By Eduardo Maqui and Elizabeth Machemedze.footnote [1]
Yet, data on NBFI risk-taking remain incomplete – particularly for hedge funds employing opaque leverage strategies through offshore financial centres (OFC). To address some of these gaps, this note maps and quantifies non-bank default risk in key UK financial markets. We document rising default risk in NBFIs, with a notable concentration in offshore entities and a large tail of risk linked to hedge funds. This analysis supports market-based finance surveillance by offering a structured, forward-looking approach to risk monitoring.
Mapping non-banks in key UK financial markets.
To map NBFIs participating in key UK financial markets, we link entity-level Legal Entity Identifier codes with NBFI-type classifications (Comerton-Forde et al (2025)) and country-of-risk information. As is common in credit analysis and portfolio-exposure assessments, the country of risk may differ from the country of incorporation. This measure captures a range of factors – including regulatory considerations and underlying sources of risk – and reflects the country most relevant to an entity’s credit‑risk profile, which may in turn influence UK financial stability.
The analysis builds on entity-level information from Bank of England trade repository and Financial Conduct Authority transaction-level databases – including derivatives, cash, securities financing and repo markets – for the period 2016 to 2025. This approach allows us to map over 70% of non-banks engaging in these markets – capturing both UK and non-UK entities – comprising asset managers (AM), hedge funds (HF), insurers (INS), liability-driven investment (LDI) funds, money market funds (MMF), private equity (PE), and pension funds (PF).
The geographical distribution of different types of NBFIs active in UK markets highlight a strong European Union (EU) footprint across most NBFIs, except for PFs and HFs
Most PFs are based in the UK and US. HFs, however, show a markedly different pattern with significant US and offshore shares. While the overall proportion of offshore NBFIs is relatively small (~4%), it is highly concentrated with Caymans-based entities accounting for over 60%. Notably, around 75% of offshore HFs are in the Cayman Islands. This finding is consistent with international evidence documenting that many HF structures are registered in offshore jurisdictions such as the Cayman Islands, even when portfolio management functions are located elsewhere.
Chart 1: Geographical distribution of NBFI types active in UK markets (a)
While such cross-border dispersion complicates efforts to monitor and assess risks posed by foreign-based but UK active NBFIs, our mapping exercise provides a foundation for linking entity-level information with risk indicators to pinpoint vulnerabilities across NBFI types and regions. Having mapped non-banks that participate in key UK financial markets, we then widen the lens to assess how their default risk varies geographically.
Measuring default risk
We measure default risk using probability of default (PD) indicators, which offer a forward-looking measure that can be used to monitor the resilience of NBFIs and their exposures across markets, complementing balance-sheet or transaction-level indicators by capturing shifts in counterparties’ perceptions of creditworthiness.
Monitoring PDs is particularly relevant for assessing credit risk in derivatives, securities financing, and repo markets – areas where NBFIs play an increasingly important role. These markets are typically collateralised, which helps mitigate potential credit losses. However, when NBFIs’ perceived default risk rises, their counterparties may tighten collateral terms, for example through higher haircuts or margin calls, which can ultimately trigger liquidity strains.
For our analysis, we use one-year-ahead PD estimates and PD-implied average ratings at the NBFI entity level (not to be mistaken for credit ratings) collated from Credit Benchmark. These measures reflect bank‑level counterparty assessments on the likelihood of default for each entity, based on anonymised inputs from a global sample of banks. By aggregating PDs across individual NBFIs active in UK markets and mapping them by type and country, our analysis can help to identify concentrations of risk and provide early warning signals of potential stress propagation through non-bank channels, enhancing risk monitoring outside the banking system.
The geography of non-bank default risk
We use PD estimates to analyse default risk in NBFIs that participate in key UK markets across regions and over time. Chart 2 illustrates the geographical distribution of NBFI default risk on a heatmap scale – ranging from lowest (yellow) to highest (red) average PDs. This highlights elevated probabilities of default for NBFIs based in certain offshore jurisdictions. This pattern suggests that these offshore NBFIs exhibit higher default risk, potentially reflecting greater leverage, less stringent regulatory oversight, and/or concentration in high-yield investment strategies. Default risk is also clustered within specific emerging economies, such as Brazil and East Asia. Over the past couple of years, the global NBFI sector has been reported to have grown by over 10% in jurisdictions like the Cayman Islands and Brazil, among others. Our findings signal that accompanying this growth is an increasing concentration of default risk in these jurisdictions.
Chart 2: Geographical distribution of NBFI default risk in key UK financial markets (a)
The evolution of PDs geographically over time among NBFIs that participate in key UK markets
Chart 3 breaks down default risk into offshore NBFIs versus NBFIs in all other regions, showing average PDs and the 1st-99th percentile ranges. The divergence between the average PDs is notable and has widened following periods of market stress in recent years. Across regions, offshore NBFIs consistently display the highest PDs on average, followed by those in the US and UK, with EU NBFIs exhibiting comparatively lower and more stable default risk profiles. The upper tail of offshore PDs has moved higher over the sample period, reaching around 500 basis points in 2025, compared with under 200 basis points in all other regions, and exceeding the 400 basis points upper range observed for offshore NBFIs in recent stress episodes (eg, ‘dash for cash’ in March 2020 and LDI crisis in September 2022). This widening gap highlights vulnerabilities arising from offshore default risk for UK markets, as many offshore NBFIs hold substantial exposures in UK assets or vis-à-vis domestic dealer-bank counterparties.
Chart 3: Default probabilities by region over time (a)
The rise in PDs for offshore NBFIs is largely associated with Caymans-based HFs, likely reflecting greater use of leverage, growth in complex derivatives strategies, and an observed concentration of high yield credit exposures. Combined with international evidence showing rapid growth in credit assets and an increasing role in the US Treasury basis trade, latent vulnerabilities from Caymans-based HF activity underscore potential risks to global financial stability.
Default risk is unevenly distributed across NBFI types and is largely concentrated in hedge funds
Chart 4 shows the shares of PD-implied high-yield (HY) and investment-grade (IG) rating-style classifications across NBFI types. HFs show a large HY share (~75%). The inverse holds for MMFs and PFs where ratings are primarily IG, indicating high creditworthiness. The larger HY to IG split reflected for HFs aligns with the higher observed PDs, indicating the increased level of default risk compared to other NBFIs.
Chart 4: Shares of HY and IG rated entities by NBFI type (a)
In light of the structural concentration of default risk identified in our analysis, Chart 5 examines HF default probabilities in more detail across regions. PDs are systematically higher for offshore HFs, followed by the US and the UK. The PD distributions for HFs based in these jurisdictions are skewed, with long upper tails likely reflecting highly leveraged or risk-taking HF activity.
Chart 5: Hedge fund default probabilities across regions (a)
Conclusions and policy implications
Taken together, our results show that HFs – particularly those offshore – are the primary contributors to increasing NBFI default risk within UK market-based finance. Their elevated PDs, combined with highly leveraged and concentrated exposures linked to key global and domestic financial markets, point to vulnerabilities that can amplify stress. In periods of market disruption, these structural features can transmit or magnify shocks across financial institutions and assets, strengthening the case for close surveillance of hedge fund activity given its potential role in systemic risk propagation.
Our findings highlight three key implications for ongoing policy work on NBFI risk monitoring from macroprudential and supervisory perspectives. First, integrating forward-looking metrics like PDs into surveillance toolkits can help mitigate non-bank data challenges and provide early warning insights alongside indicators of leverage, liquidity, and interconnectedness. Second, high and volatile PDs in HFs, especially offshore, underscore the need for strong counterparty risk management and margining, including oversight of prime brokers, consistent margin requirements, and frameworks for monitoring leverage. Third, offshore clustering of default risk highlights the importance of international cooperation, with coordinated information sharing needed to close jurisdictional gaps in MBF oversight.
Tackling these issues is essential to monitor risks and safeguard financial stability in an increasingly market-based, interconnected ecosystem.
The authors are thankful for valuable comments and feedback from Fabrizio Anfuso, Martin Arrowsmith, Nicholas Butt, Carlos Cañón, Bradley Hudd, Clare Macallan, Pelagia Neocleous, Will Parry, Simon Stockwell, Don Stewart, Nick Vause, Dane Whittleston and the Bank Underground Editorial Board.