In a previous Insight, we looked at the Bank of England’s second System-Wide Exploratory Scenario (SWES) which focuses on private equity and private credit markets. The BoE has now published the details of the stress scenario that participating firms will be asked to model.
The BoE is not trying to identify which private equity manager, private credit fund, bank, insurer or pension investor is most vulnerable under a pass/fail test. Instead, it looks at the entire system and how different firms might behave in a severe downturn, how those behaviours might interact, and whether those interactions could make financial stress worse.
The scenario covers a five-year period and is based on a global supply and geopolitical shock, looking at what happens if the world is hit by a major disruption to trade, supply chains and energy markets at the same time as financial markets become more jittery.
In the scenario, geopolitical tensions intensify, global trade becomes more fragmented, there are shortages of key technology hardware components, and energy prices rise sharply. This creates a difficult mix for advanced economies which are confronted with lower output, higher inflation and rising interest rates. Financial conditions tighten, borrowing costs increase, and companies face weaker revenues at the same time as their debt becomes more expensive to service.
For the UK, the assumptions are that GDP falls, unemployment rises, inflation reaches around 7%, and Bank Rate peaks at 7%. Equity markets also fall sharply, with the FTSE All-Share assumed to decline by around 30% in the first year of the scenario, while the S&P 500 falls by around 35%. Credit spreads widen materially, and activity in leveraged loan and high-yield bond markets becomes very subdued.
As private equity-backed companies are often more leveraged than other businesses, a combination of weaker earnings, higher interest costs and limited refinancing options can cause financial stresses to build quickly. The Bank’s scenario assumes stress is particularly acute for businesses in technology, consumer discretionary, industrials, real estate and financial services. Energy and utilities fare better because of the assumed increase in energy prices.
The technology sector is a focus, and the Bank assumes that software and hardware companies are hit by weaker demand, disrupted supply chains and increased uncertainty about the impact of artificial intelligence. Companies judged to have weaker competitive advantages are assumed to suffer more severe valuation pressure. This reflects a wider question of not simply whether AI creates value, but which companies will capture that value, and which will be disrupted by it.
The scenario also highlights several structural issues of concern to regulators, including valuation. As private assets are not priced daily in the same way as listed shares or bonds, this can make reported returns look smoother during normal conditions. While smooth returns are helpful for long-term investors, it can also delay recognition of stress. In a downturn, different parties will likely have different views of what an asset is worth. This is important as lenders, investors, sponsors and fund managers will all rely on valuations to make decisions.
Another issue is liquidity as many private market funds are long-term and closed-ended. However, not all structures are equally illiquid and while some listed private investment vehicles may reprice quickly, other semi-liquid funds may face redemption requests from investors. The Bank’s scenario assumes that some redemption requests exceed the limits offered by funds. It also assumes that fundraising becomes more difficult, with some managers postponing new fund launches.
Debt refinancing is another key area. The scenario assumes that companies with near-term debt maturities, particularly in the hardest-hit sectors, begin to show signs of stress. If public credit markets are largely shut or prohibitively expensive, borrowers may have fewer options. Private credit may help absorb some of that pressure, but it could also transmit stress if lenders become more cautious at the same time.
This is central to the Bank’s purpose of trying to understand not just whether private markets suffer losses, but whether the behaviour of participants amplifies those losses. For example, do banks reduce lending to protect capital? Do investors try to cut exposure at the same time? Do valuations fall sharply because everyone is using similar assumptions? Do lenders extend and amend loans, or do they force restructurings? And does the response of private markets affect the availability of finance to the real economy?
The exercise will take place in two rounds. In the first round, firms model the impact of the scenario on their portfolios and explain how they would respond. The Bank then aggregates the responses and feeds them back to participants. Firms can then update their responses in a second round. This process is designed to capture feedback loops and amplification effects, which might be difficult to see when each institution only looks at its own balance sheet.
For some of our clients, the immediate impact may feel indirect (i.e. local authority clients will continue to borrow from sources such as the PWLB). However, private markets are now a larger part of the wider financial system, influencing corporate financing conditions, investor behaviour, bank exposures and market confidence.
Private markets can provide useful long-term capital, diversify funding sources and offer flexibility that traditional markets may not always provide, and their growth means they are no longer a niche area of finance. Because of this, the Bank’s latest SWES illustrates the need for transparency, strong governance, sensible leverage and a clear understanding of how stresses in these markets might impact the overall financial system.
For any readers wanting to find out more about how our services can help them navigate private markets, please get in touch at info@arlingclose.com.
17/06/2026
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