The Bank of England (BofE) has launched the latest phase of its system-wide exploratory scenario (SWES) exercise, providing both bank and non-bank participants with a hypothetical stress scenario.

The Bank initially launched the SWES in June, in an effort to better understand the behaviours of banks and non-bank financial institutions (NBFI) in stressed financial market conditions, and how these behaviours and market dynamics can amplify shocks in markets and potentially pose risks to UK financial stability.

In the latest phase of the SWES, participants have been supplied with the details of a severe, but plausible, stress scenario.

The scenario was designed to be faster, wider ranging, and more persistent than those seen in recent periods of market instability, such as the September/October 2022 liability-driven investment (LDI) episode, and includes a ten-day shock to rates and risky asset prices.

The shocks in the scenario also incorporate many elements from recent market events, such as a sharp increase in UK government borrowing costs as yields on ten- year nominal gilts increase by 115 basis points, similar to the move seen during the LDI episode.

In addition to this, it includes a sharp increase in sterling investment-grade corporate borrowing costs, as much as seen during the March 2020 dash for cash.

However, the combination of the individual shocks, the fact that the majority of the market moves take place in the first three days of the exercise, and the persistence of the shock, mean that the hypothetical stressed scenario is considered more severe than those seen in historical episodes.

Participating firms include large banks, insurers, central counterparties and a variety of funds, including pension funds, hedge funds, and funds managed by asset managers, as reflection of the wide range of institutions engaged in UK financial markets.

The Bank is also working closely with the Financial Conduct Authority and The Pensions Regulator.

The exercise aims to improve understanding of how banks and non-banks behave in stressed conditions, with participants asked to consider the impact of this hypothetical stress scenario, including how it would impact their business, and what actions they would take in response.

The second round of the scenario phase, which will reflect the actions that the participants take in the first round, will be launched in Q2 2024, with a final report on the SWES set to be published by the end of 2024.

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