(Sept 14): Situational Awareness’s near collapse is a cautionary tale on the increasing role leveraged hedge funds play in global markets, the Bank for International Settlements (BIS) warned.

Officials at the Basel-based institution, reviewing events of recent months, highlighted the episode in July as they repeated warnings of underlying fragilities that central banks and investors must navigate.

“Increased use of leverage across various markets is a concern, as it has the potential to amplify ordinary market movements into significant disruptions,” Frank Smets, the BIS’s head of economic analysis and statistics, told reporters. “The failure of a highly leveraged AI-focused hedge fund serves as another reminder of these risks.”

The BIS warning accompanying its quarterly review released on Monday follows a speech last week by its chief that repeated his institution’s concerns on how the artificial-intelligence (AI) boom threatens financial stability. It also builds on a wider assessment of vulnerabilities highlighted by the institution in June. 

Leopold Aschenbrenner’s Situational Awareness fund faced a meltdown in July as a sudden deterioration in the value of its AI-focused investments sparked a wave of demands from banks for collateral. He ultimately reached a deal with Ken Griffin’s Citadel to offload the bulk of his firm’s public stock portfolio. 

Referring to the BIS’s warnings in June, Gaston Gelos, head of financial stability policy, observed to journalists that hedge funds are now “at the core of the core markets.” 

That has created “a fragile situation” that “depends on high leverage, short-term leverage and liquidity that is good in good times, but that can disappear very quickly,” he said. “It’s more and more a global phenomenon, and with increased concerns about the fiscal situation, that preoccupation has not gone away.”

His colleague Smets did acknowledge the bright spot that market stress hasn’t materialised, but suggested there’s no room for complacency.

“Despite the various challenges, risky assets were stirred but not shaken, and long-run inflation expectations appear to be well anchored,” he said. “Whether this resilience can be sustained, especially if upward pressures on yields continue, remains however uncertain.”

A separate chapter in the BIS report, by researchers Eduardo Amaral, Alejandrina Salcedo, Ilhyock Shim and Mark A Wynne, looked at how central banks increasingly refer to underlying measures of consumer prices in their communications. 

The analysis is based on about 8,000 central-bank publications from 24 economies over the past two decades. Rather than settling on a single preferred gauge, officials have broadened the range of indicators they cite, and the authors warned that this creates communication challenges.

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