Those who lend money to a hedge fund manage the risk of the fund's losses. When a fund loses money, it has to provide margin (collateral for its trades), and authorities also collect information on funds' positions and borrowing. All of these relate to the size of the positions a fund builds with derivatives and how its gains and losses arise.

Banks etc.FundingFundPositionsAuthoritySEC, FSAFundingMarginDisclosureReport
Figure 1Hedge funds, their funding providers and authorities
Figure description

This figure shows the relationships among a hedge fund, those who provide it with funding, and authorities. Funding providers such as banks provide funding to the fund through loans, securities lending and similar means, and the fund is asked for collateral or margin when there is an adverse move. Funding providers may receive disclosure of the fund's positions. The disclosure of positions and the report on positions and borrowing are flows of information, not of money or assets. Authorities collect information on the positions and borrowing of funds, including hedge funds. In the United States, advisers report to the SEC on Form PF, and in Japan the FSA collects the information through its fund monitoring survey.

Scope of hedge funds and their main strategies

A hedge fund is a fund that seeks to increase its returns by holding positions larger than its own capital through borrowing or derivatives, or by combining long and short positions. The U.S. Securities and Exchange Commission (SEC) defines hedge funds in its reporting form, Form PF. A hedge fund is a private fund that meets any one of the conditions on performance fees, the size of borrowing or positions, or short selling (selling securities or other assets you do not own). Funds holding securitized assets are excluded1. A private fund is a fund that is not treated as an investment company under the U.S. Investment Company Act because of certain exclusions in that Act2. The condition on the size of borrowing or positions is met if the fund may borrow more than half of its net assets, or if the total notional amount of its positions may exceed twice its net assets1. For example, a fund with net assets of 10 billion yen meets this condition if it may borrow more than 5 billion yen, or may hold positions with notional amounts of more than 20 billion yen.

In Japan, the Financial Services Agency (FSA) defined hedge funds in "Results of the Fund Monitoring Survey" (our translation of the title), published in October 2015. The definition is "a fund that manages investors' assets using techniques such as leverage, derivatives transactions and long-short positions, aiming to increase returns" (our translation)3. The same document divides investment strategies into six, and the following three are described as using futures or derivatives. Which strategy a fund belongs to is based on self-reporting by fund managers and others4.

Strategy Description
Global macro Looks for opportunities to profit from price distortions and market direction in currency, interest rate, equity, and commodity markets around the world, and invests through cash instruments, futures and derivatives
Managed futures Trades futures on equities, interest rates, commodities, and currencies in various countries by fixed rules based on prices and technical indicators
Equity market neutral Mainly holds long positions in individual stocks and uses futures and options to hedge the risk of a fall in the overall market

Trading on a market view (speculation)

If you buy futures when you expect the market to rise, or sell futures when you expect it to fall, you make a profit when your view is right and a loss when it is wrong. Consider a hypothetical example in which a fund expects a stock index to rise and buys 5 equity index futures contracts when the index is at 20,000. Assume the contract unit is 1,000 times the index. The size of the 5 contracts is 20,000 times 1,000 times 5, or 100 million yen. Fees are ignored.

Index when the position is closed out Gain or loss on the futures (million yen)
22,000 (up 10%) 10
20,000 (unchanged) 0
18,000 (down 10%) −10

If the index rises to 22,000, the profit is 2,000 times 1,000 times 5, or 10 million yen. If the index falls to 18,000, the loss is the same amount. Trading like this to profit from price moves is called speculation. How futures work is covered in Forwards and Futures.

As of April 2026, directional strategies are common among hedge funds' bond strategies, besides arbitrage. A directional strategy takes a view on where the market is heading and tilts positions in one direction5.

Leverage and the size of positions

Leverage is the use of borrowing or derivatives to hold positions larger than your own capital (net assets, for a fund). Consider a hypothetical example in which Fund A and Fund B each have net assets of 1 billion yen. Fund A holds only 1 billion yen of stocks. Fund B holds 800 million yen of stocks and 200 million yen of cash to use for futures margin and other needs. It then buys 2.2 billion yen of equity index futures, bringing its positions to 3 billion yen in total. Assume both the stocks and the futures move at the same rate as the index.

Fund Positions (million yen) Positions ÷ net assets (times) Gain or loss if the market rises 10% (million yen) Gain or loss if the market falls 10% (million yen) Gain or loss as a share of net assets
A 1,000 1 100 −100 ±10%
B 3,000 3 300 −300 ±30%

If the market rises 10%, Fund A gains 100 million yen, or 10% of its net assets, while Fund B gains 300 million yen, or 30%. If the market falls 10%, Fund B loses 300 million yen and its net assets shrink to 700 million yen. When positions are three times net assets, net assets rise or fall at three times the rate of the market move. Futures margin is paid and received through daily mark-to-market.

The Financial Stability Board (FSB) divides leverage into two types. Financial leverage comes from raising funds through borrowing such as loans and repo transactions, and synthetic leverage uses derivatives to create positions linked to the price of an underlying asset6. A repo transaction exchanges cash and securities such as government bonds for a set period7. OTC derivatives and repo transactions are ways to build large positions with little cash on hand. Hedge funds and others rapidly increased their use of them in the run-up to the late 2000s8.

The size of leverage is expressed as a multiple, calculated by dividing positions by net assets. Gross leverage is gross positions, excluding cash and similar assets, divided by net assets. The FSA's fund monitoring survey (second round, December 2025) calculates this value9. Gross multiples do not reflect offsetting or hedging positions, so they can make the actual risk look larger than it is10. Some trades combine long and short positions, such as those in the "Trading on price gaps (arbitrage)" and "Hedging a stock portfolio against price falls" sections. In these trades, the gain or loss from the direction of the market can be small even when the multiple is high.

Trading on price gaps (arbitrage)

In a trade on the price gap between two instruments that move alike, you buy the cheaper one and sell the more expensive one. You make a profit if the gap narrows and a loss if it widens. Consider a hypothetical example in which a fund buys a government bond with a face value of 10 billion yen at a price of 100.00 yen (per 100 yen of face value). At the same time, it sells the same amount of JGB futures, which move closely with this bond, at 100.50 yen. Assume the futures and bond prices are equal at the futures' expiry. The detailed delivery terms of the futures, interest, funding costs and fees are ignored. With a face value of 10 billion yen, a price move of 1.00 yen produces a gain or loss of 100 million yen.

Case Gain or loss on the bond (million yen) Gain or loss on the futures (million yen) Total (million yen)
Both at 101.00 yen at the futures' expiry 100 −50 50
Both at 99.00 yen at the futures' expiry −100 150 50
Bond at 99.50 yen and futures at 101.00 yen partway through, when the fund closes out −50 −50 −100

Under the assumptions of this example, holding the positions to the futures' expiry gives a profit of 50 million yen whether the bond price rises or falls. This equals the initial gap of 0.50 yen. On the other hand, if the gap widens to 1.50 yen partway through and the fund closes out at that point, it loses 100 million yen. In this example, suppose the fund paid for the bond with 500 million yen of its own capital and borrowed the rest. The 50 million yen profit from holding to the futures' expiry is 10% of its own capital, and the 100 million yen loss from closing out partway through is 20%.

Some financial firms use leverage for trading strategies that take advantage of price gaps in highly liquid markets, such as government bond markets11. Arbitrage appears to be growing in the Japanese government bond market as well, led by overseas hedge funds. These trades focus on the gap between cash bonds and futures, the gap between yen interest rate swap rates and government bond yields, and gaps between maturities and issues. In these trades, government bond purchases and sales are combined with repo transactions and yen interest rate swaps12.

Hedging a stock portfolio against price falls

Hedge funds also hedge by selling equity index futures to protect stocks they hold against price falls. Consider a hypothetical example in which a fund holds 1 billion yen of stocks that it expects to perform better than the index, and sells 50 futures contracts when the index is at 20,000. The size of the 50 contracts is 20,000 times 1,000 times 50, or 1 billion yen, the same as the stocks. Fees are ignored.

Case Gain or loss on the stocks (million yen) Gain or loss on the futures (million yen) Total (million yen)
Index down 10%, stocks down 8% −80 100 20
Index up 10%, stocks up 8% 80 −100 −20
Index down 10%, stocks down 12% −120 100 −20

If the index falls 10% but the stocks fall only 8%, the 100 million yen profit on the futures exceeds the 80 million yen loss on the stocks, giving a profit of 20 million yen. If the index rises 10% and the stocks rise only 8%, the loss on the futures exceeds the gain on the stocks, giving a loss of 20 million yen. The fund also loses if the stocks fall more than the index. When futures offset the rises and falls of the overall market, the result is determined by the difference between the stocks' price moves and the index's.

Equity market neutral, shown in the table in the "Scope of hedge funds and their main strategies" section, uses futures and options to protect against a fall in the overall market, as in this example. At the same time, it aims to outperform the index4.

Paying margin and how funding providers manage credit

When a leveraged position loses money, a fund may sell assets to pay margin.

Consider a hypothetical example in which Fund B in the "Leverage and the size of positions" section had bought 2.2 billion yen of futures. If the market falls 10%, the futures lose 220 million yen. Fund B has 200 million yen of cash on hand, but part of it has been posted as futures margin. The cash left after the posted margin is not enough, so Fund B has to sell stocks to raise the shortfall. Some derivatives require variation margin to be exchanged every day as their market value changes. With these, a large adverse market move can suddenly require a large amount of cash relative to the fund's liquid assets13.

Leveraged positions spread stress through the following two channels14.

Channel Description
Position liquidation When the market moves against a fund and it is asked for collateral or margin, it unwinds positions and sells assets. The sales push prices down further and spread to other participants holding the same assets
Counterparty If a participant fails because it cannot pay margin or loses its capital, its counterparties suffer direct losses. Even without a failure, funding strains arise if funding is withdrawn

The US Treasury market in March 2020 is an example of these dynamics. Volatility in the Treasury market rose, and margins on Treasury futures and interest rates on repo transactions went up. The FSB says that participants trading on the gap between cash Treasuries and futures closed out part of their positions, which may have amplified market instability15. How to prepare cash for margin is covered in Funding Variation and Initial Margin.

Those who provide funding to hedge funds also guard against losses from their counterparties. According to the FSB, banks and broker-dealers provide funding to leveraged nonbanks through loans, securities lending, repo transactions, and derivatives. Nonbanks are financial institutions that are none of the following: deposit-taking institutions such as banks, central banks, or public financial institutions16. Broker-dealers are firms that pass on investors' buy and sell orders and also trade with their own money17. When funding providers, such as the financial institutions known as prime brokers, receive disclosure of positions from their clients, they can estimate the clients' potential losses under stress. Based on that estimate, they can adjust the margin they require and their trading limits18. In its July 2025 report, the FSB recommends that authorities review whether these disclosure practices are adequate19.

Initial margin covers counterparties' potential future exposure (the amount a counterparty could lose)20.

How authorities view the market impact

Authorities in the United States and Japan collect information on the positions and borrowing of funds, including hedge funds. In the United States, advisers whose private fund assets under management total at least a set amount file Form PF with the SEC. For hedge funds, they also report information such as borrowing and counterparties21. In Japan, the FSA has conducted a fund monitoring survey since 2024, partly in response to requests from the International Organization of Securities Commissions (IOSCO) and others. The survey covers domestic funds with net assets of 50 billion yen or more and looks at their derivatives transactions and borrowing22.

In July 2025, the FSB set out recommendations to its member authorities on addressing the risks created by leverage at nonbanks. The scope includes hedge funds, other leveraged investment funds, pension funds, and insurers. Where relevant, banks and broker-dealers are also in scope in their role as funding providers23. The recommendations ask authorities to implement, in a timely and thorough way, the Basel Committee on Banking Supervision (BCBS) guidelines on counterparty credit risk management for banks that provide funding. At the same time, the FSB recognizes that leveraged trading by nonbanks can also support hedging, market efficiency and liquidity19.

In its April 2026 Financial System Report, the Bank of Japan analyzes the activity of hedge funds operating in the United States. Hedge funds operating in the United States have expanded both long and short positions in major countries' government bonds. They have raised their leverage through bank borrowing, repo transactions, interest rate swaps, and other means. The report says their counterparties in US bank borrowing and repo transactions are often large US and European banks. The risk that stress could spread between large hedge funds and banks has also been pointed out24.

In the Japanese government bond market, more arbitrage by overseas investors can help price discovery, for example by absorbing shocks. Price discovery is the process by which buy and sell orders from many participants set a price that reflects supply and demand25. At the same time, because this trading includes highly leveraged positions, shocks in overseas markets may now affect Japanese markets more easily. One example is when internal risk management limits or margin calls trigger the closing out of positions, and the effect reaches Japanese markets12.

Notes

  1. U.S. Securities and Exchange Commission, "Form PF" (reference copy, SEC 2048 (4-25)), Glossary of Terms, "Hedge fund," pages 88–89 (pages 89–90 of the PDF). ↩ ↩2

  2. The same document, Glossary of Terms, "Private fund," page 96 (page 97 of the PDF). ↩

  3. Financial Services Agency, "ファンドモニタリング調査の集計結果について" (Results of the fund monitoring survey) (in Japanese), October 2015, "ヘッジファンド" (Hedge fund) under "（参考）用語の定義" (Definitions of terms), page 20 (page 21 of the PDF). ↩

  4. Financial Services Agency, "ファンドモニタリング調査の集計結果について" (in Japanese), October 2015, "ヘッジファンドの投資戦略に係る用語の定義" (Definitions of hedge fund strategies) and the note at its end, page 21 (page 22 of the PDF). ↩ ↩2

  5. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2026, "Ⅴ．2．グローバルにみた金融安定性" (Financial stability from a global perspective), footnote 27 on page 59 (page 64 of the PDF). English version: "Financial System Report (April 2026)," "B. Global financial stability," footnote 28 on page 62 (page 67 of the PDF). ↩

  6. Financial Stability Board, "Leverage in Nonbank Financial Intermediation: Final report," July 9, 2025, section 2.1, page 4 (page 8 of the PDF). ↩

  7. Bank of Japan Financial Markets Department, "本邦レポ市場のトレンドと近年の特徴点" (Trends and recent features of Japan's repo market) (Bank of Japan Review 2025-J-7) (in Japanese), August 2025, "はじめに" (Introduction) on page 1. ↩

  8. Bank of Japan Financial Markets Department and Financial Services Agency Strategy Development and Management Bureau, "店頭デリバティブ取引データ等の整備と活用" (Developing and using data on OTC derivatives transactions) (Bank of Japan Review 2021-J-6) (in Japanese), June 2021, main text on page 1. ↩

  9. Financial Services Agency, "ファンドモニタリング調査（第２回）結果概要" (Summary of the results of the fund monitoring survey, second round) (in Japanese), December 2025, "(4) レバレッジの状況" (Leverage) and footnote 14, page 15 (page 17 of the PDF). ↩

  10. Financial Stability Board, "Leverage in Nonbank Financial Intermediation: Final report," July 9, 2025, Annex 2, "Leverage metrics," and footnote 31, page 34 (page 38 of the PDF). ↩

  11. The same document, section 2.1, page 4 (page 8 of the PDF). ↩

  12. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2026, "Ⅴ．2．グローバルにみた金融安定性" (Financial stability from a global perspective), main text on page 59 (page 64 of the PDF). English version: "Financial System Report (April 2026)," "B. Global financial stability," main text on page 62 (page 67 of the PDF). ↩ ↩2

  13. Financial Stability Board, "Leverage in Nonbank Financial Intermediation: Final report," July 9, 2025, section 2.2, page 6 (page 10 of the PDF). ↩

  14. The same document, section 2.1, page 5 (page 9 of the PDF). ↩

  15. The same document, "March 2020, the ‘dash for cash’" (section 2.2, page 6; page 10 of the PDF). ↩

  16. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2024, "Ⅲ．2．ノンバンク部門の金融仲介活動" (Financial intermediation by the nonbank sector), footnote 12 on page 21 (page 26 of the PDF). ↩

  17. Japan Financial Literacy and Education Corporation (J-FLEC), "証券会社ってどんな会社？" (What is a securities company?, in Japanese; Kinyu Keizai Navi), "証券会社の4大業務" (The four main businesses of a securities company). ↩

  18. Financial Stability Board, "Leverage in Nonbank Financial Intermediation: Final report," July 9, 2025, section 2.1, page 5 (page 9 of the PDF) and section 3.1.2, pages 10–11 (pages 14–15 of the PDF). ↩

  19. The same document, Executive summary, page 2 (page 6 of the PDF). ↩ ↩2

  20. The same document, Annex 2, "Initial margins ratio," page 35 (page 39 of the PDF). ↩

  21. U.S. Securities and Exchange Commission, "Form PF" (reference copy, SEC 2048 (4-25)), General Instructions 1 and 3, pages 1–2 (pages 2–3 of the PDF), and Section 1c, Questions 26–28, pages 28–30 (pages 29–31 of the PDF). ↩

  22. Financial Services Agency, "ファンドモニタリング調査（第２回）結果概要" (in Japanese), December 2025, "1．はじめに" (Introduction), items (1) to (3), page 1 (page 3 of the PDF). ↩

  23. Financial Stability Board, "Leverage in Nonbank Financial Intermediation: Final report," July 9, 2025, Executive summary, page 1 (page 5 of the PDF). ↩

  24. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2026, "Ⅴ．2．グローバルにみた金融安定性" (Financial stability from a global perspective), main text on page 56 (page 61 of the PDF). English version: "Financial System Report (April 2026)," "B. Global financial stability," "Global investment activities of the NBFI sector with a focus on hedge funds," page 58 (page 63 of the PDF). ↩

  25. Japan Commodity Futures Industry Association, "商品先物取引の機能" (Functions of commodity futures trading) (in Japanese), the section "価格発見機能とは・・・" (What is the price discovery function?). ↩