Part 1 used twelve years of Bundesbank data to argue that Germany’s KAGB redemption-restriction regime materially compressed retail open-ended property fund flow stress, including through the 2022–24 European rate shock. The German evidence is empirical: did the template work? The Irish material here is institutional: how is the template being deployed in Europe right now, by whom, with what coordination, and against which gaps in the architecture?

The Eurosystem’s May 2026 report Strengthening the macroprudential lens in the regulation of non-bank financial intermediation proposes, among other things, a reciprocation framework for cross-border NBFI macroprudential measures. The institution that has built such a framework in practice is the Central Bank of Ireland. Discussion Paper 11, published 18 July 2023, sets out CBI’s conceptual foundation. Two policy deployments since then give two worked examples: leverage and liquidity measures for Irish-resident property funds in November 2022 (under Regulations 26 and 18 of the Irish AIFM Regulations), and a codified yield-buffer framework for Sterling LDI funds in April 2024 (under Article 25 AIFMD, in coordination with CSSF and aligned with TPR/FCA guidance for the UK leg).

CBI’s own press release on the LDI codification states explicitly that this was “the second time the Central Bank of Ireland has introduced policy measures under the non-bank pillar of its macroprudential policy framework” — the first being the property fund measures. That self-framing is useful: CBI is presenting both deployments as components of the same emerging architecture rather than as unrelated regulatory actions. This article takes that framing at face value and works through what each deployment looks like, what early data show, and what the two cases together say about the Eurosystem report’s reciprocation proposal.

The CBI framework architecture

DP11 articulates the conceptual case for a macroprudential perspective in fund-sector regulation that complements rather than replaces the existing investor-protection mandate. The paper is explicit on a point that matters for what follows: macroprudential policy for investment funds “will be most effective if regulators coordinate. This underpins the importance of developing a globally-consistent approach. In certain circumstances, domestic action may also be required.”

The two deployments illustrate both halves of that statement. Property funds were a domestic action: Irish-authorised funds and managers, an Irish commercial real estate exposure that posed Irish systemic risk. Sterling LDI was the coordinated case: vehicles domiciled across Ireland and Luxembourg, sterling-denominated exposures to UK pension liabilities, a crisis whose epicentre was the UK gilt market. The two cases bookend the operating range of the macroprudential framework CBI is building. What unites them is not identical legal machinery but the use of fund regulation for explicit financial-stability rather than investor-protection purposes — Regulations 26 and 18 in one case, Article 25 AIFMD in the other.

Property funds: the slow-moving case, three years in

CBI announced the property fund measures on 24 November 2022 with two components. First, a 60% total-debt-to-total-assets leverage limit, imposed by way of condition of authorisation under Regulation 26 of the Irish AIFM Regulations. Existing funds have a five-year implementation period running to 24 November 2027, during which CBI expects gradual and orderly progress toward lower leverage. New funds must comply from inception. Funds investing at least 80% of AuM in social housing are out of scope, subject to specific lease and debt-structure conditions.

Second, guidance on the application of Regulation 18 of the Irish AIFM Regulations setting an expected minimum liquidity timeframe of 12 months for property funds, given the nature of the underlying assets. Existing funds had an 18-month implementation period (the guidance applied from 24 July 2023); new funds authorised on or after 24 November 2022 must comply from inception.

These are textbook ex-ante macroprudential tools — a numerical leverage cap and a liability-side liquidity timeframe — applied to a cohort holding illiquid commercial real estate. The conceptual architecture is similar to KAGB but the policy instruments are different: KAGB used redemption restrictions on the liability side; CBI used leverage restrictions on the asset side combined with redemption-frequency guidance.

The chart above shows monthly net flows as % of lagged NAV for the Irish RE fund cohort from December 2014 to February 2026. Pre-Nov 2022 (95 monthly observations): mean +0.78%, σ 1.81%, 27% of months in net outflow. Post-Nov 2022 (40 monthly observations): mean +0.07%, σ 0.74%, 53% of months in net outflow. Flow volatility roughly halved; the upper tail of inflow surges has been eliminated.

The headline pattern is similar to the KAGB-era German case: post-implementation flow volatility compresses materially, and the tail risk on the inflow side is eliminated. The Irish post-2022 sample is shorter, the macro environment was specifically a CRE valuation correction rather than a broader retail-fund stress, and the dataset captures all Irish RE funds in the ECB Investment Fund Statistics rather than only the macroprudential cohort (≥50% Irish CRE), which CBI’s FSR 2025:II flags in footnote 64. With those caveats: the direction of travel is consistent with what the policy was designed to achieve.

The chart above decomposes the change in fund AuM into three components — net flows, valuation effects, and changes in borrowing — annualised across the pre and post periods. Pre-Nov 2022 the Irish RE fund sector grew by roughly €3.5bn per year, with flows (+€1.6bn), valuation (+€0.7bn), and borrowing (+€1.3bn) all contributing positively. Post-Nov 2022 the sector grew by €0.23bn per year, with modest inflows (+€0.41bn) offsetting CRE valuation drag (-€0.15bn) and effectively zero change in borrowing (-€0.02bn).

The post-implementation trajectory is neither the run-and-fire-sale dynamic the policy was designed to prevent, nor a continuation of pre-implementation growth. The sector neither grew nor contracted materially in the post-implementation period — a quieter trajectory than pre-2022. This is itself the policy story: in previous CRE cycles, falling valuations would trigger run-like dynamics on retail-facing vehicles, forcing asset sales that depressed valuations further. The fact that the sector has gone quiet against a meaningful CRE correction is the circuit-breaker working as intended. The bank-to-non-bank debt substitution within the cohort is worth flagging: CBI’s FSR 2025:II reports that Irish property fund debt fell over 2024 from €15.91bn to €15.07bn, with bank and other debt down €1.75bn partially offset by an increase of €0.91bn in non-bank debt (Chart 39). That is itself a within-cohort substitution worth monitoring as the leverage transition proceeds toward its November 2027 deadline.

The watch-this-space caveat: the most recent observation in the flow data is a -2.31% Pub-style outflow in December 2025, and the 12-month rolling volatility has crept from 0.50% to 1.19% over the past year. The leverage transition has two more years to run, and the funds adjusting toward the cap may be doing so against a still-soft CRE valuation environment. None of this is a problem with the policy — it is the policy doing its work, gradually, against a difficult macro backdrop. But it is a reminder that the post-implementation period is not yet a steady state.

Sterling LDI: the fast-moving cross-border case

The chart above shows UK 30-year gilt yields from 2020 to 2026, with policy milestones marked. The crisis itself was concentrated: the Bank of England’s December 2022 Financial Stability Report describes what happened in late September 2022 as “a vicious spiral of collateral calls and forced gilt sales that risked leading to further market dysfunction, creating a material risk to UK financial stability”. Nominal 30y gilts moved from 3.45% on 11 September to a 4.78% weekly close on 9 October — about 130 basis points in four weeks. The BoE’s emergency bond-purchase programme stabilised the market within roughly two weeks. The structural question — what to do with the LDI cohort thereafter — was the regulatory community’s to answer.

The response unfolded in two stages. On 30 November 2022, CBI and CSSF issued substantively identical industry letters to managers of GBP LDI funds, framed explicitly as a coordinated CBI/CSSF/ESMA response. The letters noted that resilience buffers in the 300–400 basis-point yield-shock range had been built up across the cohort post-crisis, expected those levels to be maintained, and required advance notification and stress-tested justification before any reduction. This was supervisory expectation backed by a notification regime — not a codified rule with an explicit numerical floor.

Eighteen months later, on 29 April 2024, CBI and CSSF announced aligned codified frameworks. The CBI version requires Irish-authorised GBP LDI funds to maintain resilience to a minimum 300 bps increase in UK yields, with a three-month transition for existing funds and at-inception compliance for new ones. The CSSF version is parallel: 300 bps minimum, monthly average yield buffer reported each month-end, with limited flexibility (one of the last four monthly observations may be below 300 bps in exceptional circumstances). The November 2022 letters formally ceased to apply once the implementation period ended on 29 July 2024.

CBI Governor Gabriel Makhlouf framed the rationale in terms that the Eurosystem report would later use almost verbatim: “The gilt market disruption of 2022 demonstrated how financial vulnerabilities in non-bank financial intermediation can amplify adverse shocks to the rest of the financial system and the broader economy. The macroprudential measures announced today aim to safeguard resilience of sterling LDI funds, and — in doing so — support financial stability at a global level. Given the cross-border nature of capital markets, achieving that outcome requires effective international co-ordination.” The cross-border coordination was explicit in the announcement: CBI worked with CSSF, UK authorities, ESMA “and relevant stakeholders since the beginning of the UK gilt market crisis”; the CSSF announced its aligned framework on the same day. The UK leg ran in parallel: the BoE FPC recommended interim TPR action; TPR’s April 2023 trustee guidance set a 250 bps minimum stress buffer plus scheme-specific operational buffer (principles-based rather than a single numerical floor); the FCA published associated guidance for fund managers.

The two architectures — CBI/CSSF’s 300 bps numerical floor with monthly observation, and TPR’s 250 bps minimum stress buffer plus principles-based operational buffer — are functionally similar approaches to a shared resilience objective. CBI/CSSF chose a single numerical floor that is straightforward to monitor and enforce. TPR chose a principles-based architecture that requires trustee judgement about scheme-specific exposures. Each architecture offers different operational trade-offs; the next stress event will provide the empirical comparison that published evidence does not yet allow.

The chart above shows the structural reason GBP LDI funds got macroprudential attention first. From ECB Macroprudential Bulletin Issue 26, Table 1 (Bouveret, Ferrari, Grill, Molestina Vivar, Schmidt and Weistroffer, 2025; cross-referenced with ESRB NBFI Risk Monitor 2025, Table 3): GBP LDI is the largest cohort by NAV (€67.8bn) within the EU’s substantially-leveraged AIF universe, the largest by absolute repo borrowing (€70.0bn), and concentrates its leverage in repo rather than derivatives. Among substantially-leveraged AIFs at end-2023, GBP LDI alone accounts for €349bn of AuM — by far the dominant single cohort.

Bouveret et al. (2025) test this cohort against the exact 300 bps shock the codified buffer is designed to absorb. They find an average NAV loss of 31% for GBP LDI funds and 26% for EUR LDI funds — described as having “negligible” effect on hedge funds and other leveraged AIFs at this risk factor. Crucially, the article reports that “only very few LDI funds would have a NAV below zero” in this scenario: the calibrated buffer absorbs the calibrated stress. A milder 100 bps shock generates a €6.6bn aggregate liquidity shortfall across the LDI cohort, which Bouveret et al. note “would be covered by the redemption of money market fund shares and sales of unpledged bonds”. That is the cross-border doom loop in compressed form: a UK gilt shock forces Irish and Luxembourg LDI funds to redeem MMF shares (which are themselves a major source of short-term funding for euro-area banks via commercial paper and certificates of deposit, as documented in ESRB monitoring of euro-area MMFs) and to sell unpledged bonds into thin markets. The calibration is intended to absorb the specified shock scenario; the secondary transmission channels remain relevant and are precisely the cross-border vector the Eurosystem report is trying to address.

What the two cases together say about the Eurosystem proposal

Two deployments, three years apart, one template. Both explicitly framed by CBI as components of the same emerging macroprudential architecture. Property funds: slower-moving, single-jurisdiction, multi-year transition. LDI: fast-moving, cross-border, 18-month codification with monthly compliance reporting. Both build on the existing AIFMD machinery — Article 25 in the LDI case, Regulations 26 and 18 of the Irish AIFM Regulations in the property fund case — but apply that machinery for explicit financial-stability rather than investor-protection purposes. That is the analytical point DP11 makes: macroprudential mandate complements the investor-protection mandate; both can be advanced through the same regulatory infrastructure.

For the Eurosystem report’s reciprocation proposal, this matters in two specific ways.

First, the LDI case shows what cross-border coordination looks like when it works. CBI did not act unilaterally — it acted in deliberate coordination with CSSF and ESMA, and the codified frameworks are aligned across the two domiciles. That coordination was effective but bilateral and ad hoc. Under the Eurosystem report’s proposed reciprocation framework, similar action would have a defined process at EU level rather than depending on bilateral goodwill and the personal coordination of senior NCA staff. The LDI case is the existence proof; the reciprocation framework is the institutional infrastructure that would let it scale.

Second, the property fund case illustrates the gap that reciprocation is specifically designed to address. Article 25 AIFMD is a mandate exercised by the AIFM’s home regulator over the funds it authorises. But Irish commercial real estate is held by funds domiciled in multiple EU jurisdictions; if a substantial share of the addressable Irish CRE market is held by funds authorised outside Ireland, CBI cannot apply its leverage limit to those vehicles. Domestic action is constrained by where funds happen to be domiciled, even when the underlying systemic exposure is unambiguously domestic. Reciprocation — under which other NCAs would apply equivalent measures to the funds they authorise that hold material Irish exposures — is the institutional missing piece. It is also the piece that is hardest to achieve voluntarily, because the reciprocating NCA must balance domestic priorities alongside measures designed primarily to address a foreign systemic risk (a classic collective-action problem in EU macroprudential policy).

The Eurosystem proposal puts this missing piece on the institutional table. Whether the Commission’s eventual legislative response carries it through is a separate question. But the analytical case for reciprocation is now anchored in two concrete deployments that have run for three and one years respectively, both of which expose the same gap in the existing architecture. Twelve years of German evidence support the empirical case for ex-ante liquidity tools. Three years of Irish institutional building support the case for the cross-border framework needed to deploy them at EU scale.

These cases make the implementation problem concrete.

Paweł Fiedor - The Macro Prudential View

Sources and methodology

Eurosystem and ECB

ECB (May 2026), Strengthening the macroprudential lens in the regulation of non-bank financial intermediation. Eurosystem report.

Bouveret, A.; Ferrari, M.; Grill, M.; Molestina Vivar, L.; Schmidt, D. J.; Weistroffer, C. (2025), Leveraged investment funds: A framework for assessing risks and designing policies. ECB Macroprudential Bulletin, Issue 26.

ESRB (2025), EU Non-bank Financial Intermediation Risk Monitor 2025, Table 3.

CBI

Discussion Paper 11 – An approach to macroprudential policy for investment funds, 18 July 2023.

The Central Bank’s macroprudential policy framework for Irish property funds, November 2022.

Industry letter: Liability Driven Investment Funds, 30 November 2022.

Central Bank introduces macroprudential measures for Irish-authorised GBP-denominated LDI funds, 29 April 2024.

Financial Stability Review 2025:II, Chart 39 and footnote 64.

Other regulators

Bank of England (December 2022), Financial Stability Report.

CSSF (29 April 2024), Macroprudential measures for GBP Liability Driven Investment funds.

ESRB (2021), Issues note on systemic vulnerabilities of and preliminary policy considerations to reform money market funds — referenced for the MMF-to-bank short-term funding channel.

The Pensions Regulator (April 2023), guidance on the use of leveraged liability-driven investments by trustees of defined benefit pension schemes.

Data

ECB Investment Fund Statistics (IVF) — Irish RE funds, monthly series.

Investing.com UK 30-year bond yield (nominal, weekly close).

Bank of England yield curves — real 30-year spot curve, daily.

Calculations. All flow statistics, decompositions and rolling volatility measures for the Irish property fund section are computed by The Macro Prudential View from the ECB IVF monthly series. Pre period: December 2014 to October 2022 (95 monthly observations). Post period: November 2022 to February 2026 (40 monthly observations) for flow statistics; November 2022 to November 2025 (37 monthly observations) for the AuM decomposition, because IVF Total Assets is missing for December 2025 to February 2026 and including those months would break the additive identity (Δ AuM = Net flows + Valuation + Δ Borrowing). Working spreadsheet available on request.

Views are my own. This article is a personal analytical piece based on public sources. It does not represent the views of the European Systemic Risk Board, the Central Bank of Ireland, the Eurosystem, or any other institution.

The Eurosystem’s May 2026 report Strengthening the macroprudential lens in the regulation of non-bank financial intermediation proposes a familiar set of structural tools for retail open-ended fund liquidity risk: minimum holding periods, redemption notice periods, leverage caps. The analytical framing is forward-looking — what an EU-wide macroprudential framework for investment funds should look like. The empirical question is backward-looking: where has anything resembling this template been deployed before, and what happened?

The closest publicly observable analogue is Germany. The Kapitalanlagegesetzbuch (KAGB), in force from 22 July 2013, imposed a 24-month minimum holding period and a 12-month redemption notice on retail open-ended property funds (Publikumsfonds, or retail OEIFs — abbreviated Pub in the analysis below) but did not apply these restrictions to institutional open-ended property funds (Spezialfonds, abbreviated Spez). That asymmetry, sustained for twelve years, gives us a useful cohort comparison with monthly data publicly available from the Bundesbank’s time-series database. The 2022–24 European interest-rate shock has, additionally, given the regime its first substantive post-implementation stress test.

This article works through what twelve years of public data say about whether the template stabilises retail OEIF flow dynamics. The headline finding is supportive: post-KAGB Pub flow volatility is roughly half its pre-KAGB level, the upper tail of inflow surges has been eliminated, and the 2022–24 rate shock — which produced 62% of months in net outflow in the treated cohort — saw a worst single-month outflow of -0.75% of NAV, an order of magnitude smaller than the -5.6% the same cohort experienced in October 2008. The institutional comparison cohort, which faced the same macro environment without the same redemption restrictions, behaved very differently in both episodes. The empirical case for the toolset is materially strengthened by the German experience; the constraints on generalising it remain real.

The template, the policy, the cohort

The 2008 financial crisis exposed a specific structural fragility in German retail open-ended property funds. The funds offered daily redemption rights against an underlying portfolio of commercial real estate — a textbook liquidity mismatch. When investor confidence broke in autumn 2008, the funds had no choice but to suspend redemptions: Schnejdar, Woltering, Heinrich and Sebastian (2022) document nine retail OEIFs suspending redemptions in October 2008 alone, including KanAm Grundinvest, AXA Immoselect, SEB ImmoInvest, Morgan Stanley P2 Value, CS Euroreal and DEGI International. “By August 2012, all closed funds were forced to announce their liquidations” under the suspension rules then in force.

The KAGB’s 2013 redemption restrictions were the policy response. From 22 July 2013, new investors in retail open-ended property funds could not redeem within 24 months of subscription, and any redemption thereafter required 12 months’ notice. The intent was to better match the liquidity profile of the liability side to the underlying asset class. The same restrictions did not apply to Spezialfonds, the institutional vehicle, which serves professional investors — typically pension schemes, insurance undertakings and corporate treasuries — and operates with negotiated rather than daily redemption terms. Crucially, this means Spez and Pub differ structurally beyond just the KAGB rules: investor base, redemption terms, and to some extent portfolio composition diverge across the cohorts. That is why this analysis treats Spez as a comparison benchmark rather than a true counterfactual.

That regulatory asymmetry, in place since 2013, is what allows the analysis. Both cohorts hold broadly similar underlying assets — German and European commercial real estate. Both experienced the same macro environment. Only one had the redemption restrictions applied to its retail liability structure. The question becomes empirically tractable.

The empirical strategy

This article defines five regimes. Pre-Crisis covers 2000 to 2007: post-euro adoption, pre-shock. Crisis covers January 2008 to July 2013: the wave of suspensions and the run-up to KAGB. Post-KAGB calm covers August 2013 to December 2021: the period during which both cohorts operated under the new rules in a low-rate, generally calm macro environment. Post-KAGB rate shock covers 2022 to 2026: the period during which the European Central Bank raised the deposit facility rate from -0.5% to 4.0% between July 2022 and September 2023, and German commercial real estate valuations corrected meaningfully thereafter. Pre-2000 data is omitted because of the DM-EUR conversion in January 1999, which mechanically distorts level comparisons.

Data come from the Bundesbank’s open-ended-investment-fund statistics — specifically the Net Asset Value, loans-received and net-flow series for both Pub and Spez cohorts. Commercial real estate valuation context comes from the vdp Property Price Index. All series are publicly available and monthly. The Bundesbank series is in DM through December 1998 and EUR thereafter, which is why pre-2000 observations are excluded from the analysis. Note that all percentage values, regime statistics, leverage averages and decompositions in this article are calculated by The Macro Prudential View from the public Bundesbank series; methodology is detailed in the sources section at the end.

The master finding: flow volatility

The chart above shows monthly net flows as % of lagged NAV for both cohorts from 2000 to 2026. Post-KAGB Pub flow volatility is structurally lower than pre-KAGB Pub flow volatility — and structurally lower than the institutional comparison cohort over the same period. Pre-Crisis monthly net-flow standard deviation for Pub was 1.53% of prior-month NAV. Crisis-era it dropped to 0.95%, but the worst single month was -5.6% in October 2008 — that is the run dynamics, the single-month redemption pressure that triggered the suspensions. Post-KAGB calm: σ falls to 0.50%, with only 6% of months in net outflow. Post-KAGB rate shock: σ falls further to 0.39%, but with 62% of months in net outflow.

That last regime is the most informative one. The 2022–24 European rate shock was the first genuinely adverse macro environment the post-KAGB regime had to absorb. CRE valuations fell — the vdp office capital-value index dropped from a 2022 peak of around 188 to around 156 by mid-2024, a near-17% correction in commercial property values. Retail investors in German open-ended property funds responded: 62% of months from January 2022 onward saw net outflows. But the magnitude per month was small. The worst single month was -0.75% of NAV. The same cohort in 2008 had a worst month of -5.6%. The redemption-restriction architecture appears to have shaped what investors could do: they could subscribe freely; they could leave but only with notice; the resulting flow trajectory looks like a slow drift rather than a run. Mechanically, the 12-month notice period caps the rate at which any individual subscription can exit, converting what would otherwise be a stampede into a managed queue with a one-year runway for the fund to manage cash buffers and execute property sales.

The institutional comparison cohort tells a complementary story. Spezialfonds had a worst single month in the Crisis era of -2.6% (March 2008) — about half the magnitude of the contemporaneous Pub episode. In the post-2022 rate shock, Spez had zero months of net outflow. Same shock, very different response. The cohort with negotiated rather than daily redemption terms did not exhibit the same run-like dynamics; the structural mismatch was lower to begin with. It is also worth noting that the policy did not eliminate retail demand for liquidity — investors with immediate-exit needs continued to be able to sell their fund shares on secondary venues such as the Hamburg exchange’s Fondsbörse Deutschland at a discount to NAV, shifting the cost of liquidity from the fund’s balance sheet (where it would force asset fire sales) to the exiting investor. Gerlach and Maurer (2020) document the secondary-market dynamics in detail, showing that “OREF shares are traded at a discount on secondary markets when the fund management suspends the redemption of shares or when the fund is being liquidated” — i.e., the secondary market prices the trapped-liquidity risk explicitly, leaving the underlying fund balance sheet intact.

The chart bove distils the same finding to summary statistics across the four post-2000 regimes. Pre-Crisis, the two cohorts looked quantitatively similar — Pub σ of 1.53%, Spez σ of 1.83%, neither with extreme outflow months. Crisis era split them: Pub took the run dynamics, Spez did not. Post-KAGB calm: both cohorts compressed, with Pub at the lower stress level. Post-KAGB rate shock: Pub stress remained reduced even though 62% of months were in outflow, because each individual month’s outflow was small. The right-hand panel — worst single-month outflow by regime — shows the monotonic pattern most clearly. Pub: -5.4%, -5.6%, -1.7%, -0.75%. Spez over the same regimes: -0.7%, -2.6%, -0.5%, +0.0%. Same data, same broad asset class, different stress profile depending on whether the redemption-restriction architecture is in place. (Regime labels here are analytical sample partitions, not official supervisory classifications.)

Sectoral substitution

A separate observation, less prominent in the policy debate, is shown in the chart above: Spez NAV overtook Pub NAV in December 2017. From end-1993 to end-2025, Pub NAV grew about 2.5×; Spez NAV grew about 63×. The sector now sits at roughly €112bn of retail and €179bn of institutional NAV (latest available data, end-2025). The two trajectories are different vehicle types serving different investor classes, but they hold broadly comparable underlying assets — institutional scale has overtaken retail scale within the same broad German CRE fund universe.

This is genuinely ambiguous. One reading is that the KAGB redemption restrictions made the retail vehicle less attractive to investors who wanted liquidity, displacing money toward the institutional channel. Another reading is that the institutional CRE allocation grew secularly across the post-2010 period for reasons entirely unrelated to KAGB — German pension funds and insurance undertakings deploying duration-matched property allocations in a low-rate world, a trend visible across continental Europe regardless of OEIF regulation. The Bundesbank time series alone cannot separate these two explanations.

What it can say is that the redemption-management regime did not destroy the German CRE fund channel. Total NAV across both cohorts is higher than at any pre-2013 point. The institutional channel’s growth replaced the retail channel’s growth, but the function — providing intermediated CRE exposure — continued. For the Eurosystem proposal, this matters: the most concrete worry about ex-ante liquidity tools is that they push activity out of the regulated channel rather than reducing the underlying mismatch. The German evidence does not support that worry strongly, though the substitution toward institutional vehicles is consistent with a softer version of it.

Liability-side risk reduction

The chart above shows that both cohorts deleveraged from mid-2000s peaks. Pre-KAGB averages: Pub 1.16, Spez 1.33. Post-KAGB averages: Pub 1.10, Spez 1.26. Pub now operates at structurally lower leverage; Spez also moved down but remains higher.

This is not cleanly attributable to KAGB. Both cohorts deleveraged, in roughly parallel trajectories, suggesting macro factors — interest rates, supervisory pressure, generalised risk aversion through the 2008–2014 period — affected both. KAGB plausibly contributed to the lower steady-state Pub level, particularly as the regime took hold and new fund launches operated under the new rules from inception. But isolating the KAGB-specific contribution from the broader deleveraging would require fund-level data and a more demanding identification strategy than the cohort comparison provides.

What the chart does show is that the liability-side risk reduction the redemption-management regime was meant to encourage occurred. Pub funds today carry less debt against NAV than they did pre-Crisis. The 2022 rate shock produced a small uptick — visible at the right edge of the chart — that is worth monitoring but has not undone the post-KAGB structural shift.

What this means for the Eurosystem proposal

The German evidence supports the empirical proposition that ex-ante OEIF liquidity tools — minimum holding periods, redemption notice periods — stabilise retail OEIF flow dynamics in the face of substantial macro stress. The 2022–24 rate shock is the relevant validation: it occurred under the post-KAGB regime, with European CRE valuations correcting by mid-double digits, and the treated cohort absorbed it through a slow drift in flows rather than the run dynamics that defined 2008. Twelve years of post-implementation data, including a real-world adverse regime, suggest the redemption-management toolset works in this context.

Three constraints on inference are worth flagging. First, the German cohort was already moving toward institutional dominance through the 2010s, for reasons partly independent of KAGB. The substitution between Pub and Spez may be larger than the data alone can attribute to the policy. Second, the 2022–24 period was a rate shock with associated CRE valuation stress, not a pure redemption run; the KAGB regime has not yet been tested by a fast-moving liquidity event of the September 2022 gilt-crisis variety. The German evidence is about whether the toolset handles slow stress, not whether it handles sudden stress. Third, the cohort definition — German retail open-ended property funds — is narrower than the Eurosystem report’s proposed scope. Generalising to other markets and structures should be tested case-by-case rather than assumed.

Net: the empirical case is positive enough to support the report’s direction. The German data make it difficult to dismiss the proposition that ex-ante liquidity tools can work in practice. The lighter version of the question — do they work in all the markets and structures the report covers? — remains open and worth investigating case-by-case.

Paweł Fiedor - The Macro Prudential View

Part 2: Ireland’s CBI deployed analogous measures twice in three years — to property funds in 2022 and Sterling LDI in 2024 — providing the first cross-country test of how the template generalises.

Sources and methodology

ECB (May 2026), Strengthening the macroprudential lens in the regulation of non-bank financial intermediation. Eurosystem report.

Schnejdar, Sebastian; Woltering, René-Ojas; Heinrich, Michael; Sebastian, Steffen (2022), Fund Closure Risks of Open-End Real Estate Funds. Journal of Real Estate Research.

Gerlach, Patrick; Maurer, Raimond (2020), The Growing Importance of Secondary Market Activities for Open-end Real Estate Fund Shares in Germany. Schmalenbach Business Review 72, 65–106.

Deutsche Bundesbank, Investment companies time-series database — open-end investment companies, real estate sector. Public monthly series for both Publikumsfonds and Spezialfonds, covering Net Asset Value, loans received from financial institutions, and net flows.

vdp Property Price Index, Verband deutscher Pfandbriefbanken (Q1 2003 – Q4 2025) — office capital values used for CRE valuation context.

ECB key interest rates — deposit facility rate series for the 2022–23 ECB tightening cycle.

Calculations. All percentage values, regime statistics, leverage averages and decompositions are computed by The Macro Prudential View from the Bundesbank monthly series. Monthly net flow as % of NAV is calculated as net flow in month t divided by NAV at end of month t-1, multiplied by 100. Standard deviation is the sample standard deviation of monthly flow %s within each regime. Leverage is calculated as (NAV + loans received) / NAV. Pre/post-KAGB averages use 22 July 2013 as the regime break, with August 2013 as the first full post-KAGB month. Pre-2000 observations are excluded throughout because of the DM-EUR conversion in January 1999, which mechanically distorts level comparisons. Working spreadsheet available on request.

Views are my own.

In April 2025, US Treasuries did something they were not supposed to do. The administration’s tariff announcements triggered a sharp equity sell-off — the kind of move that, for a generation, had been the cue for Treasury yields to fall as global capital rotated toward the world’s safe asset. Instead, long-dated yields rose. Bonds and stocks sold off together. The convenience yield embedded in Treasuries — the premium markets pay for “moneyness,” for the property of being valued at face value without anyone asking awkward questions — measurably contracted. Whatever was happening, it was not the textbook safe-haven response.

The episode was not a one-off. The correlation between Treasury and equity returns has been drifting positive since the Fed began tightening in March 2022, and has spent meaningful stretches above zero ever since. The asset that anchors the global financial system has become a regime-dependent hedge — sometimes safe, sometimes not, increasingly conditional on whether anyone has tightened recently or sprung a fiscal surprise.

A few weeks short of the first anniversary of that tariff shock, the European Systemic Risk Board hosted a joint workshop of its Advisory Technical Committee and Advisory Scientific Committee on “A European Safe Asset and Financial Stability.” Olli Rehn’s welcome address framed the question against precisely this backdrop: geopolitical fragmentation, the financing needs of European public goods, the international role of the euro. Philip Lane’s keynote walked the technical landscape — three broad routes to expanding euro safe-asset supply, each with different design properties and different political preconditions.

The debate has shifted. The question is no longer whether Europe needs more safe assets. It is which design produces them, at what cost, with what residual safety properties — and whether the entire concept of a “safe asset” still means in 2026 what it meant in 2011, when the original European Safe Bonds (ESBies) proposal was first published.

This piece works through the empirics and the design space. Five charts, four design families, one question that turns out to be more complicated than it sounds: what does it actually mean to be safe?

The shortage

Start with the volumes, because they are stark.

Euro-denominated marketable central government and supranational debt totals roughly €12.5 trillion at end-April 2026. Across all rating tiers — from German Bunds to Greek GGBs, from EU NGEU bonds to ESM and EFSF — that is the entire potentially-safe stock available to the euro area. By comparison, US marketable Treasuries total around $30.8tn at end-March 2026, or €26.3tn at the prevailing exchange rate. The euro stock is roughly 47% of the size of the US benchmark.

Cut to strict AAA — the rating that would, in principle, anchor the system — and the picture sharpens. Germany, the Netherlands, Luxembourg, plus the AAA-rated supranationals (the EU at S&P AA+ but Aaa/AAA at the other three majors; EIB, ESM, CEB, EBRD all clean AAA) sum to about €3.6tn. That is roughly one-seventh the size of the US Treasury market.

Even on a more permissive cut — AAA plus AA, putting France in the AA bucket on the basis of Moody’s Aa3 (S&P and Fitch downgraded France to A+ in 2025) — the total reaches €7.4tn. Still well under a third of the US benchmark.

The composition makes it worse. The bulk of euro-denominated sovereign issuance is rated A or BBB: Italy at €2.6tn dominates the BBB tier; Spain, Belgium, Portugal and the smaller member states populate the A tier. Around 40% of the euro safe-asset universe is below AA. That is not a structural feature you can engineer your way out of by issuing more national bonds.

This is what Lane refers to as the structural undersupply of “safe-asset services” — and what the supranational layer (NGEU, EU bills, EIB issuance, the ESM/EFSF stack) has been quietly trying to address since 2010. EU-Bonds outstanding now sit just over €700bn, of which roughly €450–500bn is NGEU-related, with the borrowing window closing at end-2026 and repayments beginning from 2028. Without successor programmes, the EU bond stock will start shrinking just as the structural arguments for a larger one intensify.

Is anything safe in 2026?

The shortage is real. But it is also worth asking what, exactly, is in short supply.

Lane’s keynote followed the standard working definition in the literature: a safe asset is highly liquid and appreciates in relative value under stress. The formulation packs three distinct properties into one phrase. Credit safety: the issuer pays. Market liquidity: holders can transact at low cost in size, including under stress. Hedging: the asset gains value when other things fall, so it offsets portfolio losses. The full definition requires all three. Failure on any one dimension means the asset is not, by Lane’s own standard, fully safe.

The textbook reference points all clear the credit dimension comfortably. None of them clears all three reliably.

US Treasuries are the obvious case. The chart shows the rolling 26-week correlation between weekly returns on the 7–10 year Treasury ETF and the S&P 500 since 2009. The classic safe-haven property — Treasuries rising when equities fall — produces a negative correlation. Through the 2010s, the correlation sat consistently between –0.3 and –0.7. From 2022 onward, it inverted. Annual averages turned positive in 2023 and 2024. The April 2025 tariff shock, the SVB/Credit Suisse moment in March 2023, and the broader inflation-shock regime have all coincided with episodes where Treasuries failed to hedge.

Darrell Duffie’s recent JEP piece attributes this to a combination of dealer balance-sheet constraints, fiscal trajectory, and regulatory capital limits compressing intermediation capacity at exactly the moments when liquidity provision matters most. The credit dimension is intact — the US is one notch below AAA at all three majors after Moody’s downgraded to Aa1 in May 2025 (S&P and Fitch are at AA+), but no one is pricing actual default risk. The breakdown is in liquidity and hedging, the second and third dimensions of Lane’s definition. None of this changes the fact that Treasuries still dominate other sovereign assets in scale and breadth of usage. The hierarchy is not gone; it is just less reliable than it was.

The other pillars look no better when scrutinised on the same three dimensions.

Bunds function as a regional rather than global safe asset, anchoring euro-area portfolios but not (in the way Treasuries do) global ones — a point established empirically in the ECB’s recent work on bond substitution patterns. Germany’s fiscal turn since 2023, with the constitutional debt brake reform and ramped defence and infrastructure spending, has not threatened the AAA rating but has materially altered the supply-and-demand framing.

Gilts, in 2022, demonstrated that an asset can pass the credit test cleanly and still fail the market-functioning test. The Bank of England’s anatomy of the LDI crisis documents how liability-driven investment unwinds drove extreme moves in long-dated gilts despite no shift in UK creditworthiness. The asset was safe; the market was not.

JGBs are the inverse case: credit fine, liquidity impaired by years of BoJ purchases. As FRBSF research and AMRO’s 2025 work document, the BoJ’s footprint has hollowed out functioning JGB markets even as it tapers; the liquidity premium has risen, and the question of who replaces the central bank as marginal holder remains open.

The synthesis is uncomfortable but unavoidable. The frame established by Gorton (2017) — safe assets as instruments “always valued at face value without expensive information production” — was always context-dependent. What counted as safe in 2011 is not what counts as safe in 2026. None of the four canonical sovereign safe assets currently passes all three of Lane’s dimensions across all regimes. Safety has become contingent, regime-dependent, and dependent on the institutional and market-structure context surrounding each asset.

This sharpens the European policy question rather than dulls it. A diversified, properly engineered safe asset has the potential to be more robust on at least one of these dimensions — diversification protects against single-issuer fiscal trajectories, single-jurisdiction market structure failures, or single-central-bank footprints. The rest of this piece works through what the engineering options actually look like.

Three reform paths — and the status quo

Lane’s keynote walked through three broad routes to expanding euro safe-asset supply, alongside the implicit baseline of continuing with what we have. Each rests on a different combination of financial engineering, fiscal commitment, and political appetite.

The four designs differ not just in volume but in the kind of safety they deliver and the political capital they consume:

• The status quo continues the trajectory that began with banking union in 2014 and accelerated with NGEU in 2020. Banking union, ESM standing facility, TPI/OMT, NGEU borrowing — all of these have, incrementally, expanded the supranational safe-asset layer. The mechanism is institutional: build credibility and capacity at the European level, issue more bonds against it. It produces the existing fragmented stock by rating tier (€12.5tn total, €3.6tn AAA), and it keeps producing more — NGEU alone added several hundred billion in high-quality supply over five years. The precondition is continued institutional commitment.

• SBBS / ESBies — the proposal advanced by Brunnermeier, Langfield, Pagano, Reis, Van Nieuwerburgh and Vayanos (2017) and developed in detail by the ESRB High-Level Task Force on Safe Assets in 2018 — pools euro-area sovereign bonds in capital-key weights. A special-purpose entity issues two tranches against them: a senior tranche (typically 70% of face value), which serves as the area-wide safe asset, and a junior tranche (the remaining 30%), which absorbs first losses. No mutualisation: each member state continues to service its own debt. The senior tranche’s safety comes from diversification and subordination, not from joint guarantees. The precondition is regulatory — a Commission proposal in 2018 stalled, but the technical work is largely complete.

• Blue bonds, in Olivier Blanchard and Ángel Ubide’s 2025 PIIE proposal, take the opposite direction. Convert each member state’s debt up to 25% of GDP into jointly-issued senior bonds, with each member ring-fencing a tax stream (VAT being the canonical example) to service its share. The output is roughly €5tn of senior, jointly-marketed paper — the largest single design by far, comparable in scale to the German Bund market. The precondition is durable political commitment to ring-fenced revenues and a credible legal architecture for the senior claim. Mutualisation is limited but real: individual rather than joint-and-several guarantees, but a much closer version of common debt than anything in the status quo.

• The national strategy — the path advocated by Bruegel — argues that scaling existing supranational issuance and pursuing fiscal reforms to upgrade individual sovereigns toward AAA could deliver more usable safe-asset stock than tranching or blue bonds in the medium term. No new instrument. The mutualisation profile is identical to the status quo — existing supranational mechanisms continue, just at larger scale. The output is incremental.

Hanno Lustig’s argument deserves to be heard on this point. Lustig’s analogy is to the United States in the 1840s: state defaults were politically wrenching but ultimately disciplinary, contributing to the constitutional balanced-budget rules that anchor American state finance today. Europe, by contrast, has consistently chosen the bailout-and-ECB-balance-sheet path. Joint debt without binding fiscal constraints, in Lustig’s reading, is not a Hamiltonian moment — it is a deferral. The moral hazard concern is not about the design itself but about whether the supporting fiscal architecture can hold. Lustig’s argument applies most directly to blue bonds, where the senior claim relies precisely on the durability of national tax-revenue ring-fences over multi-decade horizons.

These four paths are genuinely different on every dimension that matters. They produce different volumes (incremental versus €1tn versus €5tn versus open-ended). They require different preconditions (institutional continuity versus regulatory enabling act versus political tax-pledge commitment versus fiscal discipline). They imply different degrees of mutualisation (existing only, none, limited individual guarantees, existing only). And they leave different residual risks for the domestic financial system.

The doom loop hasn’t gone away

Why does this matter beyond the academic case for more diversified safe assets? Because the bank-sovereign nexus that motivated banking union in the first place has not weakened.

The chart plots holdings of domestic government debt by commercial banks (MFIs excluding the ESCB, so stripping out PSPP and PEPP holdings on the central-bank side) as a share of total bank assets, monthly since 2010. Six countries: the four major peripherals — Italy, Spain, Portugal, Greece — and France and Germany as core comparators.

The data tells a sharper story than the institutional reform narrative would suggest. Italian banks hold around 10% of their assets in Italian government debt, with the all-time peak — 12% — reached in August 2020, during the COVID-era issuance surge. Greek banks rebuilt their domestic exposure from near-zero post-PSI to 9.7% by January 2025 — also an all-time high. Spanish banks have sat in the 7–9% range for over a decade. Only Portugal shows a clear de-risking, from a 9.4% peak in 2019 to 4.6% currently. France is creeping up. Germany is the only country meaningfully below its 2010 starting point.

OMT (July 2012) and the SSM (November 2014) are marked on the chart. Neither has materially bent the trajectory of any line. The 2012 Greek PSI is also visible — it is the only intervention on the chart that produced a structural break, and the cliff in the Greek line shows it. Twelve years of European banking-union architecture has not, on its own, produced a comparable structural break in any other country.

This is the macroprudential case for some safe asset, regardless of which design wins. Domestic banks in the periphery hold ten percent of their balance sheets in their own sovereign — and this share is at or near multi-decade highs. A genuine area-wide safe asset, held in place of concentrated domestic exposure, would mechanically dilute this concentration. The status quo has not resolved this problem; in some countries it has coincided with record exposures over the past five years.

What financial economics says about tranching

Of the three reform paths, SBBS / ESBies is the design where financial economics has the most to say. Blue bonds and the national strategy both turn on questions of political commitment and fiscal discipline that economic analysis can illuminate but not resolve. SBBS turns on a structural property of pooling and subordination that can be calibrated, simulated, and stress-tested.

The chart reproduces the benchmark calibration from Brunnermeier et al. (2017), Tables 3 and 4. The numbers are five-year expected losses on individual sovereigns and the engineered tranches.

The headline result: under the benchmark calibration, the senior tranche of a 30%-subordinated, GDP-weighted euro-area sovereign pool has a five-year expected loss of 0.09%. The safest individual sovereign, Germany untranched, has an expected loss of 0.13%. Tranching, applied to a diversified pool, produces an asset safer than any of its underlying components — without any mutualisation between member states.

The mechanics are not mysterious. The pool is GDP-weighted, so no single sovereign dominates. The senior tranche only takes losses once cumulative losses on the underlying pool exceed 30% — and given even modest correlation assumptions, the probability of cumulative euro-area sovereign losses breaching that threshold within five years is very small. The junior tranche absorbs the residual. The cross-check holds: 70% × 0.09% senior + 30% × 9.10% junior = 2.79%, exactly the GDP-weighted pool’s expected loss before tranching. The engineering is conservation of risk, not its disappearance.

A note on vintage: the Brunnermeier calibration uses December 2015 sovereign ratings. Since then, several sovereigns have moved — upgrades for Greece, Italy, Spain and Ireland; downgrades for France, Belgium, and others. A cross-check using S&P’s 1993–2024 historical local-currency sovereign default rates by rating bucket and current ratings yields a five-year pooled-portfolio expected loss of approximately 0.21% — well below Brunnermeier’s 2.79%. The difference reflects Brunnermeier’s use of stress-conditioned forward-looking PDs versus S&P’s unconditional realised rates. The benchmark calibration is therefore conservative. Under more benign assumptions, the senior tranche’s safety properties only improve.

This is what Lane meant by “safe-asset services.” A senior SBBS tranche, by construction, has credit risk lower than any individual euro-area sovereign. It has the regulatory tractability that comes with a single instrument standardisable across jurisdictions. And it has the structural diversification that matters in 2026: no single fiscal trajectory, no single market microstructure, no single central bank footprint determines its safety properties. The dimensions that Treasuries, Bunds, gilts, and JGBs each fail in their own way — the senior tranche, by construction, is more robust against them all.

Synthesis and open questions

Five charts and four designs into this article, what does the analytical case look like?

The shortage is real. Euro-denominated marketable central government and supranational debt is roughly half the size of the US Treasury market, and the strict-AAA subset is a seventh. The composition is heavily weighted toward A and BBB sovereigns. The supranational layer is currently growing but is structurally programmed to peak in 2026 and shrink from 2028 unless successor programmes are agreed. This supply cliff arrives at the same time as the ECB’s balance-sheet normalisation, with private markets absorbing more sovereign debt as the central-bank footprint shrinks.

The case for more safe-asset supply is reinforced, not weakened, by the observation that “safety” is contingent and multi-dimensional in 2026. Existing global benchmarks — Treasuries, Bunds, gilts, JGBs — each fail at least one of Lane’s three dimensions in some regime. A diversified, structurally engineered euro safe asset has different failure modes than any single-sovereign benchmark. That is not a marginal advantage in a world of fragmentation, geopolitical shocks, and divergent monetary policy paths.

The bank-sovereign nexus has not weakened, twelve years into banking union. Italian and Greek banks now sit at all-time-high domestic sovereign exposures, hit in 2020 and 2025 respectively. SBBS, by construction, dilutes this concentration without requiring any sovereign to cede fiscal sovereignty.

On the engineering, the financial economics is robust. A senior tranche of a diversified, capital-key-weighted euro-area sovereign pool, with 30% subordination, has a five-year expected loss lower than Germany untranched. The result holds under both the conservative Brunnermeier calibration and the more benign historical-default cross-check. No mutualisation is required. No fiscal commitment beyond the existing one is required. The precondition is a regulatory enabling act that the Commission has already drafted and that has been on the European policy shelf since 2018.

What the analysis cannot resolve is the political question. Blue bonds promise the largest stock — €5tn — but at the highest political cost: durable national tax-revenue ring-fences and individual guarantees backing a senior pool that legally subordinates remaining national debt. Lustig’s moral-hazard concern, transposed from the American 1840s, is that joint debt without binding fiscal discipline is unstable. The national-strategy path requires a degree of sustained fiscal consolidation that has historically proven difficult to maintain across multiple electoral cycles. The status quo continues to produce supranational issuance, but at a pace that may not match the volume Lane and Rehn argue is needed.

There are also things financial economics cannot tell us. Whether investors will buy the junior tranche of an SBBS structure at sustainable yields is an empirical question — it has not been tested at scale, and the ESRB HLTF’s 2018 survey of market participants found stronger interest in the senior tier than the junior. Whether the senior tranche, even at 0.09% expected loss, receives AAA-equivalent treatment for bank capital and ECB collateral purposes depends on regulatory choices that have not been made — and it is one of the choices the 2018 Commission proposal was designed to enable. Whether Europe’s political appetite for any of the three reform designs has materially changed since 2018 is a question about institutions, not models.

Lane’s keynote suggests that the technical groundwork for the main designs is largely in place. The ECB has been building adjacent infrastructure for the euro’s international role — TPI for managing sovereign-spread fragmentation, the expanded EUREP facility providing euro liquidity to non-euro-area central banks — but the safe asset itself remains the missing piece.

The 2018 ESBies proposal stalled because the volumetric and macroprudential urgency was not yet sufficient to overcome the political friction. The numbers in this piece — €3.6tn AAA stock, doom-loop exposures at multi-decade highs, the continuing erosion of the global safe-asset hierarchy — suggest the calculus may be different in 2026.

Paweł Fiedor - The Macro Prudential View

The views expressed here are personal and do not represent the views of the European Systemic Risk Board.

Charts compiled from: Brunnermeier, Langfield, Pagano, Reis, Van Nieuwerburgh and Vayanos, “ESBies: Safety in the tranches”, Economic Policy 32(90), 2017; Blanchard and Ubide, “Now is the time for Eurobonds: A specific proposal”, PIIE, 2025; the ESRB High-Level Task Force on Safe Assets, 2018; Bruegel, “Don’t look only to Brussels to increase the supply of safe assets in the EU”; Lustig, “Blue Bonds in Europe”, The Two Cents; Duffie, “How US Treasuries Can Remain the World’s Safe Haven”, Journal of Economic Perspectives, 2025; Gorton, “The History and Economics of Safe Assets”, NBER Working Paper, 2016; Bank of England, “An anatomy of the 2022 gilt market crisis”, 2023; the European Commission’s EU as an issuer page; national debt management offices for sovereign bond and bill stocks (Deutsche Finanzagentur, Agence France Trésor, MEF/Banca d’Italia, Tesoro Público, DSTA, Belgian Debt Agency, OeBFA, Finnish State Treasury, NTMA, IGCP, PDMA); ESM, EFSF, EIB, CEB, EBRD financial reports; the AFME Government Bond Data Report Q4 2025; SIFMA’s US Fixed Income Securities Statistics; the ECB Data Portal (BSI dataset); S&P Global Ratings, “Default, Transition, and Recovery: 2024 Annual Global Sovereign Default and Rating Transition Study”; rating actions verified against issuer investor-relations pages and the Wikipedia List of countries by credit rating. Lane and Rehn speeches as referenced. Author’s calculations throughout.

In December 2025 the European Central Bank announced that its 2026 thematic stress test would be a reverse stress test, conducted on 110 directly supervised banks and focused on geopolitical risk. Each bank will be asked to identify the scenarios that could produce a depletion of at least 300 basis points in its CET1 capital ratio. The exercise will use existing supervisory data templates, will inform and complement the SREP qualitatively in line with the broader 2026 ICAAP, and is — in the press release’s own language — “not intended to have any implications for Pillar 2 Guidance,” meaning the exercise is structured as a discovery exercise rather than an input to binding capital constraints. Aggregate results are due in summer 2026.

Read narrowly, this is a thematic supervisory exercise on a particular risk driver. Read more broadly, it is the first ECB thematic exercise to use the reverse methodology for directly supervised significant institutions, and the announcement frames it explicitly as a complement to the 2025 EBA exercise — “which assumed a common scenario for all banks and led to differences in their capital depletion.” That sentence in the press release does substantive work: the supervisor is framing the new exercise as addressing something the common-scenario approach does not.

This piece sets out why I think that framing is right. The argument has three parts, none of which is original to me but which fit together more cleanly than they are usually presented. First, the empirical track record of EU-wide adverse scenarios is harder to defend than the institutional discussion typically allows, even using the institutions’ own preferred severity metrics. Second, the methodological objection to single-scenario stress testing is mathematically tighter than the usual “models are imperfect” gloss suggests — and this matters, because the tighter version of the argument has a cleaner constructive response. Third, the methodological direction the ECB announcement points toward is more advanced than the announcement itself implies; the move has been compelling for at least a decade, supported by working papers from inside the major European supervisors, and is now consistent across European regulatory bodies.

The empirical record

Forward stress tests project an adverse scenario over a fixed horizon — typically three years — and ask what depletion of bank capital that scenario would produce. The scenario is published; the depletion is computed and reported; the supervisor and the public assess whether banks would have remained solvent. This is the structure of the EU-wide exercises since 2010 and of the US CCAR exercises over a similar period. The exercise has done useful work: disciplining bank capital planning, producing comparable bank-level data, standardising disclosures, and giving markets a coherent reference point for stress assessment. None of what follows is meant to question those benefits.

Whether the exercise has worked well as a representation of severe outcomes is a separate question. The most direct test is to compare scenario severity against what subsequently happened.

The chart is a heuristic comparison rather than a like-for-like forecast evaluation. Scenario severity and realised severity are measured over different windows — three-year cumulative paths against peak-to-trough declines — and scenarios are designed as plausible severe paths rather than as forecasts. With those qualifications, three observations from the data.

First, no adverse scenario in the series has projected a cumulative decline as severe as the realised peak-to-trough of either the global financial crisis or the COVID episode. The most recent 2025 scenario, calibrated against geopolitical risk and explicitly tightened relative to its 2023 predecessor, projects -6.3% cumulative real GDP — a more contained shock than what the EU economy actually delivered in either of the two major downturns of the last fifteen years.

Second, the 2020 contrast is the most direct. The ESRB scenario for the 2020 exercise was published on schedule in January 2020, projecting -4.3% cumulative real GDP over the 2020-2022 window. The exercise was cancelled in March 2020 as the pandemic arrived — the only time an EU-wide exercise has been cancelled mid-cycle. The realised peak-to-trough EU GDP decline between 2019Q4 and 2020Q2 was 13.3%. The scenario document itself, written weeks before lockdown, contained the line that its severity was “comparable to that observed in the global financial crisis from 2007 onwards.” The realised episode was substantially more severe by every reasonable measure of peak-to-trough decline, even allowing for the different time horizons of scenario and reality.

Third, the energy crisis cuts the other way. The 2023 stress test was calibrated against precisely the kind of geopolitical and energy-price shock that had begun to materialise — and projected -6.0% cumulative GDP. Realised EU GDP through 2022-2024 declined by approximately 0.2% peak-to-trough on the chain-linked volume series. The scenario was, on this metric, an order of magnitude more severe than the realised episode. Both directions of error are present in the same series.

A reader can fairly object that scenarios are not forecasts. The institutions are explicit on this point; the comparison to realised data is not a comparison of like with like. Accepted. But the methodological question remains: do single-point scenarios, however severe, capture the relevant range of outcomes? Realised shocks have repeatedly fallen outside the scenario envelope in both directions — which is exactly what we should expect if single-point scenarios are being used to represent events that have measure zero in a high-dimensional, nonlinear space.

A second observation, this time on the depletion side, sharpens the empirical case.

The 2025 EU-wide stress test results were widely reported as showing improved bank resilience, on the basis of a 109 basis point improvement in headline CET1 depletion relative to 2023 (both on a transitional basis). The decomposition tells a different story. Net earnings — predominantly net interest income — contributed +509 basis points to the capital ratio in 2025, up from +356 basis points in 2023. That tailwind is almost exactly what the elevated rate environment between the two cycles would produce. Credit losses, the line item that most directly measures realised risk, worsened by 32 basis points. Market and operational risk projections are not perfectly comparable across the two cycles, less because of a wholesale change in the stress-loss engines than because the 2025 exercise incorporated CRR3-related capital-framework changes, including REA restatements and output-floor effects. Even allowing for that, the headline improvement is overwhelmingly a rate-environment story rather than a risk story.

This is not a criticism of the EBA methodology; it is a feature of how single-scenario exercises decompose. Headline depletion measures the net of all driver lines and is sensitive to the environment as much as to the scenario. The decomposition is itself published, alongside the headline, in EBA results reports. But the headline number is what enters the public discussion, and a reader looking only at “-370bps vs -479bps” would draw conclusions about banking sector resilience that the underlying data do not directly support.

Both charts are facts about how single-scenario stress tests perform. Whether they should perform differently is a methodological question.

The methodological objection

The standard critique of stress tests is that “models are imperfect” or that “tail risks are hard to capture.” Both are true and both are weak. They invite the response that all empirical exercises have these problems and that stress tests are nonetheless useful — a response which is also true. The methodological case has to be tighter than this if it is going to do real argumentative work.

The tighter case has two layers, and they stack.

The first is a point about probability. A stress test scenario is a point in a continuous space — a several-thousand-dimensional vector specifying values for GDP and other macroeconomic variables across countries, sectors, asset classes, maturities, and quarters of the horizon. Any single point in such a space has probability zero under any continuous distribution. The exercise of asking “what is the loss under this scenario” is not the same as asking “what is a plausible severe loss.” It is asking what the loss would be at one arbitrary point. The severity of the point is itself ill-defined except as part of a region of points — which is what reverse stress testing, distributional approaches, and scenario sets are designed to characterise.

The second layer is about the loss function itself. Even granting that a scenario is “approximately right” in some informal sense, the loss function is not smooth in the relevant scenario parameters near regulatory thresholds and behavioural transitions. Outputs are not continuous in inputs near these transitions, and being approximately right on inputs can produce arbitrarily wrong outputs. This is what makes the first objection bite. If the loss function were smooth in scenario parameters, point estimates would be defensible as adequate local approximations. Because the loss function is not smooth, they are not.

The first objection holds in linear-Gaussian worlds. The second is what makes the first matter.

The dimensionality calculation is illustrative rather than literal. The variables in a stress test scenario are not independent and not uniformly distributed, so the volume-ratio formula does not apply directly, and the 33,600-variable count is an approximate multiplication derived from the scenario note rather than an official EBA figure. A quantitative analyst might fairly object that high correlation between variables reduces effective dimensionality to a handful of principal components — global growth, interest rates, inflation, perhaps a credit factor. Granted. But the non-smoothness of the loss function means that even slightly missing the right combination of those core factors can still produce entirely wrong outputs near the relevant cliff edges. Effective dimensionality buys you something for smooth functions and very little for non-smooth ones.

The non-smoothness objection is harder to wave at because it has empirical content. A direct example comes from a recent simulation framework for sterling money market funds.

Kumar’s framework approaches the problem from the right end: rather than assuming a particular adverse scenario and computing a fund’s response, it sweeps across the joint space of (redemption profile × market depth × WLA bucket) and computes failure probability as a surface. The headline finding is precisely that the redemption response has a kink at 40% WLA, with the cliff incentive structure activated as WLA falls toward the 30% regulatory minimum. The minimum itself is the supervisory threshold that triggers the acceleration; the 40% activation point is where the acceleration actually begins, ten percentage points before the minimum is hit. A stress test that linearises around current WLA values cannot represent either feature. The supervisor that wishes to know how much capital a fund needs against this risk is not well-served by a single scenario, however severe.

What makes Kumar’s contribution interesting beyond its specific NBFI application is that it is methodologically the same move as reverse stress testing for banks. Specify the failure condition; sweep the parameter space; identify the regions where failure becomes probable. The forward question — “is the fund OK under this scenario” — has been replaced by the reverse question: “what region of plausible futures threatens the fund.”

The constructive response

A useful clarification before going further. Three different exercises share the name “stress testing” and are easy to conflate. Supervisory stress testing is the common-scenario exercise applied bank by bank by the supervisor, asking how each institution would fare under a specified adverse scenario; results are used for comparability, oversight, and supervisory review. ICAAP reverse stress testing starts from a pre-defined failure or near-failure outcome and asks which firm-specific scenarios would bring the bank to that point; it is an internal capital-planning tool tied to the institution’s own vulnerabilities and business model, and has been required of banks under European supervisory guidelines for over a decade. Macroprudential distributional stress testing studies the distribution of losses, capital depletion, or credit supply across banks or the financial system; the question is not whether one bank survives one scenario, but how stress propagates across the system and what that implies for buffer-setting and financial stability.

The 2026 ECB exercise is the first thematic supervisory exercise to use the reverse methodology for directly supervised significant institutions — bringing together the structure of supervisory stress testing with a tool that has been in use for ICAAP purposes for some time. Worth noting that reverse stress testing is not the same as worst-case stress testing: it characterises the region of scenarios that produce a target loss, not a single extremal point. The shift is from one point to a set, not from one severe point to a more severe one.

Reverse stress testing has older roots. Banks have been required to conduct internal reverse stress tests as part of capital planning under various European supervisory regimes since 2010. The methodological argument for adopting it as the headline supervisory exercise — rather than as a complementary internal practice — has been articulated for at least as long. Borio, Drehmann and Tsatsaronis put the case cleanly in 2012, in a BIS working paper that has aged well: stress tests in their then-current form were “ill-suited as early warning devices” because the very structure of the exercise — point estimate from a model fitted to non-crisis data — could not capture the nonlinear dynamics that characterise actual financial instability. Their preferred response was not to abandon stress testing but to redesign it: more attention to the structural properties of the loss function, less reliance on the severity of any single calibrated point.

A more recent ECB working paper makes a structurally similar argument from inside the institution. Aikman, Angotti and Budnik (May 2024), in a paper titled “Stress testing with multiple scenarios: a tale on tails and reverse stress scenarios,” frame the case in language that is recognisably consistent with the earlier critique: scenarios “may not always be realistic or severe… can leave aside dangerous possibilities and create an illusion of safety.” The paper’s recommendation — multi-scenario analysis rather than single-point exercises, with reverse scenarios as a complement — sits comfortably alongside the move toward the 2026 exercise as part of the same methodological direction.

I find both of these arguments compelling. The constructive position they share is the right one. Forward and reverse stress testing are not substitutes; they are complements that answer different questions. The forward exercise has done useful work disciplining bank capital planning, producing comparable bank-level data, and giving markets a coherent reference point. The reverse exercise asks a different question — what region of the future threatens us — that the forward exercise structurally cannot answer. A supervisor that runs both is doing more work than one that runs either alone, and the press release’s framing of the 2026 exercise as a complement to the 2025 EBA exercise is exactly the right institutional posture.

There is one aspect of the methodological direction that is worth being honest about. The reverse exercise, like the forward exercise, requires a model. Sweeping the scenario space to characterise the loss frontier is computationally expensive and statistically demanding, and the regions it identifies are themselves model-dependent. The methodological objections that apply to forward stress testing apply, in a different form, to reverse stress testing too. The improvement is real but not unbounded; the loss function we are characterising is still being characterised by a model, and that model is still imperfect.

What reverse stress testing buys is not certainty about the future but a more honest representation of what supervisory analysis can and cannot do. Specifying a loss frontier and asking what plausible futures cross it is dimensionally honest in a way that specifying a point and computing the loss at it is not.

A regime change, slowly then suddenly

The argument I have set out here is not new. It was articulated in the academic literature by 2012, has been endorsed in working papers from inside the major European supervisors over the past two years, and is now being implemented in the form of a supervisory exercise. The interesting question is not whether the methodological objection is correct — it has been, by now, difficult to dismiss for some time — but why the institutional response has taken the shape it has and on the timeline it has.

My best guess is that two things had to happen at once. First, the empirical track record had to accumulate enough mismatches that the methodological objection could no longer be treated as a theoretical concern. The 2020 cancellation, the 2021 “most severe ever” exercise being followed by a year of NBFI stress that the scenario did not capture, and the 2023-2025 sequence of headline-level depletion improvements driven by rate environment rather than risk — these all happened in close succession and made the case empirically rather than methodologically. Second, the technical infrastructure had to mature enough that the alternative was operationally feasible. Reverse stress testing of the kind the ECB has announced, and parameter-space sweeps of the kind Kumar implements, depend on simulation frameworks, bank-level data infrastructure, and computational resources that were not realistically available a decade ago. The operational lift is substantial: the 110 banks in the ECB exercise have to construct loss surfaces rather than evaluate point losses, and that capability is genuinely new at supervisory scale.

Both conditions are now met. The 2026 exercise will not by itself replace the forward stress test apparatus; the press release is explicit that the reverse exercise complements rather than replaces the EBA’s common-scenario exercises. But it represents a meaningful change in the direction of methodological emphasis, and it is consistent with where the field — academic and supervisory — has been moving for some time.

The regime change has been slow. It seems to be becoming sudden.

Paweł Fiedor — The Macro Prudential View

Charts compiled from ESRB scenario notes for the 2014–2025 EU-wide stress test exercises, Eurostat quarterly GDP series namq_10_gdp (EU27, chain-linked volumes, seasonally and calendar adjusted), EBA 2023 EU-wide stress test results and EBA 2025 EU-wide stress test results. Cumulative growth from starting point taken directly from each ESRB scenario note where reported, or computed from annual adverse-scenario growth rates where the cumulative figure was not given in tabular form. Full referenced papers: Borio, Drehmann and Tsatsaronis, Stress-testing macro stress testing: does it live up to expectations? (BIS WP 369, January 2012); Aikman, Angotti and Budnik, Stress testing with multiple scenarios: a tale on tails and reverse stress scenarios (ECB WP 2941, May 2024); Kumar, A simulation framework for sterling money market funds (BoE WP 1177, March 2026). ECB announcement of the 2026 reverse stress test exercise: press release of 12 December 2025.

On 5 March 2025, the German 10-year Bund yield rose by 30 basis points in a single trading session — the largest one-day move since the fall of the Berlin Wall. The immediate trigger was the coalition parties’ agreement to suspend the debt brake and establish a €500bn infrastructure and defence special fund. But the magnitude of the move revealed something more structural: a market in which the most reliable buyer has been systematically withdrawing for two years, and in which the new buyers are not equivalent replacements.

This article examines that structural shift through four data series. It is not, at its core, a story about German fiscal policy, although that is the most visible current catalyst. It is a story about who absorbs European sovereign debt when the ECB does not — and whether those buyers are stable enough to do so without periodic crises of the kind 5 March 2025 briefly resembled.

The timing is not accidental. The Group of Thirty released its working group report on nonbank financial intermediation in April 2026, co-chaired by Agustín Carstens and Klaas Knot, titled Nonbank Financial Intermediation and Financial Stability: A Perfect Storm in the Making? The report’s central concern — that NBFIs have taken on a growing share of sovereign financing precisely as their structural vulnerabilities are increasing — maps directly onto what European sovereign bond data now shows.

Yields and their volatility

The yield chart tells a familiar story at first glance: rates rose sharply from near-zero as the ECB tightened in 2022, then stabilised through 2023–2024, with the five major euro area sovereign curves trading in a broadly correlated band. Bund–BTP spreads, which peaked at around 250 basis points in mid-2022, compressed to roughly 115 basis points by early 2025 — itself a notable fact given ongoing pressure on Italian fiscal metrics.

What is less visible in yield levels is volatility. The rolling realised volatility chart below makes it explicit.

The 2022 spike is expected — the ECB moved faster than at any point in its history, and markets were repricing duration risk across the entire curve simultaneously. What is more interesting is what happened in 2025. The March spike briefly exceeded the 2022 peak in short-term volatility terms, and it occurred in a regime that had looked, by the surface metrics of 2024, relatively calm.

The April episode — triggered by US tariff announcements that sparked a global risk-off rotation, initially driving capital toward core European sovereigns even as it unsettled peripheral spreads — produced a secondary spike. J.P Morgan & ESMA data (via ESRB report) showed that during the episode, European high-yield bond ETFs saw outflows of 6.4% of NAV in a single week, while sovereign bond funds saw simultaneous inflows — the flight-to-safety dynamic within the NBFI sector made visible, illustrating exactly the leveraged, fast-unwinding demand the G30 report warns about.

Two features of this overall pattern deserve attention. First, the 2025 spikes are idiosyncratic rather than systemic in origin — one driven by domestic fiscal news, one by US trade policy — suggesting the market has become sensitive to individual triggers in a way it was not when the ECB was a reliable marginal buyer.

Second, neither episode produced lasting dislocation. The ECB did not intervene. Markets self-corrected. This is the outcome policymakers point to as evidence that the absorption transition is proceeding smoothly. It may be the right conclusion — or it may reflect conditions that have not yet been genuinely tested.

The supply gap

The ECB’s withdrawal from European sovereign bond markets is neither subtle nor ambiguous in the data. Under the PSPP, the ECB built cumulative holdings of roughly €670bn in German sovereign debt, €540bn in French, €450bn in Italian and €320bn in Spanish bonds at their respective peaks. Since active portfolio reduction began in March 2023, those holdings have fallen by €202bn, €153bn, €149bn and €79bn respectively — a combined withdrawal of roughly €600bn across the five largest euro area economies in under three years.

The pace matters as much as the magnitude. The ECB is no longer reinvesting the principal payments from maturing securities under the PSPP; it is allowing its portfolio to run off at a measured and predictable pace — a portfolio that became, during the QE years, one of the largest single holders of European sovereign debt. The buyers on the other side of this withdrawal are heterogeneous — domestic banks, foreign official sector, asset managers, pension funds, insurance corporations, and an increasingly significant segment of hedge funds operating through the repo market. The ESRB’s NBFI Risk Monitor documents hedge funds’ average net borrowing in EU sovereign repo at €115bn in Q4 2024. That is not a trivial position. The pattern is not unique to the euro area. The Bank of England's Deputy Governor for Financial Stability noted on 17 April 2026 that net gilt repo positioning among hedge funds reached its highest level since data collection began in 2017 by early 2026, with borrowing concentrated among a relatively small number of firms pursuing similar strategies — a concentration risk that maps directly onto the European data.

What is striking about this transition is its coincidence with rising supply. Germany’s debt brake suspension and the €500bn special fund represent a structural shift in sovereign issuance that will persist for the better part of a decade. France, Italy and Spain face their own fiscal pressures. The G30 report notes that sovereign debt in advanced economies has expanded roughly 60% faster than credit to the private sector over the past fifteen years, and that NBFIs must increasingly serve as the marginal buyer as central banks withdraw. The European data confirms this is happening not as a projection but as a present reality.

The scissors effect

The fourth chart makes the supply-demand shift most concrete. In 2020 and 2021, the ECB absorbed roughly €52–55bn annually in German sovereign debt — covering between 25% and 40% of Germany’s net new borrowing in those years. The pandemic fiscal response was, in this sense, substantially ECB-financed. From 2023, the relationship inverted. The ECB withdrew €51.7bn net in 2023, a year in which Germany itself only net-borrowed €27.2bn. In 2024, ECB withdrawal (€72.2bn) was more than twice Germany’s net issuance (€33.3bn).

This is the scissors effect: simultaneously rising supply and withdrawing central bank support, meeting at a point where the residual buyer must absorb both the new issuance and the ongoing redemptions from the ECB’s portfolio. With German net borrowing rising again in 2025 (€67bn) and the special fund adding further issuance pressure from 2026, the structural demand for non-ECB buyers of German paper is growing in both directions at once.

The BlackRock Investment Institute, writing on 13 April 2026, concluded that increased German bond issuance “is already largely reflected in the current level of 10-year yields.” That may well be correct. But markets have a habit of interpreting the absence of stress as proof of resilience — precisely the behavioural bias the G30 report cautions against.

Who the new buyers are, and why it matters

The G30 report’s taxonomy of NBFI forms is useful here. The buyers filling the ECB’s role in European sovereign markets are not homogenous. Some — pension funds, insurance corporations, sovereign wealth funds — are genuinely long-horizon, buy-and-hold investors whose presence in the sovereign market is structurally stabilising. The FSB’s latest global monitoring report confirms that these investors have increased their sovereign debt holdings meaningfully, though gradually.

Others are not. The ESRB’s data on hedge fund sovereign repo exposure, and the G30’s documentation of near-zero repo haircuts for the largest hedge-fund borrowers — in some cases 50 basis points or lower — implying leverage ratios that can reach 200 times or more — point to a significant component of sovereign market demand that is highly leveraged, short-duration funded, and prone to rapid unwinding. The basis trade, in which hedge funds hold sovereign bonds financed through repo while taking offsetting derivatives positions, has become a meaningful source of demand in European sovereign markets. The April 2025 episode illustrated what the European equivalent could look like at larger scale under less benign conditions.

Critically, this is not a risk contained within the NBFI sector. The G30 report’s “transformation form” argument makes clear that while credit risk has migrated from banks to NBFIs, much of the associated liquidity risk remains concentrated in the banking system. When a leveraged basis trade unwinds, the prime brokerage banks are directly in the line of fire — which is why the G30 treats this not as a shadow banking problem but as a core financial system problem.

The FSB documents that NBFIs increased their share of advanced economy sovereign bond holdings by approximately 7.9 percentage points between 2021 and 2024. What this means in practice is that the marginal price-setter in European sovereign markets has changed — from a central bank with an unlimited balance sheet, no leverage constraint, and no redemption risk, to a collection of entities with varying degrees of leverage, short-term funding, and sensitivity to global risk appetite.

This does not make European sovereign markets unstable. Most of the time, the new buyer composition functions adequately. The 2025 episodes suggest that under episodic stress, the transition from central bank to NBFI as marginal buyer is visible in volatility even when it does not produce lasting dislocation.

The honest uncertainty is whether episodes that resolve without intervention are evidence of resilience, or of good fortune.

The regulatory gap

One dimension of this transition that the G30 report addresses directly, and that the European data makes urgent, is the absence of a central bank liquidity facility for NBFIs in the euro area. The Bank of England adopted its Contingent Non-Bank Financial Institution Repo Facility in 2025 — a pre-designed, contingent mechanism through which the BoE can provide repo liquidity directly to insurance corporations and pension funds under defined stress conditions, at penalty rates and with strict eligibility criteria. The facility is not standing; it activates on defined triggers. But its existence means the BoE has a documented, ex-ante response to NBFI liquidity stress in gilt markets.

The ECB has no equivalent. EUREP — the ECB’s repo facility for non-euro area central banks — is not designed for this purpose. The ECB’s operational toolkit for managing sovereign market dysfunction runs through bank intermediation and, ultimately, asset purchase programmes.

The G30 report is explicit: relying on broad asset-purchase programmes as the default backstop for NBFI stress creates moral hazard and blurs monetary-policy communication. No equivalent targeted, pre-committed tool currently exists in the euro area. This is not an argument for the ECB to backstop hedge funds. The G30’s framework carefully distinguishes between providing contingent liquidity to systemically important NBFI activities — pension funds, insurance corporations, large asset managers — under strict conditions, and open-ended support for leveraged trading strategies. The former has a legitimate financial stability rationale. The latter does not. The challenge is that designing a facility which credibly separates the two, in advance, is genuinely difficult — as the BoE’s CNRF design process illustrated. The difficulty of the design problem is, in the G30’s assessment, not a sufficient reason to avoid attempting it.

What to watch

The immediate catalyst for this article — the March 2025 Bund spike and its connection to German fiscal expansion — will fade as a market focus. German issuance will be absorbed, spreads will stabilise, and the volatility charts will normalise. That is almost certainly the right base case.

What will not normalise is the structural composition of who holds European sovereign debt. The ECB’s portfolio will continue to decline. German, French and Italian issuance will continue to rise. The NBFI share of the marginal buyer will grow further. And the institutional infrastructure for managing stress in that buyer base — data quality, supervisory frameworks, liquidity facilities, crisis simulation — remains incomplete by the most detailed practitioner assessment yet published on the subject.

The G30 report asks whether a perfect storm is in the making. The honest answer, consistent with the report itself, is that the conditions for one are assembling — and that the absence of a storm so far is not the same as the absence of risk.

Paweł Fiedor — The Macro Prudential View

Charts compiled from ECB Asset Purchase Programme statistics (April 2026), Bundesministerium der Finanzen (January 2026), ESRB NBFI Risk Monitor, and Investing.com. Full G30 report: Nonbank Financial Intermediation and Financial Stability: A Perfect Storm in the Making? BlackRock Investment Institute commentary (13 April 2026) linked in text.

Last week I used the IMF’s Global Financial Stability Report to make the case that ETF hoarding and passive flows were quietly reshaping emerging market debt dynamics. This week I am back at the same well. The GFSR, it turns out, has more to give — and the news cycle has helpfully provided a real-world stress test of one of its central anxieties.

The anxiety in question is stablecoins. Not the crypto-bro version of the argument — moon, lambos, number go up — but the macroprudential one. The IMF, the European Systemic Risk Board, and a handful of serious monetary economists have spent the past eighteen months constructing a framework for thinking about stablecoins as a financial stability problem. That framework now has a live case study: the Strait of Hormuz, where Iran’s Islamic Revolutionary Guard Corps has been collecting transit tolls from oil tankers in Bitcoin and USDT since mid-March 2026. Theory, meet practice.

Part I: What the IMF actually said

The April 2025 GFSR dedicated prominent analysis to crypto assets and stablecoins, and its tone was notably less hedged than the Fund’s usual register. The central concern is what the IMF calls “cryptoization” — the process by which residents of countries with weak or compromised monetary frameworks substitute dollar-pegged stablecoins for their domestic currency. This is dollarization by another name, but faster, cheaper, and harder to monitor. You do not need a US bank account to hold USDT. You need a smartphone.

The IMF’s concern is not symmetrical across countries. In advanced economies with deep financial markets and credible central banks, stablecoin adoption is largely a regulated integration story — a new payment rail sitting alongside existing infrastructure. The risk is different in economies with high inflation, volatile exchange rates, and weak institutional anchors. There, stablecoin adoption can quietly hollow out domestic monetary transmission, erode the central bank’s balance sheet, and accelerate capital flight in ways that are nearly invisible to conventional surveillance tools.

The countries named or implied in the GFSR — Argentina, Turkey, Nigeria, Lebanon, Venezuela — are not accidental. These are places where the dollar has long served as an informal unit of account and where stablecoin adoption is driven not by convenience but by survival. What is new is the scale and speed. The IMF’s July 2025 External Sector Report noted that stablecoin flows relative to GDP are most significant in Latin America and the Caribbean, and in Africa and the Middle East — precisely the regions with the greatest institutional vulnerability.

There is a second concern that sits at the opposite end of the risk spectrum but is equally striking. Stablecoins are not just a monetary sovereignty problem for fragile economies. They are becoming a structural feature of the US Treasury market.

Hélène Rey of the London Business School has argued that this dynamic amounts to the privatisation of global seigniorage — concentrating in a handful of private companies a function that central banks have exercised for centuries. The beneficiaries, she notes, are likely to be few given the strength of network externalities, with significant implications for the political economy of regulation.

Tether and USDC combined held approximately $146 billion in direct US Treasury securities at end-2025 (Tether's independently attested direct holdings were $122bn per its ISAE 3000R attestation, with Circle USDC comprising the remainder) — within $3.4 billion of Saudi Arabia’s holdings, and comfortably in the same league as Norway, India and Brazil. The IMF’s July 2025 External Sector Report flagged this directly, noting that at an earlier point in the year the two issuers collectively held more Treasuries than Saudi Arabia. The figure has since converged as Saudi Arabia’s holdings grew, but the point stands: two private companies, accountable to no central bank and subject to no formal reserve requirements under US law until the GENIUS Act passed in July 2025, had quietly become systemically relevant holders of the world’s benchmark safe asset. A confidence shock — a stablecoin run — would not stay in crypto markets. It would land in short-term Treasuries.

Part II: The ESRB and the multi-issuer loophole

European regulators have been watching a more specific structural vulnerability develop on their doorstep. The ESRB’s October 2025 report on crypto assets identified what it called the multi-issuer stablecoin problem, and issued a formal recommendation — ESRB/2025/9 — urging the European Commission to clarify that these schemes are not permissible under MiCAR.

The mechanics are worth understanding because they are the kind of thing that looks innocuous until it isn’t. A multi-issuer stablecoin involves an EU-regulated entity and a third-country entity — typically the parent company — co-issuing what is legally and technically a single, fungible token. The reserves backing the token are split across jurisdictions. Under MiCAR, the EU issuer is prohibited from charging redemption fees and must redeem at par, at any time. The third-country issuer faces no such constraint. In a stress scenario, non-EU token holders have a strong incentive to seek redemption through the EU entity — better terms, legally enforceable rights, a regulated counterparty. The EU issuer then faces redemption pressure it cannot fully hedge, from a reserve pool it cannot fully see, under a cross-border rebalancing mechanism that the ESRB explicitly describes as fragile.

Richard Portes of the London Business School, who co-chaired the ESRB’s Crypto Asset Task Force, has written up the academic case for urgency in a VoxEU column published in late 2025. His argument is direct: the multi-issuer loophole, if left unaddressed, exposes the EU financial system to contagion from crises originating in third-country jurisdictions, with EU supervisors holding responsibility for liabilities created entirely outside their remit.

The European Commission, as of writing, has not formally ruled the schemes impermissible. Several members of the European Parliament have written to Commissioner Albuquerque expressing concern. ECB President (and ESRB Chair) Lagarde has been more forthright in her public opposition. The institutional standoff is unresolved, which is part of what makes the ESRB recommendation significant — it is not an academic intervention but a formal macroprudential alarm from the body charged with systemic risk oversight in the EU.

Part III: The Strait of Hormuz — theory meets geopolitics

Which brings us to the news hook that makes all of the above feel less theoretical than it did a month ago.

Since mid-March 2026, Iran’s IRGC has been charging oil tankers up to $2 million per vessel to transit the Strait of Hormuz, accepting payment in Bitcoin, USDT, and Chinese yuan routed through Kunlun Bank outside SWIFT. Iran’s parliament formally codified the system in the “Strait of Hormuz Management Plan,” approved on 30–31 March 2026. At current traffic levels, public estimates from TRM Labs suggest the toll system could generate up to $20 million per day from oil tankers alone, with $600–800 million per month possible if LNG vessels are included.

This is the first time a state has deployed stablecoin infrastructure as a sovereign revenue mechanism at a major maritime chokepoint. It is not, however, a departure from Iran’s existing financial playbook. It is an extension of it. Chainalysis has documented IRGC-attributed on-chain activity growing from approximately $1 billion in 2023 to over $3 billion in 2025, based on OFAC designations and NBCTF seizure lists — figures that represent a lower bound, since they cover only identified wallets. The IRGC’s documented flows have overwhelmingly relied on stablecoins rather than Bitcoin, for reasons that are straightforward: stablecoins offer dollar-denominated value, high throughput, deep liquidity, and no issuer that can easily freeze an account.

That last point is important. In March 2026, Tether froze $6.7 million tied to IRGC and Houthi-linked networks. Bitcoin cannot be frozen by anyone. The choice of payment rail reflects operational learning about where the vulnerabilities in each system lie.

As this piece goes to press the situation is live and escalating. Iran declared the strait open on 17 April in line with a Lebanon ceasefire, then reversed course within 24 hours, reasserting “strict control” until the US lifts its naval blockade of Iranian ports. IRGC gunboats attacked a tanker on 18 April — no injuries, but a significant escalation. The ceasefire expires mid-week, with Pakistani-led mediation scrambling to extend it. What is not in flux is the underlying infrastructure: the toll system, the crypto payment rails, and the IRGC’s on-chain apparatus predate this crisis and will outlast any particular ceasefire. The Hormuz situation is the stress test — not the source of the vulnerability.

A brief note on epistemic caution: TRM Labs’ own Ari Redbord told Fortune that he was sceptical crypto was being used at scale for toll payments as opposed to being signalled as an available option. The situation was, in his words, “incredibly fast moving.” Subsequent on-chain reviews by Chainalysis (10 April) have reached the same conclusion. The Chainalysis framing is more bullish on the significance. Both are worth reading. What is not in dispute is that Iran has built the infrastructure for stablecoin-denominated state revenue collection and has been using it for sanctions evasion at scale for several years. The Hormuz toll system is the most visible deployment of that infrastructure, not its origin.

There is one political economy footnote that deserves a sentence. One commentator observed that if Iran were to demand payment specifically in USD1 — the stablecoin affiliated with the Trump family’s World Liberty Financial — the President of the United States would face a financial incentive to lift sanctions. The observation is not presented here as a prediction. It is presented as an illustration of how private stablecoin infrastructure can become entangled with geopolitical incentives in ways that conventional financial plumbing simply does not permit.

Part IV: Putting it together

The IMF, the ESRB, and Richard Portes have all been making versions of the same argument in measured institutional language: stablecoins are no longer a crypto-native curiosity. They are monetary infrastructure with systemic implications, and the regulatory frameworks governing them are running several years behind their actual footprint.

The framework they offer can be summarised across five interlocking risks. First, reserve concentration: if a major stablecoin issuer faces a confidence shock, the forced liquidation of its Treasury holdings could disrupt short-term funding markets well beyond crypto. Second, cryptoization: in fragile economies, dollar-pegged stablecoin adoption is quietly hollowing out domestic monetary sovereignty in ways that are hard to reverse. Third, regulatory arbitrage: the multi-issuer loophole is the EU-specific version of a global pattern in which jurisdictional gaps between stablecoin issuers create run risk and supervisory blind spots. Fourth, sanctions evasion: Iran has demonstrated that stablecoin infrastructure can function as a parallel financial system for a comprehensively sanctioned state, and the architecture is available to others. Fifth, dollar exorbitant privilege 2.0: the proliferation of dollar-backed stablecoins may reinforce rather than undermine dollar dominance, but it does so by privatising seigniorage — concentrating it in a handful of companies whose governance and accountability bear no resemblance to a central bank.

None of these risks is yet systemic in the sense that regulators use that word carefully. The IMF is explicit about this. Stablecoin market capitalisation remains small relative to global currency flows, and the transmission channels to traditional financial markets are still developing. But the pace of development — market cap roughly doubling in two years, IRGC volumes tripling, multi-issuer schemes securing MiCAR authorisation before the regulatory framework could catch up — is precisely the dynamic that macroprudential frameworks are designed to flag before the fact rather than respond to after.

The GENIUS Act in the US, MiCAR in Europe, and the ESRB’s recommendation are all attempts to close the gap. Whether the European Commission acts on the ESRB’s advice before the next stress test arrives is an open question. The Strait of Hormuz did not wait for an answer.

The Macro Prudential View is published weekly. If you found this useful, please share it.

Last month gave us a live demonstration of the mechanism this article is about.

When the Iran war began on February 28 (following US-Israeli strikes on Iran), foreign investors pulled $70.3 billion from emerging markets in a single month — the largest outflow since the pandemic rout of March 2020, according to IIF data reported by Reuters. The chart above shows what that looked like at the ETF level across three panels.

The top-left panel tells the price story. South Korea fell nearly 19% from its pre-war close to end of March. The broad EM index fell 9%. Brazil barely moved. The Korea vs Brazil contrast reflects something real about the shock itself — Asian tech manufacturing hubs are heavily dependent on Middle East oil imports, which makes them acutely vulnerable to an energy price spike. That is a genuine fundamental difference. But the speed, synchronicity and scale of the selling also reflected a market structure in which passive vehicles mechanically offload the same benchmark names at the same time. Every broad EM ETF holds the same Korea overweight. When the exit began, it was simultaneous across thousands of funds sharing identical index weights. Bloomberg reported that INDA and EWT — both in the drawdown panel — suffered record monthly redemptions of $1.4 billion and $1.1 billion respectively in March, confirming that price declines were accompanied by large-scale AP (Authorised Participant) redemptions into the underlying markets.

The lower-left panel adds something the price chart cannot show: the redemption channel made visible. It tracks EEM (iShares MSCI Emerging Markets ETF) shares outstanding — green bars are AP share creations, red bars are redemptions into the underlying market. Two things stand out. First, the inflow staircase in January and February: 98 million new EEM shares were created in nine weeks as risk appetite surged, representing roughly $5.8 billion of pre-war positioning in a single ETF. Second, and more important: prices fell sharply from March 2 but AP redemptions did not begin until March 16 — a full two weeks later. Once they started, 41 million shares were redeemed in eight trading days. The secondary market absorbed the initial selling through price decline. The structural forced selling came later, in a concentrated burst.

This two-week lag matters analytically. It means the price chart understates the eventual selling pressure — by the time AP redemptions activated, prices had already fallen and liquidity had already thinned. The redemptions then hit a market that was weaker than it had been when the first wave of selling began. That sequencing is not random. It is a feature of how the passive vehicle structure transmits stress, and it is what the rest of this article is about.

The IMF’s April 2026 Global Financial Stability Report Chapter 2, published this week, puts granular numbers on this dynamic across 50 emerging markets over two decades. And my own research explains the micro-mechanism that makes passive herding especially dangerous in debt markets — where the same logic produces not a visible, continuous selloff but a quiet accumulation of latent fragility that breaks suddenly under stress.

What the IMF found

Drawing on holdings data covering roughly 4,000 mutual funds and 7,000 institutional investors across 50 emerging markets, GFSR Chapter 2 documents something we suspected but could not previously quantify at this granularity. Since the global financial crisis, cumulative nonresident portfolio flows into emerging markets have approached $4 trillion, driven overwhelmingly by the nonbank financial sector. The NBFI share of EM portfolio debt liabilities has roughly doubled to 80% over two decades.

Within that universe, sensitivity to global risk varies sharply by investor type. Hedge funds are the most reactive, but passive mutual funds and ETFs are the most sensitive segment within the investment fund category — more so than active mutual funds, more so than pension funds or insurers. When global risk appetite deteriorates by one standard deviation in the VIX, passive funds and ETFs reduce their emerging market holdings significantly more than active funds. They are also more likely to pass investor redemptions directly through to underlying asset markets, given their limited flexibility to use cash buffers to absorb outflows.

The macrofinancial consequences are substantial. Countries whose debt markets rely most heavily on the flightiest investor quintile — defined by the GFSR as the top quintile of nonresident investors by VIX sensitivity, mainly hedge funds and passive vehicles — face a 28–45% decline in new debt issuance during stress episodes, spread widening of 30–120 basis points, and a 6 percentage point increase in downside GDP risk over the following quarter. These effects are persistent, remaining negative for up to four quarters on average, and are amplified for sovereigns with high debt ratios and firms with elevated leverage.

Figure 2.8 of the report makes this hierarchy crystal clear across two panels. Panel 2 shows that within the nonbank universe, hedge funds and mutual funds pull back most sharply from emerging markets when the VIX rises — insurers and pension funds show no significant adjustment. Panel 3 drills into investment funds specifically: passive strategies and ETFs display the largest additional sensitivity relative to their comparison groups, while the distinction between institutional and retail investors is not significant. The two panels together trace the mechanism from the broad NBFI universe down to the specific vehicle type — and the teal bars in the right panel are where the passive herding machine sits.

The accessibility channel: why passive herding works the way it does

The GFSR identifies passive funds and ETFs as the flightiest segment but does not spell out why their mechanics produce such powerful, synchronised behaviour. That requires looking at how ETFs actually transmit information and shocks to the securities they hold — and this is where the findings differ, in an instructive way, between equity and debt markets.

In research with Petros Katsoulis using the complete regulatory dataset of Irish-domiciled ETFs (€424 billion in AUM, roughly two-thirds of all euro-area ETF assets), we showed that ETFs form strong information links with underlying equities but weak ones with underlying corporate debt. The mechanism is arbitrage. When an ETF trades at a premium to its net asset value, Authorised Participants buy the underlying securities, deliver them to the ETF, and sell the newly created shares — creating a tight, continuous information channel between ETF prices and the prices of the underlying assets. But this only works when the arbitrage is cheap and fast to execute.

Exchange-traded equities satisfy this condition. OTC-traded corporate bonds do not. Search costs, transaction costs, and the post-crisis retreat of dealer market-making in corporate bond markets mean that APs face significant barriers to arbitraging ETF prices against the underlying bonds. The information link is therefore loose.

It is worth acknowledging that this accessibility asymmetry has real benefits in normal times. Passive vehicles have genuinely democratised access to EM assets, and the migration of liquidity traders to the ETF wrapper actually reduces cash bond market volatility when conditions are calm. The problem is what happens when the redemption channel activates under stress — which is where the normal-times stability becomes a liability rather than an asset.

The three panels below show all three dimensions simultaneously. A one-standard-deviation increase in ETF flows raises daily equity returns by 69 basis points but moves debt securities by only 0.4 basis points — a ratio of more than 170 to one. ETF illiquidity propagates to equity bid-ask spreads at 0.8 basis points; it has no measurable effect on debt spreads. Higher ETF ownership increases equity volatility — consistent with intensified arbitrage activity — but decreases debt volatility, because investors migrate to the more accessible ETF wrapper rather than transacting in the underlying bonds. The centre panel captures the return sensitivity contrast most vividly; the right panel’s sign reversal on volatility — positive for equities, negative for debt — is the single most important empirical result for what follows.

The sign reversal is not a curiosity. It is the mechanism.

The paradox: why weak links make debt more fragile, not less

Here is where the IMF’s macro findings and the micro-level evidence appear to point in opposite directions — and where working through that tension produces the most important insight. The matrix below maps the two transmission channels across the two asset classes. The bottom-right cell is where the IMF’s findings live, and it is coloured differently from the others for a reason.

The answer to the apparent contradiction is that the two bodies of evidence are measuring entirely different channels. My paper captures the arbitrage-information channel. Because corporate bonds are hard to access, APs cannot efficiently arbitrage the ETF against the underlying, the information link is loose, and ETF demand shocks do not propagate strongly into bond prices. Liquidity-motivated investors migrate to the ETF wrapper rather than transacting in the cash market, which can actually reduce bond market volatility in normal times. This looks, from the outside, like stability.

The GFSR is measuring the redemption channel. When end investors redeem en masse from a passive EM debt ETF during a risk-off episode, APs must eventually sell the underlying bonds regardless of whether the information link is tight or loose. The weakness of the arbitrage mechanism does not prevent forced selling. It just means the selling arrives without prior price discovery — and lands on a cash market that has been structurally hollowed out by the very same liquidity migration that made the normal-times volatility so low.

This is the paradox the bottom-right cell of the matrix above captures: the dynamic that makes ETF-to-debt information links weak under normal conditions leaves the cash market defenceless when the redemption channel activates under stress. Passive herding in equity markets is loud and visible in prices at all times. Passive herding in EM debt is quiet — and then catastrophic. The low normal-times volatility that the accessibility channel produces is not a sign of stability. It is the cliff being made steeper.

Note also what March 2026 showed about debt vs equity. The IIF data recorded $56 billion in equity outflows — the largest in at least 20 years — but only $14 billion in debt outflows. That asymmetry is consistent with the accessibility argument: the redemption channel hit equities first and hardest because arbitrage links are tight and price transmission is immediate. Debt markets absorbed less visible but still significant outflows, with the transmission mechanism working more slowly and less transparently. The GFSR’s spread widening and issuance data capture what that looks like at the macro level over a full stress cycle rather than a single month.

What the GFSR adds on scale and structure

Beyond the investor-type decomposition, the GFSR documents two structural features that amplify the mechanism above. The first is the scale of the shift itself. The two panels below show the growth of passive and active EM fund allocations since 2006 across both debt and equity. Read the two panels together and note that the right-hand axes are identical — making the gap between them meaningful rather than a charting artefact. In debt, passive share has risen from under 2% in 2007 to around 33% today. In equity the shift has gone further still, with passive now approaching half of all EM equity investment fund allocation. That near-parity in the equity panel is the most striking single fact in the chart and most readers will not know it.

The second structural feature is that the passive share gain is not simply a story of more money flowing in — it reflects active AUM actually shrinking in recent years while passive held up. The total height of the stacked areas in the debt panel peaked around 2021 and has not recovered to that level, but within that flat total the teal band keeps growing. Passive is not riding a rising tide. It is taking share from active in a mature and in some respects contracting market. That dynamic is what makes the redemption channel risk cumulative rather than episodic.

The GFSR documents a third amplifying feature: country-level buffers matter. Nonbank investors pull back significantly less from countries with stronger institutional quality, higher reserve adequacy, and lower public debt ratios. This creates a troubling asymmetry — the countries most dependent on flighty investors for external financing are typically those with the weakest buffers to absorb their sudden departure.

This is not an emerging markets story alone — even core sovereign borrowers are not immune. KfW — one of the world’s safest borrowers, a AAA-rated German development bank — issued a €5bn 10-year EUR benchmark in January 2026 and generated a €50bn order book. Trading-oriented accounts and hedge funds accounted for 54% of that order book, up from 41% two years earlier. Banks, traditionally the anchor buyers in SSA syndications, fell from 42% to 27% over the same period. KfW Treasury posted the investor breakdown on LinkedIn this week and it is worth looking at directly.

Two caveats are worth stating plainly. First, order book share is not the same as allocation — KfW notes that central banks and official institutions led actual allocations at 38%, and that hedge funds typically receive thin or zero allocations despite their outsized order presence. Second, KfW is not an emerging market. But that is precisely the point. The KfW data documents the growing dominance of short-horizon, trading-oriented accounts in the price discovery process for even the safest fixed income instrument in Europe. These accounts are setting the clearing price on a €50bn book. The passivisation and financialisation of the marginal buyer is not a vulnerability confined to fragile EM borrowers — it has reached the core of the global fixed income market. Scale that dynamic to EM debt, remove the central bank backstop, and add the redemption channel — and you have the mechanism the GFSR is now documenting at macrofinancial scale.

Policy implications

The GFSR’s policy recommendations are appropriate as far as they go: strengthen macroeconomic fundamentals, build reserve buffers, implement liquidity management tools for open-end funds, improve NBFI data reporting, and expand international cooperation on cross-border exposures. These are necessary conditions.

The accessibility channel points to several more targeted additions. Fund-level liquidity mismatch reporting should go beyond asset class labels to capture the accessibility of the underlying basket — specifically, how easily Authorised Participants can arbitrage ETF prices against the underlying securities. A bond ETF holding liquid investment grade credit is fundamentally different in redemption risk profile from one holding illiquid EM corporate debt, even though both appear as fixed income in current reporting frameworks. Swing pricing and anti-dilution levies should be calibrated to the accessibility of the underlying basket — the bar should be meaningfully higher for fixed-income ETFs holding illiquid EM corporate debt than for equity ETFs where the arbitrage cushion exists. Stress-testing scenarios at both fund and system level should incorporate the redemption channel explicitly, modelling the scenario where normal-times low volatility in cash bond markets coexists with latent, large-scale forced selling capacity in the ETF wrapper above it.

Most practically: supervisors and central banks in recipient countries should track the passive share and ETF ownership concentration of their debt markets as early-warning indicators. A rising passive share compresses normal-times volatility while fattening the left tail. That asymmetry is precisely what growth-at-risk frameworks should be capturing.

The bottom line

Passive investing is not the spark. It is an amplifier — and last month's EM selloff showed that amplifier working in real time. The IMF has now quantified how powerful it has become at systemic scale. The micro-evidence from ETF markets explains why benchmark-driven selling amplifies so asymmetrically across asset classes: accessibility governs whether ETF demand shocks create continuous, self-correcting transmission or accumulate quietly into a latent redemption cliff.

The contagion web is being rewired. Understanding its topology requires both the macro map the IMF has now provided and the micro-foundation the accessibility channel supplies. Policymakers and supervisors who treat passive flows as a second-order issue are working from yesterday’s map.

Paweł Fiedor — The Macroprudential View

There is a particular kind of financial confidence that deserves to be treated with suspicion. It is the confidence of those who design a system and then assure you, with impressive technical vocabulary, that the system cannot fail in precisely the way it is currently failing. Private credit has been producing this variety of assurance for several years now. The funds were semi-liquid, not illiquid. The caps were prudent, not restrictive. The ratings were rigorous, not captured. And the investors — overwhelmingly wealthy, sophisticated, advised — surely understood what they were getting into.

They did not, or they did and are now pretending otherwise. Either way, the exits are crowded.

I. The Mechanics of a Run

The chart below, sourced from Robert A. Stanger & Co. via the Wall Street Journal, tells the story with brutal economy. For most of 2022 through 2025, redemption requests from non-traded business development companies were manageable — a steady trickle of met withdrawals, small unmet amounts, nothing that disturbed the promotional material. Then in Q1 2026 the bars fall off a cliff.

What happened was not, despite what several asset managers have implied, a wave of irrational panic. It was rational behaviour, made inevitable by the structure of the funds themselves. To see why, consider a simple payoff table.

Imagine you are an investor in one of these funds. You have two choices: stay in, or request redemption. The fund has a 5% quarterly cap on withdrawals. Other investors face the same choice. The payoffs look something like this:

This is not a complicated game. The dominant strategy — the one that makes sense regardless of what others do — tilts toward redemption the moment you have any reason to doubt that everyone else will stay. And in early 2026, reasons to doubt were not in short supply. Loan defaults at First Brands and Tricolor. Blue Owl cancelling a fund merger. BlackRock TCP Capital reporting a 19% NAV write-down in a single quarter — having told investors just seven weeks earlier that its non-accrual ratio had improved. Once a few investors act on these signals, the logic becomes self-reinforcing. The run is not irrational. It is the Nash equilibrium.

Diamond and Dybvig described this mechanism for banks in 1983. The insight — that a solvent institution can be destroyed by a coordination failure among its creditors — earned a Nobel Prize in 2022. Private credit fund designers knew about Diamond-Dybvig. They believed quarterly caps and NAV pricing made their structures immune to it. What they underestimated was the first-mover advantage embedded in the cap itself: if only 5% can exit per quarter and you think 15% will try, the race to be in the first 5% is exactly the run they said couldn’t happen.

The data from four major funds in Q1 2026 illustrates how differently this played out depending on who blinked first.

Blackstone, running the largest fund, chose to protect its franchise at almost any cost — upsizing to 7% and injecting $400 million of firm and employee capital to meet 100% of requests. The optics required it; BCRED is too central to Blackstone’s retail strategy to be seen gating. Ares was more orthodox: it stuck to its 5% cap and pro-rated, leaving 57% of requests unmet. Blue Owl had two funds in the data. Its technology lending vehicle received requests totalling 40.7% of NAV — 5% paid out. Its marquee $20 billion direct lending fund, OCIC, saw requests reach 21.9% of fund value — again, 5% paid out. Across both vehicles combined, Blue Owl faced over $5.4 billion in redemption requests in a single quarter.

Public markets have already delivered their verdict. Blue Owl’s listed stock has fallen 61% over the past year, with the sharpest leg down beginning in January 2026 as redemption data began to emerge. There is a particular irony in the numbers: $OWL’s dividend yield has now risen to approximately 10% — higher than the distribution rate on its own non-traded BDC, OCIC, which pays around 8.9% to Class I investors. Those investors, locked in at the 5% quarterly cap, are earning less yield than they could obtain by buying the publicly traded manager at a distressed price in the open market. The illiquidity premium has not merely compressed. It has inverted.

II. The Banks Are in There Too, Somewhere

The direct redemption story is dramatic enough. But private credit does not exist in isolation. It sits inside a web of financing relationships that connects it, with varying degrees of visibility, to the banking system and beyond — as the diagram below shows.

The mechanism is straightforward. Funds like BCRED maintain enormous revolving credit facilities to manage deployment timing — BCRED alone disclosed $42.8 billion in committed debt capacity as of February 2026, drawn from over twenty banking relationships. These facilities are not passive. In a stress scenario, where portfolio companies draw on their own revolvers simultaneously, private credit funds may face sudden calls on liquidity from two directions at once: redeeming investors pulling from above, and borrowers drawing from below.

This is precisely the liquidity squeeze the IMF flagged in its April 2024 Global Financial Stability Report, which devoted an entire chapter to private credit. The report concluded, with the careful language of official bodies who do not wish to cause the crisis they are describing, that “liquidity risk could rise with the growth of retail funds.” It also noted that “multiple layers of leverage create interconnectedness concerns.” The full chain runs from bank revolvers to fund leverage to portfolio company debt to, ultimately, the retail investor who thought they were buying a slightly illiquid bond fund.

The portfolio overlap problem is harder to quantify but no less real. Private credit funds, competing for the same middle-market deals with similar underwriting standards, have inevitably accumulated correlated exposures. When First Brands went bankrupt, it was not a single fund’s problem. And the software sector — 21% of the Ares Strategic Income Fund’s portfolio, a similar proportion for many peers — represents a concentrated bet on AI-resilience that the market is now pricing with considerably more scepticism than it was a year ago.

The opacity runs deeper still, into the metrics that managers have been citing as evidence of portfolio health. Before examining the accounting, it is worth noting what the headline credit data already shows. According to Fitch Ratings, the default rate in its US private middle market portfolio reached 9.2% in 2025, up from 8.1% in 2024 — more than double the 4.5% default rate in the broadly syndicated loan market. Fitch notes that realised lender losses remained minimal, due to deferred payments and extended maturities. That caveat deserves scrutiny: deferred and extended is precisely the mechanism the non-accrual accounting exploits. Losses that have not yet been crystallised do not show up in the metrics managers show investors. The asset class that was sold as offering superior credit discipline has, at this point in the cycle, defaults running at twice the rate of the public market it was supposed to improve upon — and a reporting framework that is reasonably good at making them invisible until they are not.

And yet the fund-level metrics have not told this story clearly. The non-accrual ratio — the standard measure of loans in distress — is subject to a systematic distortion that makes it least reliable precisely when it matters most. When an impaired loan is restructured and written off, it exits the non-accrual count. The numerator shrinks. The percentage improves. Management issues a press release about progress.

This is what happened at BlackRock TCP Capital through most of 2025. Detailed analysis of the fund’s SEC filings — tracing every non-accrual loan back to its 2022 vintage — shows that more than half of the restructured positions ultimately ended in zero recovery. Not partial recovery. Zero. The non-accrual metric improved because the losses were being crystallised and removed from the denominator, while accounting reversals from those same restructurings generated unrealised “gains” that masked further deterioration. When Q4 2025 arrived with no restructurings left in the pipeline, the new markdowns hit NAV all at once.

This is not a TCPC-specific pathology. It is how BDC loan losses flow through financial statements — a feature of the accounting, not a bug introduced by any particular manager. The implication for investors reading fund reports is uncomfortable: a falling non-accrual ratio may be less a sign of recovery than a sign that the reckoning has already happened and is now invisible. To be fair to the managers: realized losses across the sector remain contained so far, and the bilateral nature of private credit relationships does allow for workouts and extensions that public bond markets cannot offer. The question is whether those workouts are resolving problems or deferring them — and on that question, the Fitch default data and the TCPC case study point in the same direction.

III. The Insurer in the Room

The Treasury meeting in April 2026 with domestic and international insurance regulators was not a courtesy call. It was an acknowledgement, carefully worded but unmistakable in its implications, that the private credit stress has a second act — one that runs through the balance sheets of American life insurers.

The connection has been building for a decade. Private credit, with its yield premium over public bonds and its apparent stability, was an almost irresistible proposition for life insurers seeking to match long-duration liabilities. The numbers confirm what the promotional material promised: private credit now accounts for roughly 46% of life insurer bond holdings, up from 29% a decade ago.

The concern is not simply the size of the exposure. It is the opacity. Life insurers have moved aggressively into private credit that is rated not by Moody’s or S&P, but by specialist private rating agencies whose methodologies are, in the Treasury’s delicate formulation, “called into question.” The NAIC has launched a study specifically into these securitised products. Several large insurers have moved substantial blocks of business to offshore reinsurers in Bermuda and the Cayman Islands, where regulatory standards are less demanding — a structure that makes consolidated risk assessment difficult even for those trying to perform it.

The particular risk here is not the same as the bank run. Life insurers are not facing redemption requests in any direct sense. But they are exposed to mark-to-market pressures if private credit valuations begin to reflect reality, to potential capital charges if rating agencies revisit their assessments, and to the generalised loss of confidence that tends to accompany the discovery that a large asset class was priced more optimistically than its fundamentals warranted. The feedback loop back to the funds themselves is worth noting: insurers facing valuation pressure or capital charges may reduce new allocations to private credit or, in stress scenarios, look to exit existing positions — adding to the redemption pressure at the fund level that started this story.

IV. Coming to a Continent Near You

Private credit is not an American story that Europeans can observe from a comfortable distance. The fundraising data makes this uncomfortable.

Europe’s share of private credit fundraising rose from 23% in 2024 to 33% in 2025 — a ten percentage point shift in a single year — while North America’s share fell from 72% to 63%, according to PitchBook’s 2025 Annual Global Private Market Fundraising Report. In absolute terms, European private debt fundraising hit a record $79.4 billion in 2025, up nearly 40% from the prior year. Much of this reflects a genuine structural shift: European companies have historically relied more heavily on bank financing than their American counterparts, and as European banks have retreated from leveraged lending under Basel III capital requirements, private credit has stepped into the gap. Two mega-funds — Ares Capital Europe VI (€17.1bn) and CVC European Direct Lending (€10.4bn) — helped push the numbers, but the trend predates them.

The regulatory architecture that might catch the problems is less developed. The ECB’s Financial Stability Review has flagged private credit risks with increasing urgency, but European insurance supervision remains fragmented across national authorities, and the Solvency II framework was not designed with the complexity of modern private credit structures in mind. The offshore reinsurance issue — Bermuda, Cayman — applies to European insurers too, perhaps more acutely given that several large European insurers have partnered with precisely the American private equity managers now at the centre of the US stress.

The pattern should be familiar to anyone who watched the 2008 crisis unfold. The instrument was invented in America, the risks were distributed globally, and the European discovery of the problem came with a lag that felt, in retrospect, embarrassingly preventable.

Private credit is not subprime. The borrowers are not buying houses they cannot afford; they are, mostly, established companies with genuine cash flows. But the structural parallel holds. This is an asset class that grew rapidly on the promise of higher returns and lower correlation. It was financed by retail and institutional capital that did not fully price the liquidity risk. It is now embedded in insurance balance sheets across two continents, and encountering its first serious test at a scale for which the architecture was not designed.

The architects, for their part, are confident the structure will hold. They were confident before, too. The more interesting question — the one Q2 and Q3 2026 will begin to answer — is what happens when the next round of NAV marks arrives, restructuring pipelines thin out, and quarterly redemption requests remain at levels the 5% cap was never designed to absorb. At that point, the difference between a liquidity stress and a solvency stress becomes less academic than it currently sounds.

The author writes on macroprudential and financial stability issues. Charts produced using data from Robert A. Stanger & Co., SEC EDGAR, Bloomberg, PitchBook, Milliman/S&P Global and the NAIC Capital Markets Bureau. The analysis of BlackRock TCP Capital’s non-accrual accounting draws on work by LeylaKuni, published at Accredited Investor Insights — strongly recommended. Blue Owl redemption data from SEC filings (April 2026); Fitch default rate from Fitch Ratings, “Private Credit Defaults & Recoveries 2025”, June 2026 (fitchratings.com).

Commissioner Maria Luís Albuquerque’s recent assurances regarding the state of Europe’s rather large (see below) Money Market Funds (MMFs) arrive wrapped in the frictionless vocabulary of Brussels diplomacy. We are told the European Union remains a premier destination for investors, that the 2018 regulatory framework has “worked well” in times of stress, and that the future requires merely “targeted clarifications” to ensure a “shared understanding” of appropriate liquidity levels.

One reads this with a certain intellectual vertigo. To assert that the current framework organically withstood the extreme market shocks of recent years is an exercise in profound historical revisionism. It is a fundamental misdiagnosis of the mechanics of systemic risk, and it demands a rigorous macroprudential rebuttal.

The Illusion of Intrinsic Resilience

To equate the survival of the short-term funding markets in March 2020 with the structural soundness is a dangerous category error. It mistakes the presence of a paramedic for the health of the patient.

During the onset of the pandemic’s ‘dash for cash’, corporate treasurers and institutional investors sought to liquidate their holdings with unprecedented velocity. This exposed the foundational fragility of the MMF model: the promise of daily, on-demand liquidity backed by portfolios of structurally illiquid, short-term corporate and sovereign debt. The sector did not independently survive this immense redemption pressure; it was rescued by the brute force of sovereign balance sheets.

The European Central Bank was forced to intervene via the Pandemic Emergency Purchase Programme (PEPP), actively buying commercial paper for the very first time to unfreeze the deeply impaired shadow-banking arteries. Simultaneously, the US Federal Reserve deployed the Money Market Mutual Fund Liquidity Facility (MMLF) to absorb toxic sell-offs, while the Bank of England activated the Covid Corporate Financing Facility (CCFF) to bypass the frozen short-term markets entirely. To conflate the survival of these markets via extraordinary sovereign intervention with the efficacy of the underlying regulation is a profound macroprudential misdiagnosis.

The Macroprudential Deficit and Institutional Non-Compliance

It is precisely this underlying architectural vulnerability that the European Systemic Risk Board (ESRB) sought to address in its 2021 recommendations. From a systemic risk perspective, the Low Volatility Net Asset Value (LVNAV) structure and its rigid regulatory thresholds actively incentivise a first-mover advantage, effectively guaranteeing a preemptive run during periods of acute stress.

Yet, as detailed in the damning February 2025 compliance report, the European Commission has been formally declared materially non-compliant with these vital directives. The Commission utterly failed to implement Recommendations A, B, and D, which called for the dismantling of these toxic threshold effects and a mandatory, tangible reduction in liquidity transformation.

Crucially, the Commission’s primary justification for inaction, that reopening primary legislation might impose compliance costs or temporarily alter the market’s commercial utility, was rightly dismissed as “unjustified” by the ESRB assessors. The ESRB handbook is unequivocally clear: systemic stability cannot, and must not, be held hostage to the short-term commercial convenience of the sector.

Global Divergence and the Fortress Balance Sheet

While the European Commission opts for the palliative care of non-binding guidance and supervisory convergence, the rest of the world is moving decisively to dismantle the structural threat.

The Financial Conduct Authority (FCA) in the United Kingdom, through its CP23/28 proposals, is demanding a radical recapitalisation of liquidity buffers. Refusing to rely on central bank backstops, the FCA is pursuing the complete statutory uncoupling of regulatory thresholds whilst pushing for an uncompromising minimum Weekly Liquid Assets (WLA) requirement of 50 per cent, and Daily Liquid Assets (DLA) of 15 per cent.

At the supranational level, the International Organization of Securities Commissions (IOSCO) has fundamentally revised its recommendations to enforce robust anti-dilution tools across the open-ended fund spectrum, shifting the cost of liquidity directly onto redeeming investors to extinguish the run incentive. The EU’s reluctance to enforce similarly rigorous structural mandates isolates it from the emerging international consensus.

The Geopolitics of Equivalence

This regulatory divergence is not merely an academic dispute; it is generating profound cross-border friction. Because of the FCA’s fortress balance sheet approach, HM Treasury has explicitly excluded EU MMFs from permanent equivalence under the newly operational Overseas Funding Regime.

Instead, to prevent a sudden, destabilising withdrawal of capital, the UK has been forced to repeatedly extend the Temporary Marketing Permissions Regime (TMPR) to the end of 2026, and the industry is clamouring for extensions into 2027, simply to avert a catastrophic cross-border cliff-edge for Sterling cash pools domiciled in Dublin and Luxembourg.

As demonstrated by the careful diplomatic language emerging from the Joint EU-UK Financial Regulatory Forum in London, the exchange of “observations on practices” regarding MMF resilience remains fraught.

A “shared understanding” of liquidity is undoubtedly an elegant phrase, but it will not suffice when the underlying financial architecture remains inherently unstable. MMFs perform a vital economic function, but they currently do so through the dangerous alchemy of liquidity transformation. Until we possess the structural courage to reform them at the legislative root, we are merely relying on the precarious hope that central banks will always be there to socialise the losses. True macroprudential resilience demands statutory iron, not semantic clarifications.

The AI ETF Boom and the Plumbing Beneath It

We are witnessing a historic reallocation of capital, and it is being executed through Exchange-Traded Funds (ETFs).

To understand the sheer scale of what is happening, you only need to look at the Nasdaq-100. Investors flock to the Invesco QQQ Trust under the assumption of diversified tech exposure. In reality, the fund has become incredibly top-heavy. As of early 2026, nearly 50% of the entire ETF’s weight is concentrated in just nine companies, almost all of them directly tethered to the artificial intelligence boom.

This concentration isn’t an accident; it is a reflection of a market that has violently bifurcated. The companies building the physical infrastructure for this new era have completely decoupled from the rest of the economy.

When we index the performance of these assets back to the end of 2020, the divergence is staggering. The VanEck Semiconductor ETF (SMH) has left both broad tech (QQQ) and small-cap equities (IWM) in the dust.

But perhaps the most telling metric isn’t past performance, it is current investor sentiment. Looking at year-to-date fund flows for 2026, we can see exactly how the market is placing its bets. Institutional and retail money alike are abandoning broad market exposure. QQQ has bled $10.7 billion in outflows, and small-caps have lost $4 billion. Meanwhile, capital continues to pour into the semiconductor space.

Investors are using ETFs as precision scalpels to slice into highly specific macro trends. They treat these vehicles as perfectly liquid, perfectly efficient conduits for their capital.

But this brings us to a critical, heavily overlooked problem: an ETF is not a magic wand that uniformly blesses its underlying assets with liquidity. It is a conduit. And like any conduit, what it transmits depends entirely on what it is connected to.

The Liquidity Illusion

There is a comforting, yet deeply flawed, tendency within the credentialed class to treat financial innovations as monoliths. When a new vehicle proves successful, we assign it a static set of characteristics and assume it will behave identically across all environments.

Nowhere is this intellectual complacency more evident than in our understanding of Exchange-Traded Funds (ETFs).

Over the past decade, ETFs have been heralded as the great democratizers of finance, granting investors immediate, continuous access to everything from highly liquid equities to notoriously opaque corporate bonds. The conventional wisdom dictates that ETFs inject liquidity into the system, acting as a stabilizing buffer. But this view suffers from a critical blind spot: it ignores the microstructure of the underlying markets.

An ETF is not a magic wand that uniformly blesses its underlying assets with liquidity. It is a conduit. And like any conduit, what it transmits depends entirely on what it is connected to.

This was the premise of the research I conducted with Petros Katsoulis at the Central Bank of Ireland, detailed in our paper, Information and liquidity linkages in ETFs and underlying markets. We sought to answer a specific question: Does the systemic footprint of an ETF change depending on the asset class it tracks?

The answer is a resounding yes.

The Arbitrage Engine and Market Accessibility

To understand the differential impact of ETFs, we must look at the mechanics of arbitrage. The price of an ETF share and the value of its underlying securities are kept in equilibrium by arbitrageurs who exploit price differences the moment they arise. This activity creates an “information link.”

However, this link requires accessibility.

When an ETF tracks equities, it tracks assets that are traded continuously on transparent, highly accessible exchanges. Arbitrageurs can move swiftly between the ETF and the underlying stocks. This hyper-accessibility forges a strong information link.

Corporate debt, by contrast, is a different beast. It is primarily traded over-the-counter (OTC) in private, bilateral transactions characterized by high search and transaction costs. It is fundamentally hard to access. Consequently, arbitrageurs are far less active, resulting in a weak information link between the ETF and the underlying bonds.

The Volatility Paradox

This divergence in market accessibility leads to starkly different systemic outcomes—some of which directly contradict the prevailing regulatory assumptions. Our analysis revealed three distinct phenomena:

1. The Contagion of Illiquidity: When an ETF experiences a liquidity shock (a sudden spike in trading costs), it propagates that shock directly to underlying equities. Because the information link is so strong, a disruption in the ETF instantly impairs the underlying stock. However, this illiquidity contagion does not spread to corporate debt securities. The weak information link acts as a firewall.

2. Asymmetric Returns: Demand shocks in the ETF market—represented by sudden inflows or outflows—affect the daily returns of underlying equities to a massive degree. Yet, these same ETF flows barely register on the daily returns of corporate bonds.

3. The Volatility Divergence: This is perhaps the most counterintuitive finding. What happens as ETF ownership of an asset class grows?

• In the equity market, higher ETF ownership actually increases the volatility of the underlying stocks. The ease of access supercharges arbitrage activity, making equity prices hyper-sensitive to ETF demand.

• In the corporate debt market, higher ETF ownership decreases the volatility of the underlying bonds. Because the underlying bonds are hard to trade, investors simply migrate to the ETF to satisfy their liquidity needs, leaving the underlying OTC market quiet.

The Policy Imperative

The illusion of uniform liquidity is a dangerous premise for both investors and financial regulation.

When we watch billions of dollars flee broad market tech (QQQ) and violently pivot into concentrated semiconductor bets (SMH), we aren’t just looking at a shift in market sentiment. We are watching a real-time stress test of the underlying market plumbing.

When regulators attempt to gauge the systemic risk posed by the multi-trillion-dollar ETF industry, they cannot rely on broad generalizations. The hyper-accessible equity markets underlying SMH and QQQ mean that these massive, sudden fund flows will inevitably breed arbitrage-driven volatility and potential illiquidity contagion in the underlying stocks.

However, if those same billions were flowing into high-yield corporate debt ETFs, the systemic footprint would be fundamentally different. In the corporate bond space, the risk is not contagion, but rather the hollowing out of the underlying market as liquidity migrates entirely to the ETF layer.

If we wish to build resilient macroprudential frameworks—and if investors want to truly understand the structural risks sitting inside their portfolios—we must stop looking at financial products in a vacuum. We must be willing to do the hard work of examining the plumbing.

In a highly interconnected world, one of the most persistent intellectual failings of the credentialed class, particularly within financial regulation, is the tendency to examine complex systems in isolation. We build elaborate, mathematically elegant models to stress-test banks, treating them as if they exist within a vacuum. But as the structural shifts of the past decade have shown us, the center of gravity in global finance has moved.

The conventional wisdom in macroprudential policy has long been to safeguard the banking sector. Yet, if we only look at banks, we suffer from our own form of institutional deafness. We fail to hear the signals emanating from the rapidly expanding non-bank financial intermediation (NBFI) sector, and specifically, investment funds.

What happens when an exogenous shock hits the system? Do banks and investment funds absorb the blow independently, or do their reactions feed off one another, creating a contagion web that amplifies the initial damage?

This was the core question my colleagues and I set out to answer in our recent paper, Shock amplification in an interconnected financial system of banks and investment funds, published in the Journal of Financial Stability.

The Conventional Wisdom: The Danger of the Silo

Historically, central banks and supervisory authorities have relied on single-sector stress testing models. We shock the banks. We see how the banks react. We declare the system safe or vulnerable.

But the reality of modern finance is deeply entangled. Banks and investment funds hold overlapping portfolios. Banks lend to funds; funds hold securities issued by banks. When a crisis strikes, such as the sudden economic halt caused by the COVID-19 outbreak, these entities do not merely absorb the shock in isolation. Their endogenous reactions, their desperate bids for liquidity and survival, collide.

The Contagion Web: Liquidity and Solvency

To understand this hidden plumbing, we built a novel model of contagion propagation using a remarkably granular dataset for the euro area. We subjected both sectors to a severe, multi-layered exogenous shock: a default shock, a market shock, and a redemption shock (where investors suddenly pull their capital from funds).

Our model revealed that the contagion mechanism operates through a dual channel of liquidity and solvency risk.

When investment funds face sudden, massive redemptions, they are forced to liquidate assets rapidly to generate cash. This phenomenon, the classic “fire sale,” depresses asset prices across the board. Because banks hold many of those exact same assets, their balance sheets instantly take a hit.

The findings are stark:

• Amplification, not containment: The combined, endogenous reaction of banks and investment funds significantly amplifies losses to the broader financial system compared to single-sector stress testing models.

• The Fire Sale Penalty: Adding the investment fund sector to our traditional banking model leads to substantial additional losses driven entirely by these endogenous market losses generated by investment funds’ asset liquidation.

• Capital Depletion: This interconnectedness causes a further depletion of banks’ capital ratios by around one full percentage point — a highly material impact during a severe systemic crisis.

The Policy Imperative

For those of us tasked with safeguarding the European financial system, the implications are clear. The days of siloed, single-sector stress testing must end.

If we continue to view the financial system as a collection of independent fortresses rather than a deeply integrated ecosystem, our models will remain elegant but dangerously incomplete. We must expand the scope of financial stability analysis to capture this institution-level contagion across different sectors.

Understanding the world requires us to map the connections others ignore. As the shadow banking sector continues to grow, our regulatory frameworks must evolve from monitoring isolated entities to managing the contagion web itself.

A recent Financial Times autopsy of the liberal order, titled “The pessimist who became a prophet,“ presents a dialogue between the commentator Martin Sandbu and the philosopher Michael Sandel. It is a fascinating, if somewhat suffocating, exercise in elite contrition. They dissect the failure of the technocratic consensus that has gripped the West since the fall of the Wall—a consensus that promised a flat world of frictionless commerce but delivered a fractured society of anxious debtors.

While their diagnosis of a “moral void” in governance is astute, the conversation inadvertently exposes the very solipsism that caused the rot. It reads like a seminar in the captain’s quarters of the Titanic, debating the hydrodynamic efficiency of the hull while the steerage passengers are already wading in freezing water.

Here is a reflection on that disconnect, structured through the lens of W.B. Yeats’ The Second Coming, a poem that feels uncomfortably like a morning news briefing.

Turning and turning in the widening gyre / The falcon cannot hear the falconer;

The central confession of the FT piece is that the “credentialed class”—the apparatchiks, the strategists, the Davoisie—constructed a world that functioned beautifully for themselves but severed all tether to the lived reality of the majority. Sandel rightly notes that by stripping decision-making of moral weight and subcontracting it to the “neutral” arbitration of market mechanisms, we created a vacuum.

But the metaphor of the gyre is more precise than they realize. The “falconer” (the leadership class) stands in the high tower of abstraction, shouting instructions about aggregate demand, ESG metrics, and long-term macroeconomic stability. The “falcon” (the voter, the saver, the citizen), meanwhile, has stopped listening. Not out of ignorance, nor a lack of education, but because the bird has realized, with a visceral clarity, that the falconer is no longer standing on the same earth.

The feedback loop hasn’t just broken; it was dismantled, wire by wire, by a leadership that preferred the sterile hum of their own models to the messy noise of the street.

Things fall apart; the centre cannot hold;

The article critiques the “managerial” style of governance—the conceit that if we simply pull the correct monetary levers, social cohesion will follow as a mathematical inevitability. This is the “idle voracity” of the modern state: the belief that printing money or drafting regulations can paper over the cracks of a hollowed-out culture.

In Europe, this tendency toward “misplaced deliberation” has mutated into an existential risk. As Mario Draghi’s recent report laid bare with a frankness bordering on brutality, the continent faces a “slow agony” unless it rediscovers the capacity for radical action. We have constructed a regulatory apparatus of baroque sophistication, perfecting the rules of a game that the rest of the world has stopped playing. While we deliberate endlessly on the harmonization of the internal market, our prosperity—the very engine of our social stability—stalls. The disconnect here is tragic: a political class that offers its citizens the world’s finest regulatory framework, while failing to deliver the economic dynamism required to pay for it.

Things fall apart when the Centre treats its own base not as constituents to be served, but as a stubborn variable to be managed. The Centre fails not because of external barbarians at the gate, but because it has hollowed out its own foundations, dismissing the legitimate, tangible anxieties of the majority as “misguided” or “provincial.”

Mere anarchy is loosed upon the world,

Sandel warns that a “moral void” invites chaos, framing the current populist backlash as the “anarchy” we must fear. This is a classic misreading of the timeline. The “anarchy” did not begin with the populist revolts. The anarchy was the deregulation of the social contract; it was the “creative destruction” that destroyed communities without creating anything in their place save for low-wage precarity and high-yield debt.

And what is the remedy proposed by our penitent elites? In the FT, Sandel suggests a return to “civic virtue” and “public discourse.” He pines for the days when citizens debated the common good in town halls. It is a charming, academic fantasy—the belief that the antidote to economic displacement is better conversation. It betrays a fundamental misunderstanding of the populist impulse. The working and middle classes are not revolting because they yearn for a Socratic dialogue on justice; they are revolting because the social contract has been breached. To offer “discourse” to a demographic that has seen its purchasing power evaporate and its cultural standing mocked is not a solution; it is an evasion.

The disruption we see now is not anarchy; it is a desperate attempt to re-impose order. It is the assertion of boundaries in a world that the elites insisted must remain borderless. When the leadership detaches policy from the values of the community, they dissolve the glue that binds the nation.

The best lack all conviction, while the worst / Are full of passionate intensity.

The tragedy of the current moment is the paralysis of the “best”—the well-meaning, educated establishment now wracked with guilt, holding seminars on “social cohesion” and writing op-eds about their own complicity. They are Hamlets in corporate boardrooms and parliaments, lacking the conviction to defend their own project because they suspect, deep down, that it was flawed from the start.

Meanwhile, the “worst”—the disruptors, the demagogues, the rude mechanicals—are winning because they possess “passionate intensity.” They offer clarity where the center offers caveats. They listen—or at least possess the theatrical genius to appear to listen—to the frustrations that the establishment has spent thirty years explaining away with charts.

Conclusion: Beyond the Slur

It is time to retire “populism” as a slur. It has become a lazy shorthand for “democracy that delivers results the elites dislike.”

We need not go as far as Alcuin of York’s warning to Charlemagne—Nec audiendi qui solent dicere, Vox populi, vox Dei. Alcuin, a true elitist, believed the riotousness of the crowd was “close to madness.”

But we have surely swung too far toward Alcuin’s patrician disdain. Somewhere between the “madness of the crowd” and the deafness of the technocrat lies the middle ground of functional leadership. It requires treating the voice of the majority not as divine truth, but certainly as a command that cannot be ignored. The falconer must come down from the tower, trudge through the mud, and learn to speak the language of the falcon again.