Stress testing private equity and private credit : UK FCA’s SWES Initiative

Stress testing private equity and private credit : UK FCA’s SWES Initiative

Stress testing private equity and private credit is now essential because these markets have grown into a multi‑trillion‑dollar, highly leveraged and opaque ecosystem whose resilience has never been tested at today’s scale, yet which finances a significant share of the real economy and is tightly interconnected with banks and other non‑banks. For supervisors, CROs and institutional investors, the core question is whether this ecosystem would act as a shock absorber or an amplifier during a severe but plausible downturn, and stress testing provides the only systematic way to interrogate that question before a crisis hits.

Macro context: private markets as a systemic engine

Over the past decade, assets under management in private market funds have risen to roughly 16 trillion dollars globally, with private equity and private credit expanding from around 3 trillion to about 11 trillion dollars. In the UK, PE‑sponsored corporates now account for up to 15% of total corporate debt and 10% of private‑sector employment, with over 80% of their debt funded via private credit, leveraged loans and high‑yield bonds rather than traditional bank lending.

Private markets are also projected to become the most profitable engine of global asset management, with industry revenues expected to reach over 430 billion dollars and deliver more than half of total asset‑management revenues by 2030, reinforcing their structural importance. This rapid growth has occurred within the broader non‑bank financial intermediation (NBFI) sector, whose “narrow” credit‑intermediation segment has risen to more than 76 trillion dollars and now displays significant leverage, maturity and liquidity transformation.

From a macroprudential perspective, this expansion matters because it shifts credit creation and risk‑taking away from regulated banks into entities and vehicles where data, valuation and risk‑management practices are far less transparent to authorities. As private markets increasingly finance leveraged buyouts, infrastructure and non‑investment‑grade corporates, their behaviour under stress will shape outcomes for employment, investment and ultimately real‑economy resilience.

Why stress testing private equity

Authorities have underscored that private markets “have not yet been tested through a broad‑based macroeconomic stress at their current size”, leaving a wide uncertainty band around how valuations, exits and refinancing dynamics would play out in a deep downturn. Recent years have already brought warning signs: slower exits, elongated holding periods, higher funding costs and rising use of NAV‑based financing and continuation vehicles suggest pressure points that could become acute if growth falters or rates spike again.

PE‑sponsored corporates and their lenders sit at the heart of several potential transmission channels to the wider system. First, highly leveraged capital structures financed via covenant‑lite leveraged loans and high‑yield bonds create sensitivity to earnings and refinancing shocks, with losses transmitted to banks, CLOs and credit funds that hold this paper. Second, the expanding private credit market—now estimated at around 3.5 trillion dollars in size—has become a major provider of senior and unitranche financing, often with limited secondary market liquidity and bespoke terms that complicate valuation and risk transfer in stress.aima+1

Third, leverage at the fund level through subscription lines, NAV facilities and derivatives can accelerate margin calls and forced de‑risking when portfolio valuations decline, potentially triggering cross‑asset fire‑sales in public credit and equity markets. Finally, investor behaviour under stress—such as increased demand for distributions, secondary‑market sales of fund interests, or withdrawals from multi‑asset vehicles—could interact with these structures to create pro‑cyclical liquidity spirals that echo past NBFI episodes.fsb+2

Regulatory initiatives and the UK private‑markets SWES

The Bank of England’s decision to launch a private‑markets System‑Wide Exploratory Scenario (SWES) marks an important initiative in supervisory engagement with private equity and private credit. The exercise focuses on how a severe global downturn would affect PE‑sponsored UK corporates and their financing chains—spanning private credit funds, leveraged‑loan syndicates and high‑yield bond markets—and how the collective reactions of banks and NBFIs might amplify or dampen stress.

A central objective of the SWES is to close “critical data gaps” in the private‑markets ecosystem by requiring a wide set of participants to submit consistent, granular data on exposures, funding, collateral and risk‑management actions. The Bank explicitly aims to understand system‑wide dynamics, examining how actions such as tightening covenants, cutting credit lines, exercising margin rights or selling assets could interact across institutions to threaten UK financial stability and the flow of finance to the real economy.

Methodologically, the SWES differs from traditional solvency‑focused stress tests by using a two‑round behavioral design: firms first report how they would respond to a given scenario, then revise their responses after seeing anonymized system‑wide results, thereby revealing feedback loops and coordination failures. This approach reflects a view that the largest risks in private markets are less about individual firm insolvency and more about correlated behaviors—simultaneous tightening of financing, crowded exits or common risk‑model responses—that can magnify shocks.

Designing stress tests for PE and private credit portfolios

For regulators and risk managers, stress testing private equity exposures starts with a robust bottom‑up view of portfolio‑company resilience. Key elements include

Step1

modelling revenue and EBITDA shocks consistent with macro scenarios; applying higher interest costs, tighter credit conditions and shortened refinancing windows; and tracking resulting leverage and interest‑coverage ratios at obligor level.

Step 2

These projections then feed into estimates of default probabilities, loss‑given‑default and time‑to‑distress, which can be aggregated by sector, geography and vintage

Step 3

Valuation risk must also be explicitly modelled. Because PE valuations are typically infrequent and model‑based, stress tests should apply conservative valuation haircuts, widen discount‑rate assumptions and extend exit timelines to reflect illiquidity and weaker sponsor exit options in stressed markets. For private credit portfolios, tests should incorporate spread widening, mark‑to‑market impacts on funds using fair‑value accounting, and the risk that secondary‑market bid‑ask spreads blow out, limiting the ability to sell assets without significant price concessions.

Step 4

At fund and system level, effective scenarios must capture behavioural and second‑round effects. These include:

Drawdowns and repayments on subscription lines and NAV facilities, and the associated collateral and covenant triggers.
Investor liquidity demands on semi‑liquid vehicles, multi‑asset funds or separately managed accounts with private‑markets sleeves.
Margin calls on hedges, repo, or derivatives used to manage rate, FX or credit risk, and the cross‑portfolio asset sales they can force.finreg.aoshearman+1

Supervisors and firms can combine bottom‑up credit modelling with top‑down macro shocks to explore multiple credible paths—for example, a sharp but brief recession with rate cuts versus a stagflationary shock with elevated rates—testing how each interacts with the embedded leverage and liquidity profile of PE and private credit strategies.

Supervisory and risk‑management implications

Incorporating PE and private credit into supervisory stress tests allows authorities to assess how losses and liquidity stresses in these markets could feed back into banks’ capital positions, funding conditions and broader market functioning. Output from exercises like the SWES can guide targeted supervisory reviews of banks’ counterparty credit risk management for leveraged funds, collateral policies for subscription lines and NAV facilities, and risk‑transfer chains involving CLOs and structured credit.

For insurers and pension funds, PE stress testing should be embedded into ORSA/ RCSA and long‑term strategic asset‑allocation processes, assessing whether liquidity buffers, rebalancing rules and benefit‑payment commitments remain robust under adverse scenarios.

At the institutional‑investor level, better stress testing can support more informed risk budgeting across public and private assets, helping investment committees avoid over‑allocations to illiquid, leveraged exposures whose downside behaviour is poorly understood.

At the global policy level, the Financial Stability Board’s work on leverage in NBFI emphasises the need to strengthen risk identification, address data challenges and apply the principle of “same risk, same regulatory treatment” where leveraged non‑banks create bank‑like vulnerabilities.

Results from PE stress tests can inform calibration of margining practices, leverage constraints, disclosure requirements and expectations around counterparty risk management, while also highlighting where regulators may need new powers or reporting tools to oversee private markets effectively.

Private equity stress channels, scenarios, assumptions and consequences

Stress channel	Likely stress scenario	Illustrative stress assumptions	Consequences for PE vehicles/SPVs and market interlinkages
Portfolio company earnings and leverage	Sharp global downturn with sector‑specific demand shock (e.g., consumer, cyclicals, real estate).	Revenue and EBITDA down 20–40%; interest costs +300–500 bps; refinancing spreads +200–400 bps; covenant breaches for 25–50% of highly leveraged deals; default rates for weakest credits doubling vs baseline.	PE SPVs breach financial covenants, triggering resets, equity cures or restructurings; loss‑given‑default rises on sponsor‑backed loans.fsb+1 Banks, CLOs and private credit funds holding this debt take mark‑to‑market losses and higher provisions; cross‑holdings spread losses across multiple lenders and credit funds.
Refinancing and maturity wall	Rates stay higher for longer; primary leveraged loan and HY markets partially closed; banks and private credit tighten lending standards.	30–50% of upcoming maturities forced into amend‑and‑extend at higher coupons; 20–30% EV haircuts; exit timelines extended by 2–3 years; higher equity cure requirements from sponsors.	Fund‑level IRRs and DPI weaken as exits are delayed; more capital is trapped inside SPVs, increasing dependence on sponsor support and follow‑on funding.mckinsey Concentrated lender groups face correlated downgrades and higher RWA; insurers and pensions exposed via loan funds and HY bonds see capital strain and may rebalance away from risky credit.
NAV financing and fund‑level leverage	Correlated fall in portfolio valuations plus slower exits, triggering NAV‑loan covenants and LTV tests.	NAV down 25–35% in 12–18 months; LTV triggers breached on 30% of NAV facilities; margin calls of 10–20% of balances; forced repayment via asset sales or LP capital.	Fund SPVs posting diversified collateral must sell stronger assets first, degrading average collateral quality and raising effective leverage on remaining positions.fundcount+1 Bank and private‑credit lenders to NAV structures face simultaneous margin disputes and collateral sales; stress is transmitted back to bank balance sheets and credit funds providing NAV finance.
Margin and collateral calls on derivatives and margin/NAV loans	Spike in credit spreads and rate volatility, driving large variation margin calls and tighter collateral haircuts.	IG spreads +150 bps, HY +400 bps; daily margin calls equal 5–10% of liquid assets; collateral haircuts +5–15%; 20–30% of leveraged funds must post additional collateral within 5 days.	PE funds and co‑investment SPVs sell liquid hedges and listed holdings to meet calls, leaving exposures more naked to subsequent shocks.isda+1 Banks and prime brokers de‑risk by cutting lines or liquidating pledged collateral, transmitting price pressure into public markets and feeding back into other leveraged investors using the same assets.
Investor liquidity and secondary‑market pressures	LPs over‑allocated to illiquid assets (“denominator effect”) plus fundraising slump; heavy reliance on secondaries and GP‑led deals	10–20% of LPs seek early liquidity; secondary prices at 70–80% of NAV; distribution pace falls 40–60%; new commitments down 30–50%.	Funds increasingly use continuation vehicles and strip sales to generate liquidity, adding structural complexity and layering of fees and leverage across SPVs.euromoney+1 Secondary buyers (often other PE or private‑credit funds, insurers and pensions) become concentrated holders of stressed vintages, increasing interconnectedness and potential for common‑owner fire‑sales later.
Fire‑sale dynamics in credit and equity markets	Multiple leveraged players de‑risk simultaneously in response to spread widening and margin calls, selling loans, bonds and liquid hedges.	Bid–ask spreads in leveraged loans and HY double; market depth halves; price impact of large trades doubles; 10–20% of positions in crowded names sold over a quarter, adding a 5–10% overshoot vs fundamentals.	PE credit SPVs taking mark‑to‑market losses breach internal or external risk limits, forcing further sales and embedding pro‑cyclical de‑risking rules into vehicles.fsb+1 Banks, insurers, hedge funds and OEFs that hold the same credits experience correlated losses and potential outflows, propagating stress across the broader NBFI–bank nexus.
Data gaps and opacity in leverage stack	Authorities and creditors have incomplete view of asset‑level, fund‑level and synthetic leverage, delaying recognition of vulnerabilities.	Reported leverage 20–30% below actual; quarterly NAV and covenant reporting lags; stress‑testing requires ±10–15 percentage‑point bands around base loss estimates to capture model uncertainty.	Undetected build‑up of leverage and liquidity mismatches in PE vehicles and finance SPVs leads to sudden, “surprise” downgrades or failures once information surfaces.rba+1 Lack of transparency impairs banks’ and institutional investors’ ability to price risk, causing abrupt pulls in funding or margin terms that can convert a contained problem into a system‑wide shock.

Forward‑looking agenda for private‑markets stress testing

Looking ahead, stress testing of private equity and private credit will need to evolve beyond purely macro‑cyclical downturns to include structural and non‑linear shocks. Climate‑transition scenarios, for instance, could test how sudden changes in carbon pricing, regulation or technology adoption affect PE‑backed sectors such as energy, transport and heavy industry over longer horizons. Geopolitical shocks and fragmentation—through sanctions, trade barriers or supply‑chain disruption—pose further risks for cross‑border portfolio companies and for the global syndication of leveraged finance.

Finally, effective oversight will require much closer cross‑border cooperation, since PE funds, portfolio companies and leverage providers often operate under different regulatory regimes while being tightly interconnected through financing chains. Harmonised data standards, coordinated implementation of the FSB’s recommendations on NBFI leverage and regular system‑wide stress exercises in major jurisdictions would help ensure that private markets continue to support innovation and growth without becoming a latent amplifier of the next systemic shock.

Some Relevant FCA Documents for Further Reading

FCA Board Minutes – 19 December 2024 (PDF) – records Board discussion of PRA business “of relevance to the FCA, including further details on a system‑wide exploratory scenario (SWES) exercise exploring how the UK financial system would respond to stress.”fca
Regulatory Initiatives Grid – Interim update (October 2024) – lists the system‑wide exploratory scenario among cross‑regulator initiatives, describing objectives to assess solvency and liquidity resilience and management actions under a market‑wide adverse scenario; the Grid is jointly produced by HMT, BoE, PRA, FCA and other bodies.fca

Bank of England material highlighting FCA involvement

BoE news release: “Bank of England launches system‑wide exploratory scenario exercise focused on private markets” (3 December 2025) – states that the exercise is conducted under the guidance of the FPC and PRC “working closely with and with full support of the Prudential Regulation Authority (PRA), Financial Conduct Authority (FCA) and The Pensions Regulator (TPR).”bankofengland
BoE SWES landing page for private markets – explains the design of the private‑markets SWES and again notes that the Bank is collaborating closely with the FCA and other regulators in running the exercise.bankofengland
Speech: “The SWES: using system‑wide scenario analysis to spot vulnerabilities” by Lee Foulger (BoE, 1 December 2024) – describes lessons from the first SWES and explicitly thanks “regulatory colleagues at the FCA and tPR” for their involvement and signals that, alongside the FCA, the Bank will continue to invest in system‑wide scenario work.bankofengland

Some Links

Terms Used : Brief Definitions

Private equity (PE)
Private equity is equity investment in non‑listed companies (or public companies taken private) via closed‑end funds that acquire controlling or significant minority stakes, aiming to create value and exit at a higher valuation (e.g., sale, IPO, secondary buyout). PE returns come mainly from capital gains on exit and, to a lesser extent, dividends and fees; investors are residual claimants and bear first‑loss risk after debt.

Private credit (PC) / private debt
Private credit is non‑bank, non‑public lending, where funds and other institutional investors provide bespoke loans directly to companies rather than via syndicated bank loans or public bonds. It spans senior secured, unitranche, mezzanine, subordinated and other negotiated structures; returns are primarily contractual (interest, fees, prepayment penalties), and investors rank ahead of equity in the capital structure.

Direct lending
Direct lending is a form of private credit in which a fund originates bilateral (or club) loans to mid‑market or sponsor‑backed borrowers, typically senior secured or unitranche, held to maturity rather than traded. It emphasises covenant packages, security and ongoing monitoring instead of active operational control.

Unitranche loan
A unitranche loan blends senior and subordinated debt into a single facility with one blended coupon and a single set of documents. Economically it sits between traditional senior and mezzanine debt, simplifying capital structures for borrowers while giving lenders higher spread for higher risk.

Mezzanine debt
Mezzanine is subordinated, higher‑yielding debt (often with PIK features or attached warrants) that sits below senior debt but above pure equity. It is used to finance leveraged buyouts, growth or recapitalisations when sponsors want to minimise equity dilution but traditional bank leverage is capped.

NAV financing / NAV loans
Net‑asset‑value (NAV) financing is fund‑level borrowing secured against the diversified portfolio of investments held by a PE or secondary fund. The lender underwrites the value and diversification of the underlying assets, not a single company, and margining/LTV covenants are tied to portfolio NAV rather than to one borrower.

Subscription line facility (capital call facility)
A subscription line is a short‑term revolving credit facility to a PE or PC fund, secured on investors’ uncalled capital commitments. It allows the GP to bridge capital calls, manage deal timing and smooth distributions, but it also introduces fund‑level leverage and timing risk around LP calls.

Continuation fund / GP‑led secondary
A continuation fund is a new vehicle formed to acquire one or more assets from an existing PE fund when the original fund reaches the end of its term but the GP wants more time or capital to realise value. Existing LPs can roll or sell; new LPs often provide fresh capital, creating an additional layer of fees, leverage and governance complexity.

Secondaries (secondary private equity)
Secondaries refer to purchases and sales of existing fund interests or portfolios of PE/PC assets, rather than new primary commitments. They provide liquidity to LPs and price discovery for otherwise illiquid positions, but discounts to NAV can widen sharply in stressed markets.

Leveraged buyout (LBO)
An LBO is the acquisition of a company where a significant portion of the purchase price is financed with debt secured on the target’s assets and cash flows. PE sponsors contribute equity and use leverage to amplify equity returns, making earnings resilience, interest‑coverage and refinancing risk central to stress‑testing.

Private markets / private assets
Private markets is an umbrella term for investments negotiated off‑exchange, including private equity, venture capital, private credit, infrastructure equity, real estate equity, and some forms of infrastructure/real‑estate debt. They are characterised by illiquidity, long holding periods, and reliance on appraisal‑based valuations rather than continuous market prices.

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