Bailey Warns G20 of Leveraged ETF Risks Amid AI Share Surge

Andrew Bailey, Governor of the Bank of England and Chair of the Financial Stability Board (FSB), has warned G20 finance ministers and central bank governors about the risks posed by leveraged exchange-traded funds (ETFs) and momentum-driven strategies. In a letter dated August 28, Bailey highlighted how these funds can amplify market volatility during sharp declines.

The Bank of England reported that US leveraged equity ETF holdings reached $200 billion (£148 billion) in July, with retail investors being the main holders of these funds. Leveraged ETFs use financial instruments to seek a multiple of an underlying index's or share's daily return, magnifying both gains and losses.

Bailey noted that while leveraged funds represent only a small part of the market, their use of leverage can amplify price moves beyond what their size alone might suggest. He also linked leveraged trading to the rise of artificial intelligence (AI) shares, which now account for about half of the S&P 500.

The Bank of England modelled a hypothetical scenario in which US equity prices fall 45% over six quarters, resulting in a 2.2 percentage point decline in UK GDP, with most of the effect transmitted through financial channels. Bailey called for greater resilience and preparedness to address these risks, as several market pressures could reinforce one another during a sharp decline.