Esma found that 2% of Ucits funds displayed hedge-fund-like risk profiles, AIFs showed rising leverage, and systemic relevance varied across real estate markets, raising alarms over complex and leveraged exposures. Photo: Esma

Esma found that 2% of Ucits funds displayed hedge-fund-like risk profiles, AIFs showed rising leverage, and systemic relevance varied across real estate markets, raising alarms over complex and leveraged exposures. Photo: Esma

The EU regulator has reported that some Ucits using absolute value-at-risk carried gross leverage above 400%. AIF leverage reached 530% and real estate funds faced pressure despite sector-level resilience, raising concerns about systemic vulnerabilities.

The European Securities and Markets Authority (Esma) concluded that a small group of leveraged undertakings for the collective investment in transferable securities (Ucits) using the absolute value-at-risk (Var) approach displayed risk profiles exceeding those of hedge funds, highlighting potential systemic vulnerabilities within a subset of the European fund industry. This conclusion was in Esma’s 2024 annual risk assessment, which incorporated end-of-2023 data and also examined leveraged alternative investment funds (AIFs).

Leveraged Ucits pose higher risk than hedge funds

In its first using the absolute Var approach, Esma found that these funds represented approximately 8% of the overall Ucits universe. Within this group, a small subset accounting for 2% of Ucits net asset value (Nav) showed significantly high gross leverage, exceeding 400% of Nav in some cases. Esma stated that this level of leverage, combined with complex derivative strategies and heightened market sensitivity, mirrored risk characteristics typical of hedge funds, but in some cases exceeded them.

Despite their small share of the market, these high-leverage Ucits held a total Nav of €152bn, surpassing the Nav of hedge funds registered under the AIF framework, which stood at €124bn. The segment was marked by a diverse range of strategies, including alternative Ucits, fixed income and mixed approaches, and featured a fragmented manager base. Esma concluded that the diversity and complexity of these funds warranted closer supervisory scrutiny.

Absolute Var use and risk management

The absolute Var approach allows Ucits to measure and manage potential losses under a given confidence level and time horizon, particularly when using financial derivatives for investment or hedging purposes. Esma’s analysis found that funds extensively employing this approach were more likely to engage in directional positions and exhibit higher market risk, complexity and liquidity mismatches. These characteristics underscored the need for enhanced risk oversight in the sector.

Hedge funds show highest leverage in AIF segment

Within the AIF universe, hedge funds continued to display the highest levels of leverage, although they remained a minor component of the broader EU fund industry. Esma assessed hedge fund risk on an individual basis due to the specialised nature of their strategies but noted that the sector collectively maintained significant sovereign bond exposures, which could introduce market impact risks.

The median leverage ratio among substantially leveraged AIFs rose from 450% in 2022 to 530% in 2023, according to Esma’s . This increase drew regulatory attention due to its potential implications for financial stability.

Real estate funds under pressure in select jurisdictions

Real estate AIFs operated in a challenging market environment, with falling property prices, particularly in commercial real estate, combined with investor outflows in some jurisdictions. Although Esma reported that the real estate fund sector remained resilient at the EU level, the regulator warned of systemic relevance in jurisdictions where real estate funds held significant shares of the local real estate market.

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