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Many of the world’s largest hedge funds will reveal whether their investment activities risk amplifying economic shocks and harming the UK’s financial system, after being recruited into the first-ever stress tests involving the shadow banking sector.

The Bank of England has released the names of more than 50 City institutions taking part in the exercise, which will measure the ways that banks and non-bank financial institutions – often referred to as the shadow banking sector – affect financial stability.

The list includes large banks such as HSBC, Goldman Sachs, JP Morgan and Merrill; insurers including Aviva and Legal & General; as well as clearing houses, asset managers, pension funds and hedge funds including Brevan Howard, Citadel, Millennium Capital Partners, Rokos Capital Management and Capula Investment Management.

It comes amid growing concerns about the role of the shadow banking system, which has doubled in size since the 2007-08 financial crisis and accounts for about half of the global corporate loans, but does not face the same stringent oversight as traditional banks.

Unlike bank sector stress tests that measure the resilience of individual firms, the shadow banking exercise is meant to help regulators understand how the firms react to one another’s decisions during a market downturn, and how their actions could collectively “amplify shocks in UK financial markets that are core to UK financial stability”.

“Given market-based finance plays an increasingly important role in financing the real economy, material market dysfunction can, for example, lead to a tightening of credit conditions and reduce the provision of finance to households and to businesses,” the Bank of England warned.

The two-phase test will show how firms would respond to a hypothetical economic shock, before putting forward a second scenario, based on the group’s collective actions, and ask how the firms would react to that heightened state of financial stress.

The Bank of England’s Prudential Regulation Authority is running the exercise alongside the Financial Conduct Authority and the Pensions Regulator, and plans to publish its findings in 2024 – a decade after traditional banks first came under similar scrutiny in 2014.

The potential threats posed by shadow banking have been illustrated in recent years by the dash for cash at the start of the pandemic in 2020 – which resulted in investors pulling their money at speed.

The Bank also pointed to the UK’s pension fund crisis in September 2022 that was originally prompted by the government’s disastrous mini-budget, but caused UK bond prices to plunge at a record rate. Market panic eventually forced the Bank of England to step in with £65bn in emergency funding to prop up the bond market and avoid risks spilling out to other parts of the financial sector.

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The chaos contributed to higher mortgage rates and borrowing costs for companies and homeowners across the country.

Brevan Howard, Citadel and Rokos Capital Management declined to comment. Millennium and Capula did not respond to requests for comment.

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