Welcome to the first-ever Alphabet Soup! This series is all about simplifying complex financial policy topics and giving you practical solutions. Along the way we will have some fun explaining the many unappetizing acronyms sprinkled across the world of global financial policy.
Alphabet Soup is brought to you by Highland Global Advisors, a consulting firm that helps businesses make informed decisions about policy, regulation, and markets. The team behind Alphabet Soup is led by Michael Pedroni, a seasoned financial regulation and global economic policy expert with a global network of connections.
Bon appetit!
NBFI, SWES, FSB, IOSCO.
Sixteen all-caps letters that you should know if mutual funds, retirement accounts, or pension plans matter to you. And if you enjoy the NYT’s Connections game, here’s a challenge: What’s the common theme tying together these rather dreary-sounding acronyms?
Hint: They’re all linked to central banks’ growing efforts to exert more control over asset managers—an industry where the Federal Reserve, Bank of England, and European Central Bank currently have little, if any, direct authority.
So, let’s plunge face-first into this month’s bowl of Alphabet Soup.
NBFI: The “Shadow Banks” That Central Banks Love to Hate
NBFI stands for non-bank financial intermediation—a term as appetizing as a bowl of cold porridge. But like it or not, you’ll hear NBFI endlessly in the halls of Basel and Brussels, on Washington’s Constitution Avenue and C Street, and on Threadneedle Street in London.
Ever since the 2008-2009 financial crisis, central banks, finance ministries, and securities regulators have worked to ensure banks are never again too big to fail. Their solution? Push risk off bank balance sheets and into the “non-bank” sector.
For a while, it was trendy to call non-banks—mutual funds, hedge funds, money market funds, private credit—shadow banks. But in an effort to sound less gothic, regulators rebranded them as NBFI. (Some of us preferred “market-based finance,” but here we are.)
And here’s the rub: central banks are suspicious of possible risks lurking in NBFI.
Why? Because:
1. NBFI has grown dramatically relative to banks (which was the whole point of post-crisis reforms).
2. Central banks typically don’t have any formal control over NBFI, which is the domain of securities regulators.
3. Central banks and securities regulators hold very different views about risks in NBFI—with central bankers saying behind closed doors that securities regulators are too permissive.
4. In a crisis, central banks are the lenders of last resort, but with banks playing a smaller role, they now fear they’ll have to inject liquidity into NBFI instead.
SWES: It Rhymes with Stress
Enter the SWES! If you thought NBFI was an ugly acronym, SWES takes the cake. It stands for System-Wide Exploratory Scenario, a concept born at the Bank of England.
At its core, SWES is a stress test of the entire financial system—banks and NBFI—against a simulated market shock.
Quick diversion: imagine Monty Python’s Julius Caesar in Life of Brian saying “SWES Test”… he would pronounce it exactly the same as “Stress Test” – so at least that’s convenient….
I actually like the SWES, because it acknowledges a real problem: Post-crisis reforms have constrained banks so much that they may no longer be able to distribute emergency central bank liquidity across the financial system in a crisis.
Central banks need to see where liquidity bottlenecks occur—or, in economists’ terms, where liquidity demand vastly outstrips supply, making the cost of liquidity ridiculously unaffordable.
According to Andrew Bailey, the Bank of England’s recent SWES results were telling:
· Margin calls at derivatives clearing houses surged more than most market participants had expected.
· Hedge funds relying on government repo markets for leverage oversetimated their ability to continue borrowing.
Expect the Bank of England, strongly backed by the Fed and ECB, to use these findings to justify more NBFI regulation and greater central bank oversight of non-bank liquidity.
FSB: The Stability Watchdogs
Which brings us to our next acronym: FSB.
The Financial Stability Board was created in 2009 to identify risks to the global financial system and coordinate regulatory responses across countries.
In theory, the FSB should be where central banks and securities regulators collaborate to craft a balanced approach to NBFI oversight.
In reality? The FSB is central bank territory.
Each of the 23 member countries is represented by its central bank, but only 9 also include their securities regulator. That means securities regulators—who actually oversee NBFI—often have little influence, while central banks almost always agree they need to “do more” to control NBFI.
IOSCO: The Securities Regulators’ Underdog Club
So, where do securities regulators get a voice?
Meet IOSCO—the International Organization of Securities Commissions.
IOSCO members were so worried about being relegated to the regulatory “kids’ table” by central banks at the FSB that they wanted a longer, more impressive name and added an extra ‘O’ to their acronym. (I’m kidding… but seriously, why does it need that second O?)
IOSCO sets global standards for financial markets regulation and has done a commendable job demanding a seat at the grownups’ table. But securities regulators and central banks still have a fundamental disconnect: they don’t trust each other and they look at the world through a different set of lenses, because banking risks are fundamentally different than asset management risks.
NBFI gets caught in the middle of this disconnect—at just the moment policymakers argue that capital markets are increasingly important to the future of finance.
Why This Matters for Investors
This power struggle isn’t just an abstract regulatory debate—it affects the millions of people around the world who rely on investment funds for retirement.
The Bank of England deserves credit for attempting a more holistic approach—not just regulating one ingredient in the soup, but looking at how they all interact.
But if central banks push too far, too fast with new regulations, they risk overcooking the broth. Poorly designed rules will cost everyday investors dearly – raising costs, limiting investment opportunities, and potentially harming retirement solvency.
Getting this right matters—for investors, for financial markets, and for global stability. Let’s hope central banks and securities regulators can find a way to share the kitchen.