CNBC - Elliot Smith - DEC 15, 2022
A number of pension funds were hours from collapse when the central bank intervened in the long-dated bond market.
The Bank emphasized the need for regulators across jurisdictions to strengthen the resilience of the sector, saying that “there is a need for urgent international action to reduce risks in non-bank finance.”
A number of pension funds were hours from collapse when the central bank intervened in the long-dated bond market. It came after a series of massive moves in interest rates on U.K. government debt exposed vulnerabilities in liability-driven investment (LDI) funds, which are held by U.K. pension schemes.
LDIs — commonly used in final salary pension plans and other fixed-income schemes — look to cover current and future liabilities by acquiring assets and generating returns. Most are highly leveraged and often use long-dated U.K. government bonds, known as “gilts,” as collateral to raise cash.
At the time of September’s bond price crash on the back of former Prime Minister Liz Truss’ disastrous “mini-budget,” long-dated bonds comprised around two-thirds of Britain’s roughly £1.5 trillion ($1.86 trillion) in LDI funds.
LDIs were forced to sell gilts, which in turn pushed down prices. This sent the value of their assets below that of their liabilities, meaning the pension funds holding them risked falling into insolvency.
In its latest financial stability report published Tuesday, the Bank said had it not acted, “the stress would have significantly affected households’ and businesses’ ability to access credit.”
Its temporary emergency bond-buying program allowed LDI funds time to shore up their liquidity positions and ensure the country’s financial stability.
The Bank emphasized the need for regulators across jurisdictions to strengthen the resilience of the sector, saying “there is a need for urgent international action to reduce risks in non-bank finance.”
The central bank said it will begin an “exploratory scenario exercise” focused on non-bank financial institutions in order to better understand and mitigate the associated risks.
“The resilience of this sector needs to be improved in a number of ways to make it more robust,” the Bank concluded.
“This includes the need for regulatory action to ensure LDI funds keep their higher levels of resilience. Some steps have already been taken, and further work will be done next year.”