BIS warns hedge-fund leverage could amplify market shocks

The Bank for International Settlements warned that rising leverage among hedge funds could turn ordinary market moves into major disruptions, citing the near-collapse of the AI-focused Situational Awareness fund in July.

Frank Smets, the BIS head of economic analysis and statistics, said the fund’s failure was another reminder of the risks created by leveraged trading. 

A sharp decline in its AI investments triggered collateral demands from banks before founder Leopold Aschenbrenner reached a deal with Ken Griffin’s Citadel to sell most of the firm’s public stock portfolio.

Gaston Gelos, the BIS head of financial stability policy, said hedge funds are now at the core of major markets. He described the system as fragile because it depends on high short-term leverage and liquidity that can disappear quickly during stress.

The warning accompanied the BIS’s quarterly review and followed a speech from its chief about the financial-stability risks of the artificial-intelligence boom. 

The institution also highlighted concerns about fiscal conditions and the ability of markets to absorb sustained pressure on bond yields.

BIS officials said recent market stress has not yet become a broad disruption. Smets said risky assets had remained resilient and long-term inflation expectations appeared anchored, but added that the durability of that resilience remains uncertain.