeting, in which he, chair Ashley Alder and their fellow executive and non executive directors defended the FCA’s record on dealing with issues including the British Steel pension crisis and the continued fallout from the collapse of fund manager Neil Woodford’s investment business.