The private markets system-wide exploratory scenario (PM SWES) is a hypothetical scenario and not a forecast of macroeconomic and financial conditions. It does not represent the Bank’s expectations of the consequences for financial markets of any particular shock. The scenario is a tool to allow the Bank to explore the impact of a stylised shock to the private market ecosystem and related credit markets. The scenario has been produced by Bank of England staff, under the guidance of the Financial Policy Committee and the Prudential Regulation Committee. This tail risk scenario is used for the purposes of enhancing financial stability and is distinct from scenarios that the Monetary Policy Committee may use to illustrate the uncertainties around its forecasts.
This page details the hypothetical macroeconomic and financial market scenario to be used in the private markets system-wide exploratory scenario (PM SWES). The variable paths can be found within Variable paths in the private markets system-wide exploratory scenario.
The PM SWES scenario embodies a severe but plausible global aggregate supply and geopolitical shock, which leads to a deep global recession. Supply chains are disrupted, particularly for tech hardware components, and energy prices rise sharply. Advanced economies experience a combination of high inflation and falling output, and policy rates increase. Financial conditions tighten sharply and borrowing costs rise. Weak productivity growth leads to a slow recovery with financial markets recovering slower than in past crises.
Weak activity and nominal GDP growth lead to a decline in corporate revenues. This happens alongside elevated funding costs and impaired exit markets, which puts pressure on leveraged corporates and the private market ecosystem.
The Publication of the stress scenario for the private markets system-wide exploratory scenario provides detail on how we expect to use the scenario to improve our understanding of how banks and non-banks active in private markets would respond to a severe but plausible global downturn, how their actions interact at a system level, and whether these interactions can amplify stress across the financial system and pose risks to UK financial stability and the provision of finance to the UK real economy.
Figure 1: Summary of the scenario (a)
Footnotes
- Source: Bank calculations.
- (a) Variables are shown in the following forms: UK CPI inflation, volatility index, Bank Rate and UK unemployment rate as peak levels; UK GDP and FTSE All-Share as start-to-trough falls; leveraged loan spreads as the start-to-peak change; and the UK GDP annual growth as the average of the annual growth rates from year 3 to year 5.
The severity of the scenario has been calibrated to represent a tail-risk outcome for the global economy and is broadly consistent with the severity of other stress tests we have run, such as the Bank Capital Stress Test (BCST).
Chart 1: When calibrating the private markets SWES hypothetical scenario, Bank staff looked to benchmark against historical crises and past stress tests (a) (b) (c) (d) (e)
Footnotes
- Sources: Bloomberg Finance L.P., ICE BofA Indices, ONS and Bank calculations.
- (a) All variables are specified in annual averages.
- (b) UK GDP recovery is defined as the average annual growth rate of the three years following the GDP trough.
- (c) The ‘leveraged loan price index’ is the Morningstar LSTA US Leveraged Loan price index. The 2025 Bank Capital Stress Test value of this variable is shown as the change to the end of year 1 of that scenario rather than the annual average change.
- (d) Bank Rate shows the peak level for the private markets SWES and 2025 Bank Capital Stress Test and the trough level for the GFC.
- (e) ‘Total GBP HY borrowing costs’ are calculated as the sum of sterling high-yield corporate bond spreads and SONIA 3-year swap rates.
Year 1
A severe global aggregate supply shock leads to falling output and high inflation in advanced economies.
Geopolitical tensions intensify which leads to a fragmentation in global trade and supply chains. This impacts the production and transportation of commodities and causes a shortage in the supply of hardware components for tech products and other inputs. This causes a large negative global aggregate supply shock, resulting in a combination of higher inflation and falling output across advanced economies.
Increased uncertainty drives risk-off behaviour across global financial markets. This increase in risk aversion leads to a sharp rise in risk premia and asset prices fall, particularly for riskier assets. These falls are exacerbated by stretched valuations, driving sharp falls in major equity indices with the FTSE All-Share index falling by around 30% and the S&P 500 by around 35% in the first year of the scenario (Chart 2).
Chart 2: UK equity prices fall sharply in the scenario
Annual average of the FTSE All-Share index
Footnotes
- Sources: Bloomberg Finance L.P and Bank calculations.
The UK experiences a sharp decline in the terms of trade, as import costs rise sharply, similar to that experienced in the 1970s. This pushes up on CPI inflation,footnote [1] and leads to a period of weak economic activity and weak nominal GDP growth, which in turn leads to a fall in corporate revenues. Corporates in sectors vulnerable to these trade and supply chain disruptions, and to higher interest rates, are particularly affected. Among the worst hit are companies in the technology, consumer discretionary and industrials sectors (Table 1).
In contrast, energy and utility companies benefit from higher energy prices. This includes domestic energy producers, listed energy companies, and energy linked investors benefit.
Table 1: The size of the shocks varies by sector
Change from year 0 to year 2
Sector | Scenario impact | Total revenues for UK corporates | Equity prices for UK corporates |
|---|---|---|---|
Consumer Discretionary | Severe | -20% | -40% |
Industrial | Severe | -20% | -50% |
Real Estate | Severe | -20% | -50% |
Technology | Severe | -20% | -50% |
Financial Services | Severe | -20% | -50% |
Consumer Staples | Moderate | -10% | -35% |
Health Care | Moderate | -10% | -35% |
Materials | Moderate | -10% | -35% |
Telecom | Moderate | -10% | -35% |
Energy | None | +15% | +20% |
Utilities | None | +5% | +5% |
Source: Bank calculations.
The technology sector is severely impacted across both software and hardware. Expectations of future disruption from artificial intelligence (AI) weigh on valuations in software and services sectors, particularly in companies judged as having weaker competitive advantages or a ‘smaller moat’ as a result of AI. Disruption to supply chains and weaker demand also weighs heavily on hardware.
At the same time, AI-development is hit by higher energy prices and a shortage of key hardware components. This increases the costs for users of AI and slows the development of new models, meaning the near-term productivity gains from AI are limited.
Monetary policymakers raise interest rates in the UK, US and euro area as cost-push inflation is expected to persist. Throughout the hypothetical scenario, participants are asked to assume that quantitative tightening continues, reducing the volume of gilts in the Asset Purchase Facility by £70 billion a year using a combination of active sales and allowing bonds to mature.footnote [2] Existing liquidity facilities at the Bank of England remain available for eligible financial institutions to use.
Rising uncertainty drives a widening in credit spreads. Sterling and US dollar denominated high-yield corporate bond spreads widen by 390 basis points and 490 basis points respectively in the first year, bringing nominal high-yield corporate bond spreads to around 800 basis points. Activity in primary markets, particularly for high-yield bonds and leveraged loans, is muted, with very low volumes in US and European markets.
Against this backdrop of uncertainty, listed private investment structures see sharp repricing and semi-liquid structures face increased redemption requests, for some exceeding offered redemption limits. Private market fundraising becomes challenging and some managers currently roadshowing new vintages postpone new funds.
Some companies with near-maturity debt and in the most impacted sectors begin to exhibit signs of stress as broad-based uncertainty and increasing long-term rate expectations hit.
Towards the end of the year, banks across the wider sector begin to take management actions to preserve capital positions as credit impairments begin to increase and their costs and expenses rise with inflation. These include restrictions or deferrals of variable remuneration, reductions or suspensions of share buybacks, and adjusting risk-weighted asset portfolios.
Year 2
Macroeconomic and financial conditions deteriorate further and the stress across private markets increases.
Geopolitical tensions remain high and oil prices rise a bit further to their peak in the scenario. The severe disruption to global trade and supply chains continues to push up on import prices, leading to a further worsening in the terms of trade.
Inflation remains significantly above target, with concerns that persistently higher commodity and import prices might lead to second round wage and price effects. Monetary policy continues to tighten to bring inflation down in the first part of the year, but interest rates start to come down in the second half of the year as monetary policy makers become more confident that inflation is beginning to fall.
Macroeconomic conditions deteriorate further. The combination of the severe global supply shock and higher interest rate environment causes UK real GDP to fall to its trough, 4% lower than its start point, and unemployment begins to climb.
The US and euro area experience similar shocks, with similar monetary policy responses. The bilateral exchange rates between sterling, the US dollar and the euro are assumed to stay flat in the scenario.footnote [3]
Advanced economies begin the scenario with elevated sovereign debt levels. As the shock unfolds, governments are assumed to have limited fiscal room to deploy any additional large scale policy interventions. The fiscal position of advanced economies weakens over the scenario, as automatic stabilisers increase government spending, and tax revenues decline with lower activity. This, on top of heightened uncertainty, contributes to the sharp rise in term premia and government borrowing costs.
Public and corporate funding markets continue to tighten, with equities and leveraged lending prices falling further and credit spreads rising, particularly among sub-investment grade corporates and the worst impacted sectors. Sterling and US dollar high-yield corporate bond spreads peak at around 1200 basis points in year 2. Coupled with higher interest rates, this brings total sterling borrowing costs around 1800 basis points and broadly in line with borrowing costs in the GFC (Chart 3). This puts pressure on corporate capital structures, weakens debt servicing capacity, and increases refinancing risk.
Chart 3: High-yield corporate borrowing costs rise to around GFC levels
Annual average total sterling high-yield borrowing costs (a)
As macrofinancial conditions worsen some banks across the wider sector are forced to take more significant actions including reductions or suspensions of dividends, and some look to issue additional capital.
Corporate revenues continue to fall and, with increasing interest service burdens, defaults rise materially. Corporate revenues continue to fall and, with increasing interest service burdens, defaults rise materially. The largest impacts are felt across such as cyclicals and the technology sector.
There are some large and high-profile defaults, including among PE-sponsored corporates, particularly in the most stressed sectors.
This creates significant uncertainty, among both institutional and retail investors. In a number of cases, lenders to over levered funds have counterparty concerns and losses across the market also reveal sporadic instances of fraud including via double pledging of assets.
Private markets more broadly are affected, consistent with impacts seen in public markets. Some private markets funds realise material losses. Providers of fund financing reassess their risk appetite. Private real estate funds are heavily impacted by macrofinancial conditions, with US and European private real estate fund returns falling significantly. Some open-ended property funds limit quarterly redemptions due to investor redemption requests. Private infrastructure also faces reduced returns, but these are less stark relative to moves in other private market assets.
A large (non-UK and non-participating) life insurer with high proportions of private market investments sustains large losses that impact its capital ratios significantly and calls into question their financial resilience. Market participants speculate on the possibility of broader stress among institutions exposed to private markets. Commentary focuses on the quality of the credit underwriting, quality of credit ratings, and use of structuring.
Many financial institutions including AAMs explore providing liquidity solutions to support investor rebalancing, deploy capital to take advantage of asset price dislocations, or provide equity and other forms of capital that can help delever or restructure corporates. Such countercyclical actions help dampen the stress and support the real economy.footnote [4]
Year 3
Conditions begin to stabilise, but interest rates remain high and growth is weak. Maturity walls begin to materialise with high volumes of refinancing needs.
Macroeconomic conditions begin to stabilise, but the recovery is weak. The pace of expected gains from AI are slower than expected due to higher energy costs and supply chain disruption. This particularly impacts technology and services sectors, and leads to a slower economic and financial market recovery than seen in past crises. Financial markets begin to exhibit signs of slow recovery, with equity prices increasing and spreads falling.
Monetary policymakers continue to lower interest rates over the coming years (Chart 4) as they bring inflation back to 2%. But weak productivity growth and the persistence of the unemployment shock lowers the supply capacity of the economy. This keeps inflationary pressures higher than expected, despite the weak demand environment, and in turn slows the pace of the decline in interest rates.
Against this backdrop, many corporates continue to experience stress. Outstanding private credit and leveraged loans face significant refinancing needs. A high volume of refinancing supply comes to market.
Private markets continue to suffer from low fundraising and limited exit opportunities alongside a wide dispersion in fund performance over the stress. This persistent pressure impacts sentiment and the outlook for the sector causing a revaluation of credit risk for rated alternative asset managers. By year 3, rated alternative asset managers, including those participating in the exercise, have been downgraded by two notches.
Chart 4: Monetary policy makers raise interest rates in the scenario
Annual average Bank Rate
Footnotes
- Sources: Bank of England and Bank calculations.
Chart 5: Output falls in the UK and then recovers slowly in the scenario
UK real GDP
Footnotes
- Sources: ONS and Bank calculations.
Years 4 to 5
Macroeconomic and financial conditions continue to recover, but the recovery is uneven and some sectors remain depressed.
Economic and financial conditions begin to normalise, but growth remains slow. Even by the end of the scenario, the level of real GDP is still 2% below its pre-crisis starting point (Chart 5) and unemployment remains elevated at around 7%. Bank rate continues to fall as inflationary pressures subside.
Recovery from the stress has not been even. Although some sectors have benefited through the scenario, including the energy and utilities sectors. The recovery in the most severely impacted sectors remains very weak, with equities in these sectors still trading around 35% below pre-crisis levels (Chart 6 and 7).
Chart 6: The size and persistence of revenue shocks vary by sector (a)
Total revenues for UK corporates by sector
Footnotes
- Source: Bank calculations.
- (a) Revenue paths split by GICS sector have been grouped into five broader categories where the sectors in each category share the same stress profile. ‘Severe: persistent’ includes ‘Financial Services’ and ‘Technology’. ‘Severe: cyclical’ includes ‘Consumer Discretionary’, ‘Industrial’ and ‘Real Estate’. ‘Moderate’ includes ‘Consumer Staples’, ‘Health Care’, ‘Materials’ and ‘Telecom’.
Chart 7: Technology sector equity prices fall by more than the aggregate while energy firms benefit in the scenario
Equity prices for UK corporates by selected sectors (a)
The decline in the terms of trade opens up a gap between measured CPI inflation, which includes imported costs, and the GDP deflator.
This also helps to keep the exercise more tractable for participants operating across jurisdictions.
Participants in the SWES will be asked about any countercyclical behaviours they may take including under what conditions they may be used and where there is dependency on third parties (eg raising a fund that requires third party investment).