Launch of the scenario phase of the system-wide exploratory scenario

BoE has published a statement to announce that it has initiated its SWES exercise, aiming to examine the behavior of banks and NBFIs during periods of stressed financial market conditions. The exercise will explore how these behaviors could interact and potentially amplify shocks in key UK financial markets, thus affecting the stability of the country’s financial system. Participating entities include large banks, insurers, central counterparties, and various investment funds such as pension funds and hedge funds.
The report describes the situation in a day-to-day development.
Day 1: a geopolitical shock leads to financial market shock, causing a sharp deterioration in the economic outlook – 40% of the shock realised
– Media coverage is mainly on the geopolitical shock / event, causing speculation that the situation will worsen.
– Markets slowly turn away from risky assets, causing their prices to fall and an increase in volatility.
– Government debt and sovereign wealth funds go on sale among retail and institutional investors.
– Large economies are especially vulnerable to shock.
Day 2: asset prices fall, bond sales continue – 55% of the shock realised
– Risky asset prices continue to decline.
– Offshore USD market is under stress.
– Mid-size funds take action to decrease their risks, repo prices increase.
Day 3: government bonds continue being sold; counterparty credit concerns increase – 75% of the shock realised
– Market prices continue to fall, leading to forced-selling behaviour.
– Credit rating agencies become more vigilant on vulnerable corporates.
Day 4: mid-sized hedge funds defaults causing firms to sell collateral on the market – 85% of the shock realised
– Collateral to the exposure of the hedge funds gets sold as the fund defaults.
– Sterling begins to depreciate.
Day 5 – 10 onwards: no prospect of the situation getting better in the mid-run – 100% of the shock realised
– The situation continues to worsen the market, no mid-run remedy in sight.
– Credit rating agencies decrease ratings on the sovereign bonds.
The expected outcome of this exercise is to check the liquidity strategy under extreme financial conditions. Liquidity need arise from:
– increases in collateral calls through additional variation margin calls and/or increases in initial margin;
– revaluations of collateral, for example that is posted for securities financing transactions resulting in a need to post additional collateral; and
– funds facing redemptions from other market participants (including other SWES participants) who are seeking to meet their own liquidity needs.
SWES participants should submit their scenario responses by January 2024 for the period ending on 31 October 2023.
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The BoE has concurrently published several other press statements, including:
(1) News publication and
(2) Detail on the system-wide exploratory scenario hypothetical scenario