UK regulators are sounding the alarm over a sharp rise in leveraged hedge fund positions in the gilt market, warning of potential systemic risks if trades unwind suddenly, according to a report by the Daily Telegraph.

Foreign hedge funds now account for around 30% of gilt trading, up from 15% in 2018, per data from the Bank of England (BoE), with much of this activity is concentrated in “basis trades” – arbitrage strategies exploiting small price differences between cash gilts and futures – financed via repurchase agreements (repos).

The bank's data shows hedge funds had borrowed a record £77bn against gilts as of June, the largest increase in borrowing across the shadow banking sector. The BoE says 90% of net repo borrowing is concentrated among a handful of funds, raising concerns that a rapid deleveraging by a few players could amplify market shocks.

Officials fear a repeat of 2022’s LDI crisis, when forced selling of long-dated gilts sent yields soaring and pushed up borrowing costs for households and businesses.

The BoE’s latest Financial Stability Report warns that stress in leveraged gilt trades could spill over into other asset classes. Proposed reforms include greater use of central clearing and adjustments to collateral valuation rules, moves that could curb hedge fund leverage.

Governor Andrew Bailey, now chair of the Financial Stability Board, has cautioned that similar basis trades in US Treasuries have already triggered near-crises.